Solution Manual For SM Business Law Today, Comprehensive, 13th Edition Roger LeRoy Miller Text & Cas by StudyGuide

Solution Manual For: SM Business Law Today, Comprehensive, 13th Edition Roger LeRoy Miller

Solution Manual For SM Business Law Today, Comprehensive, 13th Edition Roger LeRoy Miller Text & Cases 13e, 9780357634783; Chapter 01: Law and Legal Reasoning

Critical Thinking Questions in Features Managerial Strategy—Business Questions 1.

―When faced with a clearly erroneous precedent, my rule is simple,‖ writes Supreme Court Justice Clarence Thomas. ―We should not follow it.‖ How do these words offer a cautionary tale for managers relying on stare decisis to make business decisions? Solution Simply put, the doctrine of stare decisis applies in all instances, except when it does not. As noted in the text, a court is able to depart from precedent if it feels that legal, social, or technological changes have rendered the previous decision untenable. In this case, just because the United State Supreme Court believes, at present, that automobile salespeople are exempt from the overtime rules of the FLSA, there is a possibility that the Court could reverse itself in the future. In this context, managers need to be aware that (1) any decision they make based on a court decision is subject to change, and (2) if they believe that a previous business law-related court decision is flawed, they can challenge it in court.

Should Roberta consider paying her salespeople overtime even though it is not required by federal law? Why or why not? Solution Just because Roberta is legally able to avoid paying the salespeople at her new used car dealership overtime, should she? As with so many managerial decisions, the answer to this question involves the tricky determination of costs and benefits. On the one hand, Roberta‘s costs will be lower if she does not have to pay overtime to the salespeople. On the other hand, the

Solution Manual For: Chapter 01: Law and Legal Reasoning

salespeople may be more motivated if they feel they are being properly compensated for the extra hours they spend on the lot. The extra motivation will likely lead to additional sales, which very well may offset the overtime costs.

Chapter Review Practice and Review Suppose that the California legislature passes a law that severely restricts carbon dioxide emissions of automobiles in that state. A group of automobile manufacturers files a suit against the state of California to prevent enforcement of the law. The automakers claim that a federal law already sets fuel economy standards nationwide and that these standards are essentially the same as carbon dioxide emission standards. According to the automobile manufacturers, it is unfair to allow California to impose more stringent regulations than those set by the federal law. Using the information presented in the chapter, answer the following questions. 1.

Who are the parties (the plaintiffs and the defendant) in this lawsuit? Solution In this situation, the automobile manufacturers are the plaintiffs, and the state of California is the defendant.

Are the plaintiffs seeking a legal remedy or an equitable remedy? Why? Solution The plaintiffs are seeking an injunction, which is an equitable remedy, to prevent the state of California from enforcing its statute restricting carbon dioxide emissions.

What is the primary source of the law that is at issue here? Solution This case involves a law passed by the California legislature and a federal statute, thus the primary source of law is statutory law.

Read through the appendix that follows this chapter, and then answer the following question: Where would you look to find the relevant California and federal laws? Solution Federal statutes are found in the United States Code, and California statutes are published in the California Code. You would look in both of these sources to find the relevant state and federal statutes.

Practice and Review: Debate This 1.

Under the doctrine of stare decisis, courts are obligated to follow the precedents established in their jurisdictions unless there is a compelling reason not to. Should U.S. courts continue to adhere to this common law principle, given that our government now regulates so many areas by statute? Solution Both England and the U.S. legal systems were constructed on the common law system. The doctrine of stare decisis has always been a major part of this system—courts should follow

Solution Manual For: Chapter 01: Law and Legal Reasoning

precedents when they are clearly established, excepted when compelling reasons dictate otherwise. Even though more common law is being turned into statutory law, the doctrine of stare decisis is still valid. After all, statutes often must to be interpreted by courts. What better basis for judges to render their decisions than by basing them on precedents related to the subject at hand? In contrast, some students may argue that the doctrine of stare decisis is passé. There is certainly less common law governing, say, environmental law than there was 100 years ago. Given that federal and state governments increasingly are regulating more aspects of commercial transactions between merchants and consumers, perhaps the courts should simply stick to statutory language when disputes arise.

Issue Spotters 1.

The First Amendment to the U.S. Constitution provides protection for the free exercise of religion. A state legislature enacts a law that outlaws all religions that do not derive from the JudeoChristian tradition. Is this law valid within that state? Why or why not? Solution No. The U.S. Constitution is the supreme law of the land, and applies to all jurisdictions. A law in violation of the Constitution (in this question, the First Amendment to the Constitution) will be declared unconstitutional.

Apex Corporation learns that a federal administrative agency is considering a rule that will have a negative impact on the firm‘s ability to do business. Does the firm have any opportunity to express its opinion about the pending rule? Explain. Solution Yes. Administrative rulemaking starts with the publication of a notice of the rulemaking in the Federal Register. Among other details, this notice states where and when the proceedings, such as a public hearing, will be held. Proponents and opponents can offer their comments and concerns regarding the pending rule. After reviewing all the comments from the proceedings, the agency‘s decision makers consider what was presented and draft the final rule.

Business Scenarios and Case Problems 1.

Binding versus Persuasive Authority. A county court in Illinois is deciding a case involving an issue that has never been addressed before in that state‘s courts. The Iowa Supreme Court, however, recently decided a case involving a very similar fact pattern. Is the Illinois court obligated to follow the Iowa Supreme Court‘s decision on the issue? If the United States Supreme Court had decided a similar case, would that decision be binding on the Illinois court? Explain. (See The Common Law.) Solution A decision of a court is binding on all inferior courts. Because no state‘s court is inferior to any other state‘s court, no state‘s court is obligated to follow the decision of another state‘s court on an issue. The decision may be persuasive, however, depending on the nature of the case and the particular judge hearing it. A decision of the United States Supreme Court on an issue is binding, like the decision of any higher court, on all inferior courts. The United States Supreme Court is the nation‘s highest court, however, and thus, its decisions are binding on all courts, including state courts.

Solution Manual For: Chapter 01: Law and Legal Reasoning

Sources of Law. This chapter discussed a number of sources of American law. Which source of law takes priority in the following situations, and why? (See Sources of American Law.) 1. A federal statute conflicts with the U.S. Constitution. Solution 1. The U.S. Constitution—The U.S. Constitution is the supreme law of the land. A law in violation of the Constitution, no matter what its source, will be declared unconstitutional and will not be enforced. 2.

A federal statute conflicts with a state constitutional provision.

Solution 2. The federal statute—Under the U.S. Constitution, when there is a conflict between a federal law and a state law, the state law is rendered invalid. 3.

A state statute conflicts with the common law of that state.

Solution 3. The state statute—State statutes are enacted by state legislatures. Areas not covered by state statutory law are governed by state case law. 4.

A state constitutional amendment conflicts with the U.S. Constitution.

Solution 4. The U.S. Constitution—State constitutions are supreme within their respective borders unless they conflict with the U.S. Constitution, which is the supreme law of the land. 3.

Remedies. Arthur Rabe is suing Xavier Sanchez for breaching a contract in which Sanchez promised to sell Rabe a Van Gogh painting for $150,000. (See The Common Law.) 1. In this lawsuit, who is the plaintiff, and who is the defendant? Solution 1. In a suit by Arthur Rabe against Xavier Sanchez, Rabe is the plaintiff and Sanchez is the defendant. 2.

If Rabe wants Sanchez to perform the contract as promised, what remedy should Rabe seek?

Solution 2. Specific performance is the remedy that includes an order to a party to perform a contract as promised.

Suppose that Rabe wants to cancel the contract because Sanchez fraudulently misrepresented the painting as an original Van Gogh when in fact it is a copy. In this situation, what remedy should Rabe seek?

Solution 3. Rescission is a remedy that includes an order to cancel a contract.

Solution Manual For: Chapter 01: Law and Legal Reasoning

Will the remedy Rabe seeks in either situation be a remedy at law or a remedy in equity?

Solution 4. In both cases, these remedies are remedies in equity. 4.

Philosophy of Law. After World War II ended in 1945, an international tribunal of judges convened at Nuremberg, Germany. The judges convicted several Nazi war criminals of ―crimes against humanity.‖ Assuming that the Nazis who were convicted had not disobeyed any law of their country and had merely been following their government‘s (Hitler‘s) orders, what law had they violated? Explain. (See The Common Law.) Solution Crimes against humanity constituted, at the time of the Nuremberg trials, a new international crime, consisting of ―murder, extermination, enslavement, deportation, and other inhumane acts committed against any civilian population, before or during the war, or persecutions on political, racial or religious ground.‖ In response to the defendants‘ assertion that they had only been following orders, the Nuremberg judges explained in part that these were familiar crimes within domestic jurisdictions and that thus the accused must have known, when they committed their acts, that they would be considered criminal. In terms of a philosophy of law, it might be said that these criminals violated ―natural law.‖ The oldest and one of the most significant schools of jurisprudence is the natural law school. Those who adhere to the natural law school of thought believe that government and the legal system should reflect universal moral and ethical principles that are inherent in human nature. Because natural law is universal, it takes on a higher order than positive, or conventional, law. The natural law tradition presupposes that the legitimacy of conventional, or positive, law derives from natural law. Whenever it conflicts with natural law, conventional law loses its legitimacy. For example, a precept of natural law may be that murder is wrong, which is a value reflected by specific laws prohibiting murder. If a specific, written law requires murder, it conflicts with the natural law precept, in which case individuals should disobey the written law and obey the natural law.

Spotlight on AOL—Common Law. AOL, LLC, mistakenly made public the personal information of 650,000 of its members. The members filed a suit, alleging violations of California law. AOL asked the court to dismiss the suit on the basis of a ―forum-selection‖ clause in its member agreement that designates Virginia courts as the place where member disputes will be tried. Under a decision of the United States Supreme Court, a forum-selection clause is unenforceable ―if enforcement would contravene a strong public policy of the forum in which suit is brought.‖ California has declared in other cases that the AOL clause contravenes a strong public policy. If the court applies the doctrine of stare decisis, will it dismiss the suit? Explain. [Doe 1 v. AOL, LLC, 552 F.3d 1077 (9th Cir. 2009)] (See The Common Law.) Solution The doctrine of stare decisis is the process of deciding cases with reference to former decisions, or precedents. Under this doctrine, judges are obligated to follow the precedents established within their jurisdiction. In this problem, the enforceability of a forum selection clause is at issue. There are two precedents mentioned in the facts that the court can apply. The United States Supreme Court has held that a forum selection clause is unenforceable ―if enforcement would contravene a strong public policy

Solution Manual For: Chapter 01: Law and Legal Reasoning

of the forum in which suit is brought.‖ And California has declared in other cases that the AOL clause contravenes a strong public policy. If the court applies the doctrine of stare decisis, it will allow the suit to move forward. In the actual case on which this problem is based, the court determined that the clause is not enforceable under those precedents. 6.

Business Case Problem with Sample Answer— Reading Citations. Assume that you want to read the entire court opinion in the case of Friends of Buckingham v. State Air Pollution Control Board, 947 F.3d 68 (4th Cir. 2020). Refer to the appendix to this chapter, and then explain specifically where you would find the court‘s opinion. (See Finding Case Law.) —For a sample answer to Problem 1–6, go to Appendix E. Solution The court‘s opinion in the case Friends of Buckingham v. State Air Pollution Control Board can be found in volume 947 of the Federal Reporter, third series, on page 68. The Federal Reporter contains the decisions of all the United States Courts of Appeals, including, as is the case here, the Fourth Circuit Court of Appeals. Also, this case was decided (though not necessarily filed) in 2020.

A Question of Ethics—The Doctrine of Precedent. Sandra White operated a travel agency. To obtain lower airline fares for her nonmilitary clients, she booked military-rate travel by forwarding fake military identification cards to the airlines. The government charged White with identity theft, which requires the ―use‖ of another‘s identification. The trial court had two cases that represented precedents. In the first case, David Miller obtained a loan to buy land by representing that certain investors had approved the loan when, in fact, they had not. Miller‘s conviction for identity theft was overturned because he had merely said that the investors had done something when they had not. According to the court, this was not the ―use‖ of another‘s identification. In the second case, Kathy Medlock, an ambulance service operator, had transported patients for whom there was no medical necessity to do so. To obtain payment, Medlock had forged a physician‘s signature. The court concluded that this was ―use‖ of another person‘s identity. [United States v. White, 846 F.3d 170 (6th Cir. 2017)] (See Sources of American Law.) 1. Which precedent—the Miller case or the Medlock case—is similar to White‘s situation, and why? Solution In this problem, White operated a travel agency. To obtain low fares for her clients, she submitted fake military identification cards to the airlines. She was charged with the crime of identity theft, which requires the ―use‖ of another‘s identification. In a previous case, David Miller, to obtain a loan, represented that certain investors approved of the loan when they did not. Miller‘s conviction for identity theft was overturned on the ground that he had not ―used‖ the investors‘ identities—he had only said that they had done something when they had not. In a second case, Kathy Medlock, the operator of an ambulance service, obtained payment for transporting patients for whom there was no medical necessity to do so by forging a physician‘s signature. White‘s actions most closely resemble Medlock‘s forgery. White not

Solution Manual For: Chapter 01: Law and Legal Reasoning

only told the airlines that her clients were members of the military—she created false identification cards and sent them to the airlines. In all of these cases, the defendants lied about their actions. Whether or not their conduct fell within the meaning of a word within a statute, or matched the actions of a perpetrator in another case, none of these parties can claim to have acted ethically. Honesty is a part of ethical behavior in any set of circumstances, and none these defendants were truthful about their actions. In the actual case on which this problem is based, the court concluded that White‘s actions were most similar to Medlock‘s. White was convicted of identity theft. On appeal, the U.S. Court of Appeals for the Sixth Circuit affirmed the conviction. 1.

In the two cases cited by the court, were there any ethical differences in the actions of the parties? Explain your answer.

Solution No, in the two cases cited by the White court—and in the White case—there were no ethical differences in the actions of the parties. Almost any definition of ethics, and any set of ethical standards, includes honesty as a component. In the White case, Sandra White lied to the airlines that her clients were members of the military, and created false identification cards to obtain cheaper fares. In the first case cited by the White court, David Miller, to obtain a loan, represented that certain investors approved of the loan when they did not. In the second case cited by the White court, Kathy Medlock, the operator of an ambulance service, obtained payment for transporting patients for whom there was no medical necessity to do so by forging a physician‘s signature. In all of these cases, the defendants lied. Whether or not their conduct fell within the meaning of a word within a statute, or matched the unlawful actions of each other, none of these parties can claim to have acted ethically. Honesty is a part of ethical behavior in any set of circumstances, and none these defendants were truthful.

Critical Thinking and Writing Assignments 1.

Business Law Writing. John‘s company is involved in a lawsuit with a customer, Beth. John argues that for fifty years higher courts in that state have decided cases involving circumstances similar to his case in a way that indicates he can expect a ruling in his company‘s favor. Write at least one paragraph discussing whether this is a valid argument. Write another paragraph discussing whether the judge in this case must rule as those other judges did, and why. (See The Common Law.) Solution John‘s argument is valid. Under the doctrine of stare decisis, judges are generally bound to follow the precedents set in their jurisdictions by the judges who have decided similar cases. A judge does not always have to rule as other judges have, however. A judge can depart from precedent. One argument that a party might offer to counter an assertion of precedent is that the times have changed—the social, economic, political, or other circumstances have changed—and thus it is time to change the law.

Solution Manual For: Chapter 01: Law and Legal Reasoning

Time-Limited Group Assignment—Court Opinions. Go to the section entitled Reading and Understanding Case Law in the appendix at the end of this chapter, and read through the subsection entitled ―Decisions and Opinions.‖ 1. One group will explain the difference between a concurring opinion and a majority opinion. Solution A majority opinion is a written opinion outlining the views of the majority of the judges or justices deciding a particular case. A concurring opinion is a written opinion by a judge or justice who agrees with the conclusion reached by the majority of the court but not necessarily with the legal reasoning that led the conclusion. 2.

Another group will outline the difference between a concurring opinion and a dissenting opinion.

Solution A concurring opinion will voice alternative or additional reasons as to why the conclusion is warranted or clarify certain legal points concerning the issue. A dissenting opinion is a written opinion in which judges or justices who do not agree with the conclusion reached by the majority of the court expound their views on the case. The third group will explain why judges and justices write concurring and dissenting opinions, given that these opinions will not affect the outcome of the case at hand, which has already been decided by majority vote. Solution Obviously, a concurring or dissenting opinion will not affect the case involved—because it has already been decided by majority vote. Nevertheless, such opinions often are used by another court later to support its position on a similar issue.

Appendix Exhibit 1.

For a federal district court to hear a case, the ―amount in controversy‖ must be at least $75,000. Jones paid $5,000 for the motor and $304 in freight charges. What other losses or injuries might Jones claim in order to cross the ―amount in controversy‖ threshold? Explain. Solution The amount in controversy in a dispute is measured by the value of the object of the litigation. This is not necessarily the amount of money sought or the award obtained through a judgment— it is the value of the consequences that may result from the litigation. It should be considered from the perspective of the plaintiff, with a focus on the economic value of the rights the plaintiff seeks to protect. In the Adelman’s case, Jones could have sought the price of the nonconforming goods, the freight charges, and other costs directly related to the alleged breach of contract—lost profits attributable to the time that the truck was out of operation due to the defective motor, for example. In the facts of the actual case, Jones asked for damages for emotional distress, punitive damages, and attorney fees, based on a tort claim. The appellate court was ―convinced‖ that ―Jones‘s alleged monetary damages would result in an amount in controversy of $138,171, well above the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

$75,000 requirement.‖ And ―there is no evidence that Jones‘s damages claims were made in bad faith,‖ which is clearly an important factor.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

Table of Contents Critical Thinking Questions in Features .................................................................................................................. 9 Adapting the Law to the Online Environment ........................................................................................... 9 Critical Thinking Questions in Cases ..................................................................................................................... 10 Case 2.1 ................................................................................................................................................... 10 Case 2.2 ................................................................................................................................................... 11 Case 2.3 ................................................................................................................................................... 11 Chapter Review ............................................................................................................................................................. 12 Practice and Review ................................................................................................................................ 12 Practice and Review: Debate This ........................................................................................................... 13 Issue Spotters .......................................................................................................................................... 13 Business Scenarios and Case Problems ................................................................................................... 13 Critical Thinking and Writing Assignments .............................................................................................. 19

Critical Thinking Questions in Features Adapting the Law to the Online Environment 2.

One observer has said that the American legal system should evaluate social media companies based on how ―they affect us as citizens, not only [on how] they affect us as consumers.‖ What is your opinion of this statement? Solution The person who made this statement clearly sees a ―citizen‖ as having different motivations and concerns than a ―consumer.‖ Presumably, a citizen is mostly concerned with the good of society

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

as a whole, and therefore would be open to the idea of government regulation that restricted the negative influence of social media, regardless of the First Amendment. A consumer, by contrast, would be primarily concerned with having a marketplace that offers the widest possible varieties of freedom (of choice, of speech, etc.) and would for that reason be opposed to government regulation of social media. There is, however, an argument to be made that the citizens that make up a society benefit when the marketplace of ideas—whether they are subjectively ―positive‖ or ―negative‖—is allowed to flourish in the absence of government regulation. 3.

Tim Cook, Apple‘s chief operating officer, has suggested that the United States Congress should pass a law limiting the ability of Apple and other tech countries to keep consumer data private. Why would a business executive make such a request? Solution Cook may have wanted to end a controversy that puts Apple squarely at odds with the federal government. After all, large companies such as Apple rely on favorable treatment from the government in regulatory matters, international trade agreements, and many other areas. Also, large corporations such as Apple sometimes gain an advantage over competitors when their industries are regulated. For example, Apple has significant resources with which to lobby Congress for favorable treatment, and it is better positioned to bear the costs of regulation than are other, smaller tech companies. Finally, Apple‘s position as a champion of consumer privacy would be damaged if it ―caved‖ and changed its stance without being forced to do so by a new federal law.

Critical Thinking Questions in Cases Case 2.1 1.

What ―dangerous conditions‖ might have prompted the city to enact the ordinances at issue in this case? Why? Solution As noted in the facts of the case, both ordinances at issue included an extensive rationale for their adoption, stating essentially that a geographically small city has the right to restrict a business from operating within the city when the restriction is for the safety of the city‘s citizens and visitors. As the basis for the city‘s regulation, the appellate court referred to ―the dangerous conditions‖ created by the irresponsible driving behavior of scooter renters, especially at night, amplified by the lack of training, supervision, and oversight practiced by the rental scooter businesses that ―existed throughout the entire city.‖ The court paraphrased the expressive clauses in the ordinances more specifically:  



The City is geographically small and crowded and is being besieged by inexperienced scooter drivers seeking amusement and driving in a dangerous manner. The City is a tourist destination frequented by tens of thousands of individuals, and its streets are congested by scooters that are being driven illegally and in areas where they are not permitted. The City‘s residents and visitors are put in dangerous situations as a result of the improper use of scooters, especially at night.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

   2.

City businesses have complained about numerous trespasses on their property by people driving scooters while being disruptive City police have been unable to cope with the situation and essential police resources are being drained. The City has been unable to control the situation through less restrictive means.

What is the likely economic impact of the ordinances on the businesses in the city? Discuss. Solution With the exception of the scooter rental businesses, the effect on the city‘s economy is likely to be positive in light of the result in the Classy case. The answer to the previous question contains the reasons in support of this outlook. With a ban on motorized scooters, the ―small and crowded‖ city is not likely to be ―besieged by inexperienced scooter drivers seeking amusement and driving in a dangerous manner.‖ The streets, filled with ―tens of thousands‖ of tourists, will not be ―congested by scooters that are being driven illegally and in areas where they are not permitted.‖ Residents and visitors will not be ―put in dangerous situations as a result of the improper use of scooters, especially at night.‖ There will be an end to the ―numerous trespasses‖ on business property ―by people driving scooters while being disruptive.‖ And ―essential police resources‖ will not be ―drained,‖ at least not by irresponsible scooter drivers and riders. All of which bodes well for business.

Case 2.2 3.

If this case had involved a small, private retail business that did not advertise nationally, would the result have been the same? Why or why not? Solution It is not likely that the result in this case would have been different even if the facts had involved a small, private retail business that did not advertise nationally. The intended impact of the decision in Heart of Atlanta was to uphold the constitutionality of the Civil Rights Act of 1964 and the power of Congress to regulate interstate commerce to stop local discriminatory practices. In the Supreme Court‘s opinion, ―The power of Congress to promote interstate commerce also includes the power to regulate the local incidents thereof, including local activities in both the States of origin and destination, which might have a substantial and harmful effect upon that commerce.‖ Thus, if the case had involved a small, local retail business, the Court would have found participation in interstate commerce based on the use of a phone, or a Facebook page (or other Internet presence), or sales to customers who traveled across state lines—or, as in Wickard v. Filburn, participation might have been based on any transaction that might otherwise have occurred in interstate commerce.

Case 2.3 4.

Whose interests are advanced by the banning of certain types of advertising? Solution The government‘s interests are advanced when certain ads are banned. For example, in the Bad Frog case, the court acknowledged, by advising the state to restrict the locations where certain ads could be displayed, that banning of ―vulgar and profane‖ advertising from children‘s sight arguably advanced the state‘s interest in protecting children from those ads.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

If Bad Frog had sought to use the offensive label to market toys instead of beer, would the court‘s ruling likely have been the same? Explain your answer. Solution Probably not. The reasoning underlying the court‘s decision in the case was, in part, that ―the State‘s prohibition of the labels . . . does not materially advance its asserted interests in insulating children from vulgarity . . . and is not narrowly tailored to the interest concerning children.‖ The court‘s reasoning was supported in part by the fact that children cannot buy beer. If the labels advertised toys, however, the court‘s reasoning might have been different.

Chapter Review Practice and Review A state legislature enacted a statute that required any motorcycle operator or passenger on the state‘s highways to wear a protective helmet. Jim Alderman, a licensed motorcycle operator, sued the state to block enforcement of the law. Alderman asserted that the statute violated the equal protection clause because it placed requirements on motorcyclists that were not imposed on other motorists. Using the information presented in the chapter, answer the following questions. 6.

Why does this statute raise equal protection issues instead of substantive due process concerns? Solution When a law or action limits the liberty of some persons but not others, it may violate the equal protection clause. Here, because the law applies only to motorcycle operators and passengers, it raises equal protection issues.

What are the three levels of scrutiny that the courts use in determining whether a law violates the equal protection clause? Solution The three levels of scrutiny that courts apply to determine whether the law or action violates equal protection are strict scrutiny (if fundamental rights are at stake), intermediate scrutiny (in cases involving discrimination based on gender or legitimacy), and the ―rational basis‖ test (in matters of economic or social welfare).

Which level of scrutiny or test would apply to this situation? Why? Solution The court would likely apply the rational basis test, because the statute regulates a matter of social welfare by requiring helmets. Similar to seat-belt laws and speed limits, a helmet statute involves the state‘s attempt to protect the welfare of its citizens. Thus, the court would consider it a matter a social welfare and require that it be rationally related to a legitimate government objective.

Under this standard or test, is the helmet statute constitutional? Why or why not? Solution The statute is probably constitutional, because requiring helmets is rationally related to a legitimate government objective (public health and safety). Under the rational basis test, courts

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

rarely strike down laws as unconstitutional, and this statute will likely further the legitimate state interest of protecting the welfare of citizens and promoting safety.

Practice and Review: Debate This 10. Legislation aimed at protecting people from themselves concerns the individual as well as the public in general. Protective helmet laws are just one example of such legislation. Should individuals be allowed to engage in unsafe activities if they choose to do so? Solution Certainly many will argue in favor of individual rights. If certain people wish to engage in risky activities such as riding motorcycles without a helmet, so be it. That should be their choice. No one is going to argue that motorcycle riders believe that there is zero danger when riding a motorcycle without a helmet. In other words, individuals should be free to make their own decisions and consequently, their own mistakes. In contrast, there is a public policy issue involved. If a motorcyclist is injured in an accident because that motorcyclist was not wearing a protective helmet, society ends up paying in the form of increased medical care expenses, lost productivity, and even welfare for other family members. Thus, the state has an interest in protecting the public in general by limiting some individual rights.

Issue Spotters 11. South Dakota wants its citizens to conserve energy. To help reduce consumer consumption of electricity, the state passes a law that bans all advertising by power utilities within the state. What argument could the power utilities use as a defense to the enforcement of this state law? Solution Even if commercial speech is neither related to illegal activities nor misleading, it may be restricted if a state has a substantial interest that cannot be achieved by less restrictive means. In this situation, however, the interest in energy conservation is substantial, but it could be achieved by less restrictive means. That would be the utilities‘ defense against the enforcement of this state law. 12. Suppose that a state imposes a higher tax on out-of-state companies doing business in the state than it imposes on in-state companies. Is this a violation of the equal protection clause if the only reason for the tax is to protect the local firms from out-of-state competition? Explain. Solution Yes. The tax would limit the liberty of some persons (out of state businesses), so it is subject to a review under the equal protection clause. Protecting local businesses from out-of-state competition is not a legitimate government objective. Thus, such a tax would violate the equal protection clause.

Business Scenarios and Case Problems 13. The Free Exercise Clause. Thomas worked in the nonmilitary operations of a large firm that produced both military and nonmilitary goods. When the company discontinued the production of nonmilitary goods, Thomas was transferred to the plant producing military equipment. Thomas left his job, claiming that it violated his religious principles to participate in the manufacture of goods to be used in destroying life. In effect, he argued, the transfer to the military equipment

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

plant forced him to quit his job. He was denied unemployment compensation by the state because he had not been effectively ―discharged‖ by the employer but had voluntarily terminated his employment. Did the state‘s denial of unemployment benefits to Thomas violate the free exercise clause of the First Amendment? Explain. (See Business and the Bill of Rights.) Solution Thomas has a constitutionally protected right to the free exercise of his religion. In denying his claim for unemployment benefits, the state violated this right. Employers are obligated to make reasonable accommodations for their employees‘ beliefs that are openly and sincerely held, as were Thomas‘s beliefs. By moving him to a department that made military goods, his employer effectively forced him to choose between his job and his religious principles. This unilateral decision on the part of the employer was the reason Thomas left his job and why the company was required to compensate Thomas for his resulting unemployment. 14. Spotlight on Plagiarism—Due Process. The Russ College of Engineering and Technology of Ohio University announced in a press conference that it had found ―rampant and flagrant plagiarism‖ in the theses of mechanical engineering graduate students. Faculty singled out for ―ignoring their ethical responsibilities‖ included Jay Gunasekera, chair of the department. Gunasekera was prohibited from advising students. He filed a suit against Dennis Irwin, the dean of Russ College, for violating his due process rights. What does due process require in these circumstances? Why? [Gunasekera v. Irwin, 551 F.3d 461 (6th Cir. 2009)] (See Due Process and Equal Protection.) Solution To adequately claim a due process violation, a plaintiff must allege that he was deprived of ―life, liberty, or property‖ without due process of law. A faculty member‘s academic reputation is a protected interest. The question is what process is due to deprive a faculty member of this interest and in this case whether Gunasekera was provided it. When an employer inflicts a public stigma on an employee, the only way that an employee can rectify the situation is through publicity. Gunasekera‘s alleged injury was his public association with the plagiarism scandal. Here, the court reasoned that ―a name-clearing hearing with no public component would not address this harm because it would not alert members of the public who read the first report that Gunasekera challenged the allegations. Similarly, if Gunasekera‘s name was cleared at an unpublicized hearing, members of the public who had seen only the stories accusing him would not know that this stigma was undeserved.‖ Thus the court held that Gunasekera was entitled to a public name-clearing hearing. 15. Business Case Problem with Sample Answer—Freedom of Speech. Mark Wooden sent an email to an alderwoman for the city of St. Louis. Attached was a nineteen-minute audio that compared her to the biblical character Jezebel—she was a ―bitch in the Sixth Ward,‖ spending too much time with the rich and powerful and too little time with the poor. In a menacing, maniacal tone, Wooden said that he was ―dusting off a sawed-off shotgun,‖ called himself a ―domestic terrorist,‖ and referred to the assassination of President John F. Kennedy, the murder of a federal judge, and the shooting of Congresswoman Gabrielle Giffords. Feeling threatened, the alderwoman called the police. Wooden was convicted of harassment under a state criminal statute. Was this conviction unconstitutional under the First Amendment? Discuss. [State of Missouri v. Wooden, 388 S.W.3d 522 (Mo. 2013)] (See Business and the Bill of Rights.) —For a sample answer to Problem 2-3, go to Appendix E.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

Solution No, Wooden‘s conviction was not unconstitutional. Certain speech is not protected under the First Amendment. Speech that violates criminal laws—threatening speech, for example—is not constitutionally protected. Other unprotected speech includes fighting words, or words that are likely to incite others to respond violently. And speech that harms the good reputation of another, or defamatory speech, is not protected under the First Amendment. In his e-mail and audio notes to the alderwoman, Wooden discussed using a sawed-off shotgun, domestic terrorism, and the assassination and murder of politicians. He compared the alderwoman to the biblical character Jezebel, referring to her as a ―bitch in the Sixth Ward.‖ These references caused the alderwoman to feel threatened. The First Amendment does not protect such threats, which in this case violated a state criminal statute. There was nothing unconstitutional about punishing Wooden for this unprotected speech. In the actual case on which this problem is based, Wooden appealed his conviction, arguing that it violated his right to freedom of speech. Under the principles set out above, the Missouri Supreme Court affirmed the conviction. 16. Equal Protection. Abbott Laboratories licensed SmithKline Beecham Corp. to market an Abbott human immunodeficiency virus (HIV) drug in conjunction with one of SmithKline‘s drugs. Abbott then increased the price of its drug fourfold, forcing SmithKline to increase its prices and thereby driving business to Abbott‘s own combination drug. SmithKline filed a suit in a federal district court against Abbott. During jury selection, Abbott struck the only self-identified gay person among the potential jurors. (The pricing of HIV drugs is of considerable concern in the gay community.) Could the equal protection clause be applied to prohibit discrimination based on sexual orientation in jury selection? Discuss. [SmithKline Beecham Corp. v. Abbott Laboratories, 740 F.3d 471 (9th Cir. 2014)] (See Due Process and Equal Protection.) Solution Yes, the equal protection clause can be applied to prohibit discrimination based on sexual orientation in jury selection. The appropriate level of scrutiny would be intermediate scrutiny. Under the equal protection clause of the Fourteenth Amendment, the government cannot enact a law or take another action that treats similarly situated individuals differently. If it does, a court examines the basis for the distinction. Intermediate scrutiny applies in cases involving discrimination based on gender. Under this test, a distinction must be substantially related to an important government objective. Gays and lesbians were long excluded from participating in our government and the privileges of citizenship. A juror strike on the basis of sexual orientation tells the individual who has been struck, as well as the trial participants and the general public, that the judicial system still treats gays and lesbians differently. This deprives these individuals of the opportunity to participate in a democratic institution on the basis of a characteristic that has nothing to do with their fitness to serve. In the actual case on which this problem is based, SmithKline challenged the strike. The judge denied the challenge. On SmithKline‘s appeal, the U.S. Court of Appeals for the Ninth Circuit held that the equal protection clause prohibits discrimination based on sexual orientation in jury selection and requires that heightened scrutiny be applied to equal protection claims involving sexual orientation. The appellate court remanded the case for a new trial.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

17. Procedural Due Process. Robert Brown applied for admission to the University of Kansas School of Law. Brown answered ―no‖ to questions on the application asking if he had a criminal history and acknowledged that a false answer constituted ―cause for . . . dismissal.‖ In fact, Brown had criminal convictions for domestic battery and driving under the influence. He was accepted for admission to the school. When school officials discovered his history, however, he was notified of their intent to dismiss him and given an opportunity to respond in writing. He demanded a hearing. The officials refused to grant Brown a hearing and then expelled him. Did the school‘s actions deny Brown due process? Discuss. [Brown v. University of Kansas, 599 Fed. Appx. 833 (10th Cir. 2015)] (See Due Process and Equal Protection.) Solution No, the school‘s actions did not deny Brown due process. Procedural due process requires that any government decision to take life, liberty, or property must be made fairly. The government must give a person proper notice and an opportunity to be heard. The government must use fair procedures—the person must have at least an opportunity to object to a proposed action before a fair, neutral decision maker. In this problem, Robert Brown applied for admission to the University of Kansas School of Law. He answered ―no‖ to the questions on the application about criminal history and acknowledged that a false answer constituted cause for dismissal. He was accepted for admission to the school. But Brown had previous criminal convictions for domestic battery and driving under the influence. When school officials discovered this history, Brown was notified of their intent to dismiss him and given an opportunity to respond in writing. He demanded a hearing. The officials refused, and expelled him. As for due process, Brown knew he could be dismissed for false answers on his application. The school gave Brown notice of its intent to expel him and gave him an opportunity to be heard (in writing). Due process does not require that any specific set of detailed procedures be followed as long as the procedures are fair. In the actual case on which this problem is based, Brown filed a suit in a federal district court against the school, alleging denial of due process. From a judgment in the school‘s favor, Brown appealed. The U.S. Court of Appeals for the Tenth Circuit affirmed, concluding that ―the procedures afforded to Mr. Brown were fair.‖ 18. The Commerce Clause. Regency Transportation, Inc., operates a freight business throughout the eastern United States. Regency maintains its corporate headquarters, four warehouses, and a maintenance facility and terminal location for repairing and storing vehicles in Massachusetts. All of the vehicles in Regency‘s fleet were bought in other states. Massachusetts imposes a use tax on all taxpayers subject to its jurisdiction, including those that do business in interstate commerce, as Regency does. When Massachusetts imposed the tax on the purchase price of each tractor and trailer in Regency‘s fleet, the trucking firm challenged the assessment as discriminatory under the commerce clause. What is the chief consideration under the commerce clause when a state law affects interstate commerce? Is Massachusetts‘s use tax valid? Explain. [Regency Transportation, Inc. v. Commissioner of Revenue, 473 Mass. 459, 42 N.E.3d 1133 (2016)] (See The Constitutional Powers of Government.) Solution Yes, Massachusetts‘s use tax is valid under the commerce clause. When a state regulation that affects interstate commerce is challenged under the commerce clause, the court weighs the state‘s interest in regulating the matter against the burden that the regulation places on interstate

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

commerce. Because a court balances the interests involved, it is difficult to predict the outcome in a particular case. State laws that alter conditions of competition to favor in-state interests over out-of-state competitors in a market are considered discriminatory and usually invalidated. In this problem, Regency Transportation, Inc., operates a freight business throughout the eastern United States. Regency maintains a headquarters, warehouses, and other facilities in Massachusetts. All of the vehicles in Regency‘s fleet were bought in other states. When Massachusetts imposed a use tax on the purchase price of each tractor and trailer in Regency‘s fleet, the trucking firm challenged the assessment as discriminatory under the commerce clause. But Massachusetts imposes the tax on all taxpayers subject to its jurisdiction, not only those that, like Regency, do business in interstate commerce. Hence, the tax is not discriminatory. As for the balancing test, Massachusetts presumably imposes the tax based on the benefits derived from a company‘s using and storing vehicles in the state. The burden that the regulation places on interstate commerce seems slight weighed against the state‘s interest in regulating this matter. In the actual case on which this problem is based, Nichols filed a suit in a federal district court against TNI, alleging discrimination on the basis of sex. TNI filed a motion for summary judgment, which the court granted. But the U.S. Court of Appeals for the Eighth Circuit reversed. ―Genuine issues of material fact remain.‖ 19. Freedom of Speech. Wandering Dago, Inc. (WD) operates a food truck in Albany, New York. WD brands itself and the food it sells with language generally viewed as ethnic slurs. Owners Andrea Loguidice and Brandon Snooks, however, view the branding as giving a ―nod to their Italian heritage‖ and ―weakening the derogatory force of the slur.‖ Twice, WD applied to participate as a vendor in a summer lunch program in a stateowned plaza. Both times, the New York State Office of General Services (OGS) denied the application because of WD‘s branding. WD filed a suit in a federal district court against RoAnn Destito, the commissioner of OGS, contending that the agency had violated WD‘s right to free speech. What principles apply to the government‘s regulation of the content of speech? How do those principles apply in WD‘s case? Explain. [Wandering Dago, Inc. v. Destito, 879 F.3d 20 (2d Cir. 2018)] (See Business and the Bill of Rights.) Solution The First Amendment to the U.S. Constitution protects the freedom of speech. Government regulation of speech is presumed to be unconstitutional. To ―pass muster‖ under the free-speech clause, a law or government action that regulates the content of speech must serve a compelling state interest and must be narrowly tailored to achieve that interest. In this problem, the government, through OGS, disfavored WD‘s speech because of its branding. The agency may have labeled the branding offensive because of its perceived effect on the members of a certain ethnic group. The interest that the government sought to serve might have been a mandate of positive expression. But denying the business application of any vendor whose branding might demean or offend could silence dissent in the ―marketplace of ideas.‖ In some contexts, an ethnic slur might be hostile and involve conduct. A regulation of that conduct would arguably serve the interest of preventing immediate harm. For example, the government can regulate threats of violence, harassment, and fighting words. But WD‘s speech did not fall into any of these categories.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

WD‘s use of ethnic slurs reflected its owners‘ viewpoint about when and how such language should be used. There does not seem to be a sufficiently substantial compelling state interest to justify proscribing this viewpoint. By rejecting WD‘s application only on the ground of the business‘s branding, OGS impermissibly discriminated against WD‘s expression of the owners‘ viewpoint, and thereby violated the First Amendment. In the actual case on which this problem is based, the court rejected WD‘s contention and entered a judgment in the defendants‘ favor. A state intermediate appellate court reversed, holding, based in part on the points stated above, that OGS violated WD‘s right to freedom of speech. The appellate court concluded that WD was entitled to an injunction denying WD‘s future lunch program applications because of the use of ethnic slurs in its branding. 20. A Question of Ethics—Free Speech. Michael Mayfield, the president of Mendo Mill and Lumber Co., in California, received a ―notice of a legal claim‖ from Edward Starski. The ―claim‖ alleged that a stack of lumber had fallen on a customer as a result of a Mendo employee‘s ―incompetence.‖ The ―notice‖ presented a settlement offer on the customer‘s behalf in exchange for a release of liability for Mendo. In a follow-up phone conversation with Mayfield, Starski said that he was an attorney—which, in fact, he was not. Starski was arrested and charged with violating a state criminal statute that prohibited the unauthorized practice of law. [People v. Starski, 7 Cal.App.5th 215, 212 Cal. Rptr.3d 622 (1 Dist. Div. 2 2017)] (See Business and the Bill of Rights.) 1. 2.

Starski argued that ―creating an illusion‖ that he was an attorney was protected by the First Amendment. Is Starski correct? Explain. Identify, discuss, and resolve the conflict between the right to free speech and the government‘s regulation of the practice of law.

Solution 1. No. The First Amendment guarantees the freedom of speech for individuals against interference by the government. To protect citizens from those who would abuse the right, speech is subject to reasonable restrictions. Speech that violates criminal laws is not constitutionally protected. In this problem, Michael Mayfield received a ―notice of a legal claim‖ from Edward Starski. The ―claim‖ alleged that a stack of lumber fell on a customer at Mayfield‘s company as a result of ―incompetence‖ of one of Mayfield‘s employees. The ―notice‖ included a settlement offer on the customer‘s behalf in exchange for a release of liability. In a conversation with Mayfield, Starski stated that he was an attorney—when, in fact, he was not. He was arrested and charged with violating a state statute that prohibited the unlawful practice of law. He argued that ―creating an illusion‖ he was an attorney fell within the protection of the First Amendment. He is wrong. It is within the government‘s power to restrict speech to frustrate a false claim made to accomplish a fraud. And the interest of the government in regulating the practice of law is part of its interest in protecting the public. In the actual case on which this problem is based, the court convicted Starski of the charge. On appeal, a state intermediate appellate court affirmed the conviction. Responding to his free speech defense, the court concluded, that Starski was wrong. 2.

The question concerns the extent to which the government can regulate the practice of law without infringing on certain rights. The rights at issue include the right of a person to

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

exercise free speech, and the rights of the public to be protected from misleading or deceptive speech, and to have access to competent legal representation. In recognition of a person‘s right to exercise free speech, the government might choose not to prohibit the unauthorized practice of law. This would deny the public‘s right to be protected from misleading or deceptive speech. The government might choose to prohibit the practice of law entirely, but this would deprive the public of legal representation of all kinds in all circumstances. So, the government must strike a balance that protects the public and individual rights. The government generally prohibits the unauthorized practice of law—the practice of law by those who have not met the state‘s competency standards to be licensed as attorneys. The government also sanctions persons who have not met the standards from misrepresenting their status to practice law. The government‘s objective is to ensure that those performing legal services do so competently, without infringing on the rights to free speech, to be protected from misleading or deceptive speech, and to have access to competent legal representation. The regulation protects the public and goes no further than necessary, in recognition of the rights at issue.

Critical Thinking and Writing Assignments 21. Business Law Writing. Puerto Rico enacted a law that required specific labels on cement sold in Puerto Rico and imposed fines for any violations of these requirements. The law prohibited the sale or distribution of cement manufactured outside Puerto Rico that does not carry a required label warning and barred that cement from being used in government-financed construction projects. Antilles Cement Corp., a Puerto Rican firm that imports foreign cement, filed a complaint in federal court. Antilles claimed that this law violated the dormant commerce clause. (The dormant commerce clause doctrine applies not only to commerce among the states and U.S. territories, but also to international commerce.) Write three paragraphs discussing whether the Puerto Rican law violates the dormant commerce clause. Explain your reasons. (See The Constitutional Powers of Government.) Solution The court ruled that like a state, Puerto Rico generally may not enact policies that discriminate against out-of-state commerce. The law requiring companies that sell cement in Puerto Rico to place certain labels on their products is clearly an attempt to regulate the cement market. The law imposed labeling regulations that affect transactions between the citizens of Puerto Rico and private companies. State laws that on their face discriminate against foreign commerce are almost always invalid, and this Puerto Rican law is such a law. The discriminatory labeling requirement placed sellers of cement manufactured outside Puerto Rico at a competitive disadvantage. This law therefore contravenes the dormant commerce clause. 22. Time-Limited Group Assignment—Free Speech and Equal Protection. For many years, New York City has had to deal with the vandalism and defacement of public property caused by unauthorized graffiti. In an effort to stop the damage, the city banned the sale of aerosol spraypaint cans and broad-tipped indelible markers to persons under twenty-one years of age. The

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 02: Constitutional Law

new rules also prohibited people from possessing these items on property other than their own. Within a year, five people under age twenty-one were cited for violations of these regulations, and nearly nine hundred individuals were arrested for actually making graffiti. Lindsey Vincenty and other artists wished to create graffiti on legal surfaces, such as canvas, wood, and clothing. Unable to buy supplies in the city or to carry them in the city if they were bought elsewhere, Vincenty and others filed a lawsuit on behalf of themselves and other young artists against Michael Bloomberg, the city‘s mayor, and others. The plaintiffs claimed that, among other things, the new rules violated their right to freedom of speech. (See The Constitutional Powers of Government.) 1. 2. 3.

One group will argue in favor of the plaintiffs and provide several reasons why the court should hold that the city‘s new rules violate the plaintiffs‘ freedom of speech. Another group will develop a counterargument that outlines the reasons why the new rules do not violate free speech rights. A third group will argue that the city‘s ban violates the equal protection clause because it applies only to persons under age twenty-one.

Solution 1. The rules in this problem regulate the content of expression. Such rules must serve a compelling governmental interest and must be narrowly written to achieve that interest. In other words, for the rules to be valid, a compelling governmental interest must be furthered only by those rules. To make this determination, the government‘s interest is balanced against the individual‘s constitutional right to be free of the rules. For example, a city has a legitimate interest in banning the littering of its public areas with paper, but that does not justify a prohibition against the public distribution of handbills, even if the recipients often just toss them into the street. In this problem, the prohibition against young adults' possession of spray paint and markers in public places imposes a substantial burden on innocent expression because it applies even when the individuals have a legitimate purpose for the supplies. The contrast between the numbers of those cited for violating the rules and those arrested for actually making illegal graffiti also undercuts any claim that the interest in eliminating illegal graffiti could not be achieved as effectively by other means. 2. The rules in this problem do not regulate the content of expression—they are not aimed at suppressing the expressive conduct of young adults but only of that conduct being fostered on unsuspecting and unwilling audiences. The restrictions are instead aimed at combating the societal problem of criminal graffiti. In other words, the rules are content neutral. Even if they were not entirely content neutral, expression is always subject to reasonable restrictions. Of course, a balance must be struck between the government‘s obligation to protect its citizens and those citizens‘ exercise of their right. But the rules at the center of this problem meet that standard. Young adults have other creative outlets and other means of artistic expression available. 3. Under the equal protection clause of the Fourteenth Amendment, a state may not ―deny to any person within its jurisdiction the equal protection of the laws.‖ This clause requires a review of the substance of the rules. If they limit the liberty of some person but not others, they may violate the equal protection clause. Here, the rules apply only to persons under the age of twenty-one. To succeed on an equal protection claim, opponents should argue that the rules should be subject to strict scrutiny—that the age restriction is similar to restrictions based on race, national origin, or citizenship. Under this standard, the rules must be necessary

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

to promote a compelling governmental interest. The argument would be that they are not necessary—there are other means that could accomplish this objective more effectively. Alternatively, opponents could argue that the rules should be subject to intermediate scrutiny— that the age restriction is similar to restrictions based on gender or legitimacy. Under this level of scrutiny, the restrictions must be substantially related to an important government objective. In this problem, the contrast between the numbers of those cited for violating the rules and those arrested for actually making illegal graffiti undermines any claim that the restrictions are substantially related to the interest in eliminating illegal graffiti. If neither of these arguments is successful, opponents could cite these same numbers to argue that the rules are not valid because there is no rational basis on which their restrictions on certain persons relate to a legitimate government interest.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

Table of Contents Critical Thinking Questions in Features ............................................................................................................... 21 Adapting the Law to the Online Environment ......................................................................................... 21 Managerial Strategy ................................................................................................................................ 22 Critical Thinking Questions in Cases ..................................................................................................................... 22 Case 3.1 ................................................................................................................................................... 22 Case 3.2 ................................................................................................................................................... 23 Chapter Review ............................................................................................................................................................. 23 Practice and Review ................................................................................................................................ 23 Practice and Review: Debate This ........................................................................................................... 25 Issue Spotters .......................................................................................................................................... 25 Business Scenarios and Case Problems ................................................................................................... 26 Critical Thinking and Writing Assignments .............................................................................................. 34

Critical Thinking Questions in Features Adapting the Law to the Online Environment 23. From an ethical point of view, is there any difference between calling subordinates during off hours for work-related questions and sending e-mails or text messages? Solution The basic ethical issue is whether employees should be compensated for time spent on workrelated electronic communications for which they are not paid. Under the FLSA, managers are normally not eligible for overtime pay. But what about employees who are, in fact, covered by

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

the overtime rules of the FLSA? If an employee is required to check and respond to e-mails, texts, or other electronic communications, then should be entitled to overtime pay under FLSA. If the employee checks and responds to electronic communications voluntarily, however, it is not likely that the employee would be entitled to overtime pay.

Managerial Strategy 24. After a school shooting, Dick‘s Sporting Goods stopped selling certain firearms at its stores. What are the potential benefits and drawbacks of this form of corporate social responsibility? Solution Anytime a company takes a stance on a political or social issue, it can assume that it will receive support from some customers and criticism from others. In this instance, given the fervor of the gun control debate in the United States today, Dick‘s certainly expected to lose customers who are passionate about the right to bear arms. In fact, the company experienced a 3.1 percent decline in sales for the fiscal year following its policy change. Afterwards, however, sales rose at a commensurate rate, showing that the public may have a short attention span even when it comes to the most highly-charged political issues. 25. Why might a state law require corporate managers to maximize company profits? Solution Laws that require corporate managers and directors to focus on maximizing profits are designed to ensure accountability. Without these controls, the theory goes, managers would be tempted to use factors other than profitability in the decision-making process. These factors could be ethical, such as a sincere desire to protect the environment, or unethical, such as economic selfinterest. By forcing managers to make business judgments, rather than moral or personal ones, such laws provide a measure of stability for shareholders and stakeholders alike. Furthermore, if companies are less profitable and less efficient, not only will investors suffer, but employees and customers will also be worse off.

Critical Thinking Questions in Cases Case 3.1 26. Suppose that Case Western had tolerated Al-Dabagh‘s conduct and awarded him a diploma. What impact might that have had on other students at the school? Why? Solution Al-Dabagh‘s expulsion for unprofessional, unethical behavior stood as an example for other students. If Case Western had tolerated Al-Dabagh‘s conduct and awarded him a diploma, it is likely that other students would have taken their cue from this result to engage in their own misconduct, and they would have expected their misbehavior to be accepted. Just as the administration of a university sets the ethical tone of the school by its adoption and enforcement of an ethics policy, so does management‘s behavior set a firm‘s ethical tone. Top management demonstrates its commitment to ethical decision making by maintaining an ethical workplace. Discharging an employee for ethical reasons, for instance, acts as a deterrent to unethical behavior in the workplace.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

A manager who is not committed to an ethical workplace is not likely to succeed in creating one. For example, a manager who looks the other way when knowing about an employee‘s unethical behavior sets an example—one indicating that transgressions will be tolerated.

Case 3.2 27. What marketing tool did Watson gain by inflating its AWPs? Solution The marketing tool that Watson gained by inflating the AWPs of its drugs was ―the spread‖—the difference between the fabricated numbers and the prices that pharmacies actually paid. Watson knew that Mississippi Medicaid would reimburse the pharmacies at rates based on Watson‘s published AWPs. The higher these numbers were, the more the pharmacies would be paid, regardless of the actual costs. Watson could use this fact to make the purchase of their products more profitably attractive to the pharmacies. Of course, the higher the published AWPs were, the higher could be the prices that Watson charged the pharmacies. But Watson could negotiate ―discounts‖ with their customers to further convince the pharmacies they were making a ―profitable‖ deal. 28. Watson argued that AWP was a ―term of art‖ in the pharmaceutical industry that meant ―suggested price.‖ Suppose that the court had accepted this argument. What might have been the effect of this decision? Solution If the court had accepted Watson‘s contention that AWP was a term of art in the pharmaceutical industry meaning merely suggested price,‖ there are a number of possible effects. Any of these results would have had negative reverberations throughout—and beyond—the industry. The court‘s acceptance of the argument would have condoned Watson‘s pricing policy. This would likely have led to a judgment in the drug maker‘s favor in this case, which would have meant a forfeit by Mississippi Medicaid, the state, and the taxpayers of the amounts previously overpaid. As a precedent, this would have allowed Watson to publish any number whatsoever as an AWP. This number could be as inflated as the market would bear, serving as the basis for prices charged to Watson‘s customers as well as for reimbursements by the state to those customers. And the numbers could be fabricated with no relation to actual prices or costs. The possibility of this sort of extraordinary fraud would not likely be lost on Watson‘s competitors, who could begin to engage in the same conduct. This deceit might maximize each company‘s profits, but it would be to the burden of the taxpayers and the public‘s trust.

Chapter Review Practice and Review James Stilton is the chief executive officer (CEO) of RightLiving, Inc., a company that buys life insurance policies at a discount from terminally ill persons and sells the policies to investors. RightLiving pays the terminally ill patients a percentage of the future death benefit (usually 65 percent) and then sells the policies to investors for 85 percent of the value of the future benefit. The

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

patients receive the cash to use for medical and other expenses, and the investors are ―guaranteed‖ a positive return on their investment. The difference between the purchase and sale prices is Right Living‘s profit. Stilton is aware that some sick patients may obtain insurance policies through fraud (by not revealing their illness on the insurance application). An insurance company that discovers such fraud will cancel the policy and refuse to pay. Stilton believes that most of the policies he has purchased are legitimate, but he knows that some probably are not. Using the information presented in this chapter, answer the following questions. 29. Would a person who adheres to the principle of rights consider it ethical for Stilton not to disclose the potential risk of cancellation to investors? Why or why not? Solution If one of the fundamental rights is the right to be treated fairly and to be able to invest one‘s money with full understanding of the risks, then it would be unethical for Stilton to sell these viaticals without full disclosure that some may be subject to cancellation. 30. Using Immanuel Kant‘s categorical imperative, are the actions of RightLiving ethical? Why or why not? Solution The categorical imperative asks the decision maker to assess the results of the action as if everyone in a similar situation made the same decision. If all insurance companies participated in the viatical industry and did not disclose the risk of cancellation, then investors would become leery of investing in the products and the market would disappear. The people for whom the sale of these policies is necessary to sustain a respectable life as it ends would not be able to get the cash to help them die with dignity. This would make the world a worse place and therefore the actions are not ethical. 31. Under utilitarianism, are Stilton‘s actions ethical? Why or why not? If most of the policies are, in fact, legitimate, does this make a difference in your analysis? Solution Utilitarianism asks the decision maker to perform a cost/benefit analysis of the alternatives. Stilton should evaluate the risks or chances of an investor buying a void policy compared to the benefits gained from purchasing legitimate policies. The cost/benefit analysis also should include whether he sells individual policies to individual investors or whether he sells a share of a bundle of policies. If he does the former, the risks to the individual investor are greater than if the latter. If the latter, the benefit of the legitimate policies may offset any loss from cancelled policies. 32. Using the IDDR approach, discuss the decision process Stilton should use in deciding whether to disclose the risk of fraudulent policies to potential investors. Solution The steps in the IDDR approach begin with an Inquiry that identifies the ethical issue, the stakeholders, and relevant ethical theories. Here, then, Stilton must recognize the issue—whether to disclose the potential fraud by those whose policies he buys. He should identify the stakeholders, including his company‘s investors and employees, those insured by the policies, the insurance companies that are at risk of being defrauded, and the larger insurance market and investment communities. To fully weigh the consequences, Stilton should be familiar with the laws related to insurance, his personal ethical standards, and his company‘s policies.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

The second step in the IDDR approach discusses possible actions. Factors include the strengths and weaknesses of each, considering the consequences and the impacts on stakeholders. As part of this step, Stilton should list the alternatives, and the likely results of each. This is also when Stilton should apply the mission and goals of his company. The IDDR approach‘s third step is to make a Decision and provide reasons for it. At this point, using the analysis produced in the previous steps, Stilton must decide what to do and why. The last step is to Review the chosen action to determine its success or failure in terms of the issue and the stakeholders.

Practice and Review: Debate This 33. Executives in large corporations are ultimately rewarded if their companies do well, particularly as evidenced by rising stock prices. Consequently, shouldn‘t we just let those who run corporations be able to decide what level of negative side effects is ―acceptable‖ or their companies‘ products? Solution The first problem with this attitude is that executives and managers (and even directors) may be looking at only short-run profits. They therefore might ignore the long-run profitability to their company. If a drug that works well against a potential pandemic causes severe side effects in some people, in the short run, this same drug may save many lives and reduce human suffering. Thus profits could be great initially, with a consequent rise in the stock price. In the longer run, though, when the news gets around that some of those who took the drug suffered severe side effects, future sales of the drug might fall, thus reducing profits and causing the stock to price to drop. One now has to ask the question about who is in the best situation to decide the optimum level of side effects of any drug or good or service sold. (It‘s impossible to create drugs with zero negative side effects.) Any government regulator will want to make sure that there are few, if any, people who suffer from negative side effects. After all, the government regulator will look bad if the press reports about those who reacted badly to a drug. Therefore, there is a bias within any government regulatory apparatus against any good or service that has bad side effects. More limits on drugs, though, that help millions just because few suffer side effects will cost those who don‘t obtain the drug—perhaps with their lives.

Issue Spotters 34. Acme Corporation decides to respond to what it sees as a moral obligation to correct for past discrimination by adjusting pay differences among its employees. Does this raise an ethical conflict between Acme and its employees? Between Acme and its shareholders? Explain your answers.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

Solution When a corporation decides to respond to what it sees as a moral obligation to correct for past discrimination by adjusting pay differences among its employees, an ethical conflict is raised between the firm and its employees and between the firm and its shareholders. This dilemma arises directly out of the effect such a decision has on the firm‘s profits. If satisfying this obligation increases profitability, then the dilemma is easily resolved in favor of ―doing the right thing.‖ 35. Delta Tools, Inc., markets a product that under some circumstances is capable of seriously injuring consumers. Does Delta have an ethical duty to remove this product from the market, even if the injuries result only from misuse? Why or why not? Solution Maybe. On the one hand, it is not the company‘s ―fault‖ when a product is misused. Also, keeping the product on the market is not a violation of the law, and stopping sales would hurt profits. On the other hand, suspending sales could reduce suffering and could stop potential negative publicity if sales continued.

Business Scenarios and Case Problems 36. Business Ethics. Jason Trevor owns a commercial bakery in Blakely, Georgia, that produces a variety of goods sold in grocery stores. Trevor is required by law to perform internal tests on food produced at his plant to check for contamination. On three occasions, tests of food products containing peanut butter were positive for salmonella contamination. Trevor was not required to report the results to U.S. Food and Drug Administration officials, however, so he did not. Instead, Trevor instructed his employees to simply repeat the tests until the results were negative. Meanwhile, the products that had originally tested positive for salmonella were eventually shipped out to retailers. Five people who ate Trevor‘s baked goods that year became seriously ill, and one person died from a salmonella infection. Even though Trevor‘s conduct was legal, was it unethical for him to sell goods that had once tested positive for salmonella? Why or why not? (See Ethics and the Role of Business.) Solution Of course, it was unethical to sell goods that their maker knew were defective and could cause harm. This is the most reasonable and likely conclusion under any set of standards, even if it were possible to eventually obtain a negative result with respect to a defect from testing that repeatedly yielded a positive result. The decision maker must identify the parties involved (the bakery, its employees, and the general public) and collect the relevant facts to understand the problem. Ingesting food tainted with salmonella can cause serious illness and death. Because selling food contaminated with salmonella is a public health risk, the general public is a stakeholder in this problem. The owner of the bakery (Trevor) and its employees are also stakeholders, and although they are interested in making a profit, they also will suffer a loss if the bakery‘s conduct results contamination and customers stop buying the bakery‘s products. The bakery may not be legally required to report the initial test results to the Food and Drug Administration (FDA), but it is clearly unethical not to do anything to address the salmonella contamination found in food that will be sold to the public. Instructing employees to retest the food until the results come out differently does not remedy the problem or avoid potentially fatal consequences. Liability can attach through tort and contract law principles to the sale of goods that the seller knows or should know are defective. Thus, the baker‘s action in this problem can lead to legal liability if someone is injured by salmonella.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

The bakery could report the initial results to the FDA, even though it is not required, and ask for the agency‘s advice on how to handle the salmonella contamination. The bakery should establish procedures for testing (and retesting) food and discover the source of the contamination. This will show employees that the company is concerned with doing the right thing. The bakery might also refuse to sell and voluntarily dispose of the tainted goods. Clearly, the bakery‘s decision should not be to simply retest the food until the results are negative and ship it to retailers because this shows a lack of concern for the buyers and indirectly the company‘s other stakeholders The decision might be to report to the FDA, and follow its instructions for retesting or disposing of the food. Or it might be to voluntarily pull the tainted food off the shelves so as not to put public health at risk. In either situation, the bakery needs to decide how to avoid potential salmonella contamination in the future. The decision makers need to document the reasons underlying their decision and course of action. If the decision was to report the results to the FDA and follow its advice on how to handle the contamination, the bakery could justify its actions by articulating that it is concerned with public safety. The same justification applies to a decision to destroy the tainted food. The bakery is justified in taking a course of action showing it is better to be safe (and take a monetary loss) than sorry (when a buyer ingests salmonella and dies). Either of these courses of action avoids potentially costly litigation that could result from injured persons suing the company over defective goods, avoids negative publicity and loss of goodwill from a salmonella outbreak. In addition, taking such preventive measures allows the bakery to avoid having the FDA investigate the salmonella problem and possibly issue regulations that would hamper its operation and profits. Whether the bakery decided to report the results to the FDA or just destroy the contaminated food, it should evaluate the effectiveness of its decision and how to avoid potential salmonella contamination in the future. It should establish internal procedures for testing and retesting for salmonella, and should instruct employees on safe handling of food to avoid contamination. 37. Ethical Conduct. Internet giant Zoidle, a U.S. company, generated sales of £2.5 billion in the United Kingdom (UK) in 2013 (roughly $4 billion in U.S. dollars). The U.K. corporate tax rate is usually between 20 percent and 24 percent, but Zoidle paid only 3 percent (£6 million). At a press conference, company officials touted how the company took advantage of tax loopholes and sheltered profits to avoid paying the full corporate income tax. They justified their practices as ethical, declaring that it would be verging on illegal to tell shareholders that the company paid more taxes than it should. Zoidle receives significant benefits for doing business in the UK, including large sales tax exemptions and some property tax breaks. The UK relies on the corporate income tax to provide services to the poor and to help run the agency that regulates corporations. Is it ethical for Zoidle to avoid paying taxes? Why or why not? (See Ethics and the Role of Business.) Solution Minimizing taxes can increase profits. Some people argue that a corporation‘s only goal should be profit maximization, which will be reflected in a higher market value. From an economist‘s perspective, when all firms strictly adhere to the goal of profit maximization, resources tend to

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

flow to where they are most highly valued by society. Ultimately, profit maximization, in theory, leads to the most efficient allocation of scarce resources. But a business‘s focus on profits in the short run can lead to unethical conduct in the long run. In the short run, a company may increase its profits by taking full advantage of tax laws, even though it knows that the public may perceive this conduct as less than ethical. In the long run, because of bad publicity—exemplified by the executive‘s statements in this problem—as well as government audits or investigations, and public or private lawsuits, such perception may compound and cause profits to suffer. Those who run corporations can and should act ethically. Some business leaders and others believe further that corporations should be accountable to society for their actions. One view of corporate social responsibility stresses that corporations have a duty not just to shareholders, but also to other groups affected by corporate decisions. Under this approach, a corporation would consider the impact of its decision on the firm‘s employees, customers, creditors, suppliers, and the community in which the corporation operates. Another theory of social responsibility argues that corporations should behave as good citizens by promoting goals that society deems worthwhile and taking positive steps toward solving social problems—employment discrimination, human rights, environmental concerns, and similar issues. Under either of these views, in this problem, the corporation would consider the government and the poor in determining and executing fiscal and tax policies. Aside from the public‘s perception and a corporation‘s social responsibility, an overemphasis on short-term profit maximization is the most common reason that ethical problems occur in business. Thus, the conduct of the corporation in this problem—taking full advantage of the letter of the tax laws and touting that choice publicly—may lead to unintended unethical consequences. 38. Consumer Rights. Best Buy, a national electronics retailer, offered a credit card that allowed users to earn ―reward points‖ that could be redeemed for discounts on Best Buy goods. After reading a newspaper advertisement for the card, Gary Davis applied for, and was given, a credit card. As part of the application process, he visited a Web page containing Frequently Asked Questions as well as terms and conditions for the card. He clicked on a button affirming that he understood the terms and conditions. When Davis received his card, it came with seven brochures about the card and the reward point program. As he read the brochures, he discovered that a $59 annual fee would be charged for the card. Davis went back to the Web pages he had visited and found a statement that the card ―may‖ have an annual fee. Davis sued, claiming that the company did not adequately disclose the fee. Is it unethical for companies to put terms and conditions, especially terms that may cost the consumer money, in an electronic document that is too long to read on one screen? Why or why not? Assuming that the Best Buy credit-card materials were legally sufficient, discuss the ethical aspects of businesses strictly following the language of the law as opposed to following the intent of the law. [Davis v. HSBC Bank Nevada, N.A., 691 F.3d 1152 (9th Cir. 2012)] (See Ethics and the Role of Business.) Solution In this case, the court found that the company did not violate any laws and that the disclosures were adequate. From an ethical perspective, the question becomes whether the word ―may‖ on the website gave adequate notice to the potential user or borrower that a charge would occur. It is settled legally that it up to a contract signer to read all the components of a contract. In the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

online environment, it is hard to ever prove that a Web page was not edited or changed from one day to the next. A consumer may read the terms and conditions just before a round of edits and then agree and seem bound by changes that did not exist at the time they read them. From a fairness perspective, that would be unethical. At the same time, presumably the reader could print off a copy of the agreement and keep it filed. Underlying societal questions exist as to whether it is fair to assume that a purchaser in an online environment would print off that form contract language in the same way that a signer of a contract keeps a copy of the written contract. The law often is considered the minimum ethical standard that society will allow. If a company follows the law, there will be no formal, societally-imposed consequences. There are many instances, and this is one, where following the law strictly may not be the most ethical action. If the purpose of the Truth-in-Lending Act is to ensure that consumers have full information before making a decision, there may be more ethical ways (warnings, bigger text announcing continuation of terms, more specific language than ―may‖ in the terms) that a company can help consumers be fully informed. 39. Business Ethics. Mark Ramun worked as a manager for Allied Erecting and Dismantling Co., where he had a tense relationship with his father, who was Allied‘s president. After more than ten years, Mark left Allied, taking 15,000 pages of Allied‘s documents on DVDs and CDs, which constituted trade secrets. Later, he joined Allied‘s competitor, Genesis Equipment & Manufacturing, Inc. Genesis soon developed a piece of equipment that incorporated elements of Allied equipment. How might business ethics have been violated in these circumstances? Discuss. [Allied Erecting and Dismantling Co. v. Genesis Equipment & Manufacturing, Inc., 511 Fed.Appx. 398 (6th Cir. 2013)] (See Making Ethical Business Decisions.) Solution Business ethics might have been violated in these circumstances by Mark Ramun, Mark‘s father, and the employees and managers of Genesis. The ―tense relationship‖ between Mark and his father at Allied may have been caused or exacerbated by either or both of them. And instead of confronting whatever it was that made their relationship ―tense,‖ they may have exacted revenge—the father by forcing Mark out of the firm, or Mark by leaving it, after ten years. Of course, this is speculation. What is not speculation, however, is that Mark took 15,000 pages of Allied‘s documents on DVDs and CDs (trade secrets) when he left the firm. This act was likely a violation of the law (theft or misappropriation) and clearly a violation of business ethics. Later, Mark joined Allied‘s competitor, Genesis Equipment & Manufacturing, Inc. Genesis soon developed a piece of equipment that incorporated elements of Allied equipment. This points to a second violation of the law and ethics (use of stolen property) by both Mark and Genesis. Mark appears to have been competing against his family in the marketplace and trying to sell his products through another company. Assuming that Genesis profited from its sale of the equipment, this would have caused losses to Allied and unjustly enriched Genesis. If Mark was paid a bonus or given a promotion, he too would have gained undeservedly. In the actual case on which this problem is based, Allied filed a suit in a federal district court against Genesis and Mark for misappropriation of trade secrets. A jury awarded Allied more than

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

$3 million in damages, but the court issued a judgment as a matter of law in favor of the defendants. On appeal, the U.S. Court of Appeals for the Sixth Circuit reversed. ―It is neither speculative nor conjectural that Genesis unjustly benefitted from its use of Allied's trade secrets.‖ 40. Ethical Principles. Stephen Glass made himself infamous as a dishonest journalist by fabricating material for more than forty articles for The New Republic magazine and other publications. He also fabricated supporting materials to delude The New Republic’s fact checkers. At the time, he was a law student at Georgetown University. Once suspicions were aroused, Glass tried to avoid detection. Later, Glass applied for admission to the California bar. The California Supreme Court denied his application, citing ―numerous instances of dishonesty and disingenuousness‖ during his ―rehabilitation‖ following the exposure of his misdeeds. How do these circumstances underscore the importance of ethics? Discuss. [In re Glass, 58 Cal.4th 500, 316 P.3d 1199 (2014)] (See Ethical Principles and Philosophies.) Solution Ethics is the study of what constitutes right and wrong behavior. It is a branch of philosophy focusing on morality and the way moral principles are derived and implemented. Ethics has to do with the fairness, justness, rightness, or wrongness of an action. Those who study ethics evaluate what duties and responsibilities exist or should exist for its practitioners. The circumstances set out in this problem underscore the importance of ethics by illustrating the consequences of engaging in ethical misconduct. Those consequences can extend beyond the short run. Clearly, Glass engaged in ethical misconduct. By fabricating material for more than forty articles for The New Republic magazine and other publications whose reputations are founded on truth, Glass betrayed the trust of his editors. He further behaved unethically by fabricating supporting materials to delude The New Republic's fact checkers. And once he was suspected, he tried to avoid detection. Later, based on these misdeeds and others, the California Supreme Court refused to admit Glass to the California bar. Does Glass deserve a ―second chance‖? Based on the facts in this problem, it can be argued that no, he does not—he had more than one ―second chance‖ and blew them all. This is indicated by the California Supreme Court‘s citation of ―numerous instances of dishonesty and disingenuousness‖ during Glass‘s ―rehabilitation‖ following ―the exposure of his misdeeds.‖ From a more forgiving perspective, it could be argued that he does deserve another chance—because of his misdeeds, his every move will be closely scrutinized and any misconduct would most likely be swiftly spotted and thwarted. In the actual case on which this problem is based, Glass had earlier applied for, and been denied, admission to the New York bar. Then, as stated in the facts, on Glass‘s application to the California bar, the California Supreme Court denied him. 41. Business Case Problem with Sample Answer— Business Ethics. Operating out of an apartment in Secane, Pennsylvania, Hratch Ilanjian convinced Vicken Setrakian, the president of Kenset Corp., that he was an international businessman who could help turn around Kenset‘s business in the Middle East. At Ilanjian‘s insistence, Setrakian provided confidential business documents. Claiming that they had an agreement, Ilanjian demanded full, immediate payment and threatened to disclose the confidential information to a Kenset supplier if payment was not forthcoming. Kenset denied that there was a contract and filed a suit in a federal district court against Ilanjian, seeking return of the documents. During discovery, Ilanjian was uncooperative. Who behaved unethically

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

in these circumstances? Explain. [Kenset Corp. v. Ilanjian, 600 Fed.Appx. 827 (3d Cir. 2015)] (See Making Ethical Business Decisions.) —For a sample answer to Problem 3–6, go to Apppendix E. Solution It seems obvious from the facts stated in this problem that Hratch Ilanjian behaved unethically in the circumstances. Ethics, of course, involves questions relating to the fairness, justness, rightness, or wrongness of an action. Business ethics focuses on the decisions that businesses and businesspersons apply moral and ethical principles to make their decisions and whether those decisions are right or wrong. In this problem, from an apartment, Ilanjian defrauded Vicken Setrakian, the president of Kenset Corp., into believing that Ilanjian was an international businessman who could help Kenset turn around its business in the Middle East. Ilanjian insisted that Setrakian provide confidential business documents. Then, claiming that they had an agreement, Ilanjian demanded full and immediate payment. He threatened to disclose the confidential information to a Kenset supplier if payment was not forthcoming. Kenset denied that they had a contract. In the ensuing litigation, during discovery, Ilanjian was uncooperative. Each of these acts was unethical. In the actual case on which this problem is based, in negotiations with Setrakian, Ilanjian misrepresented himself. Later, he threatened to use Kenset‘s information in violation of the confidence between the parties. And during discovery, he was uncooperative. The court concluded that there was no contract, ordered the return of confidential documents, and enjoined Ilanjian from using the information. The U.S. Court of Appeals for the Third Circuit affirmed. 42. Spotlight on Bed, Bath & Beyond—Ethics and the Role of Business. Bed Bath & Beyond Inc. sold a ceramic pot, called the ―FireBurners‖ Pot, with a stainless steel fuel reservoir at its center and a bottle of gelled fuel for use with the fire pot called ―FireGel.‖ A red sticker on the fire pot warned, ―DON‘T REFILL UNTIL FLAME IS OUT & CUP IS COOL.‖ ―CARE AND USE INSTRUCTIONS‖ with the product cautioned, in a ―WARNINGS‖ section, ―Do not add fuel when lit and never pour gel on an open fire or hot surface.‖ The label on the back of the fuel gel bottle instructed, ―NEVER add fuel to a burning fire,‖ and under a bold ―WARNING‖ stated, ―DANGER, FLAMMABLE LIQUID & VAPOR.‖ M.H., a minor, was injured when a fire pot in one of the products—bought from Bed Bath & Beyond—was refueled with the gel and an explosion occurred. Safer alternatives for the design of the fire pot existed, but its manufacturer chose not to use them. In these circumstances, is Bed, Bath & Beyond ethically responsible for the injury to M.H.? Discuss. [M.H. v. Bed, Bath & Beyond, Inc., 156 A.D.3d 33, 64 N.Y.S.3d 205 (1 Dept. 2017)] (See Ethics and the Role of Business.) Solution Yes, Bed, Bath & Beyond is ethically responsible for the injury that its ―FireBurners‖ pot caused to M.H. In designing and making a product for consumers, its maker has a duty to make the product reasonably safe so that it does not create an unreasonable risk of harm to the user. This is the standard under the law of product liability. Liability for its breach can be assessed against any seller of the product. As the legal standard, these principles also express the minimal ethical standards. In this problem, a manufacturer made a ceramic pot, called the ―FireBurners‖ Pot, with a stainless steel fuel reservoir at its center and a bottle of gelled fuel for use with the fire pot called ―FireGel.‖ The design was apparently unsafe, prompting the addition of a plethora of warnings about the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

use of the pot. These warnings generally cautioned against adding fuel to the reservoir when it was hot. Safer alternatives for the design existed, but its maker chose not to use them. M.H., a consumer, was injured when a pot was refueled with the gel and an explosion occurred. Under the law of product liability, the seller—Bed, Bath & Beyond—could be held liable for the injury on the basis of a breach of the applicable legal duty. The sale of the pot in an unsafe condition was likewise a breach of a minimal ethical duty. It could also be contended that the retailer owed a greater ethical obligation to its customers, and to anyone who might suffer harm due to the unsafe design of the pot. This obligation could be framed in the same terms as the legal responsibility—the product should be made reasonably safe. This duty could be met by retaining the pot‘s decorative quality while disabling its gel burning capacity or adopting any other safer alternative. Doing so effectively could work to the satisfaction of the seller‘s customers, as well as its owners, shareholders, and others. In the actual case on which this problem is based, M.H. filed a suit in a New York state court against Bed, Bath & Beyond. The court denied the plaintiff‘s motion for summary judgment. A state intermediate appellate court reversed the denial, and remanded the case for the entry of a summary judgment in M.H.‘s favor. 43. A Question of Ethics—Applying the IDDR Framework. Priscilla Dickman worked as a medical technologist at the University of Connecticut Health Center for twenty-eight years. Early in her career at the Health Center, Dickman sustained a back injury while at work. The condition eventually worsened, causing her significant back pain and disability. Her physician ordered restrictions on her work duties for several years. Then Dickman‘s supervisor received complaints that Dickman was getting personal phone calls and was frequently absent from her work area. Based on e-mails and other documents found on her work computer, it appeared that she had been running two side businesses (selling jewelry and providing travel agent services) while at work. The state investigated, and she was convicted of a civil ethics violation for engaging in ―personal business for financial gain on state time utilizing state resources.‖ Separate investigations resulted in criminal convictions for forgery and the filing of an unrelated fraudulent insurance claim. Dickman ―retired‖ from her job (after she obtained approval for disability retirement) and filed a claim with the state of Connecticut against the health center. She alleged that her former employer had initiated the investigations to harass her and force her to quit. She claimed that the Health Center was unlawfully retaliating against her for being disabled and being put on workplace restrictions. [Dickman v. University of Connecticut Health Center, 162 Conn.App. 441, 132 A.3d 739 (2016)] (See Making Ethical Business Decisions.) 44. Assume that you are Dickman‘s supervisor and have been informed that she is frequently away from her desk and often makes personal phone calls. The first step of using the IDDR method is inquiry, so you start asking questions. Several people tell you that that Dickman has offered to sell them jewelry. Others say she has offered to make travel arrangements for them. You have not spoken to Dickman directly about the complaints and are not sure if you should. You know that the Health Center would need more evidence of wrongdoing to justify firing Dickman but are uncertain as to whether you can search her computer. Should you report your findings to management? Is there any ethical problem involved in investigating and possibly firing a longterm employee? Is it fair to terminate an employee who is under disability restrictions? How would you frame the ethical dilemma that the Health Center faced in this case, and who are the stakeholders? What ethical theories would you use to guide your decision? Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

Yes, as Dickman‘s supervisor, you should report your findings to management. A supervisor might also want to speak with Dickman before going to management, to explain that others have noticed her away from her desk, and get her side of the story. Given the complaints that the employer received, there is no ethical dilemma in investigating Dickman. The possibility of misconduct would warrant investigation and possibly termination, even in a long-term employee or an employee who has a disability restriction. ―Disability restrictions‖ do not make an otherwise fair termination unfair. The ethical dilemma that the Health Center faced in this case was whether to discharge Dickman. Besides Dickman, the stakeholders include the Health Center and its employees and also the patients served by the health center. Perhaps the most pertinent ethical theory is the categorical imperative—what would happen if Dickman were allowed to stay on staff, and other employees took this as a cue to emulate her conduct. A supervisor should be circumspect and make sure that the complaints against an employee are not based based on gossip and innuendo. For instance, if the supervisor knew that the co-workers who complained about Dickman did not like her or were trying to get Dickman fired. But there is no indication of that here. The comments about Dickman are presented as factual and seem to have been offered without hostility. A simple check of her presence at her workstation, a log of the calls from her work phone, and the history of website visits on her work computer could prove or disprove the information. She might be asked about any negative findings. This would give her a reasonable opportunity to explain. The supervisor and employer should taken into consideration the length of Dickman‘s employment and her disability, as well as the credibility of her response and her demeanor. If the findings prove to be true, management‘s dilemma is whether to discharge Dickman. It could be believed that her workplace transgressions are not so serious as to warrant a discharge. Her actions have not been secretive, however—other employees are aware of at least some of her misconduct. Permitting her to stay on would likely encourage others to commit similar acts. 45. Now suppose that you are Dickman. You have been a medical technologist for a long time but now experience severe back pain while at your desk at the Health Center. You find that you have less pain if you get up and move around during the day, rather than just sitting. That is why you are often away from your desk. You know that you will not be able to do this job much longer, and that is why you recently started a jewelry business and began providing travel services. Sure, you have made a few personal phone calls related to those businesses while at the Health Center, but other employees make personal calls, and they have not been fired. You feel that the Health Center‘s investigation was intended to force you to quit because you are disabled and cannot perform the tasks that you used to perform. Using the inquiry portion of the IDDR method, how might you frame the ethical issue you face, and who are the stakeholders? What ethical principles can help you analyze the problem thoroughly? Solution Dickman‘s ethical dilemma is how to continue performing her medical technologist job when she cannot sit at her desk without pain and to what extent she can run side businesses from the health center.‖ Medical technologists work in the lab, analyzing and testing blood, fluid, tissue, and urine samples of patients. Dickman has an ethical duty to the patients and to the health center to competently perform this analysis and testing. Patients could be harmed if she fails to do the lab tests properly or in a timely fashion. Therefore, Dickman needs to decide how she can continue competently performing this work. The stakeholders affected by her decision include herself, her employer, her co-workers, and patients of the health center.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

As stated in the facts to this question, Dickman experiences pain sitting at her work desk. She finds it less painful to move around—i.e., away from her desk. But did she inform her supervisor or tell any of her co-workers or a physician about this pain? She would need to gather any witnesses or evidence she has to support her claim. Also, she needs to decide whether it is acceptable for her to run side businesses while she‘s at the health center. Is she merely making a few personal phone calls related to these side businesses, or is it taking time away from the testing and analysis that she was hired to perform. Applicable ethical principles include the categorical imperative—if her co-workers copy her conduct, what might result? If the side jobs are interfering with her medical technologist duties, she most likely cannot justify spending time on them. The amount of time spent could be verified by looking at her work call log and computer history. If it turns out that she spent a great deal of time on these side business and neglected her technologist duties, then the employer would clearly have a right to fire her. In the actual case on which this problem is based, Dickman‘s discrimination claim was dismissed for lack of ―credible evidence or legal support.‖ She appealed the dismissal. A state intermediate appellate court affirmed it.

Critical Thinking and Writing Assignments 46. Business Law Writing. Assume that you are a high-level manager for a shoe manufacturer. You know that your firm could increase its profit margin by producing shoes in Indonesia, where you could hire women for $100 a month to assemble them. You also know that human rights advocates recently accused a competing shoe manufacturer of engaging in exploitative labor practices because the manufacturer sold shoes made by Indonesian women for similarly low wages. You personally do not believe that paying $100 a month to Indonesian women is unethical because you know that in their country, $100 a month is a better-than-average wage rate. Write one page explaining whether you would have the shoes manufactured in Indonesia and make higher profits for the company, or avoid the risk of negative publicity and its potential adverse consequences for the firm‘s reputation. Are there other alternatives? Discuss fully. (See Business Ethics on a Global Level.) Solution It is arguable that ethical behavior generates sufficient good will to warrant practicing it out of a desire for increased profits. Corporate activities that receive wide publicity and are perceived as ―positive‖ may benefit shareholders in the long run, if the enhanced public image of the corporation entices more consumers to buy its product. But such long-run possible benefits are difficult to calculate. Under the same reasoning, ―negative‖ choices may have an impact on a company‘s business, but that impact may also be difficult to gauge. This is in part because motive is difficult to determine, especially in the complicated world of business ethics, both with respect to a business and to its market and customers. In the debate between motive and conduct as a measure of ethical behavior, conduct may be the most practical option and the measure that will have the greatest impact. Thus, a firm might choose to do business in a more costly manner— here, by opting out of the less expensive production facility or by paying higher wages—and ultimately realize a healthier return. Of course, making that decision might have different consequences.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

47. Time-Limited Group Assignment—Corporate Social Responsibility. Methamphetamine (meth) is an addictive drug made chiefly in small toxic labs (STLs) in homes, tents, barns, and hotel rooms. The manufacturing process is dangerous, often resulting in explosions, burns, and toxic fumes. Government entities spend time and resources to find and destroy STLs, imprison meth dealers and users, treat addicts, and provide services for affected families. Meth cannot be made without ingredients that are also used in cold and allergy medications. Arkansas has one of the highest numbers of STLs in the United States. To recoup the costs of fighting the meth epidemic, twenty counties in Arkansas filed a suit against Pfizer, Inc., which makes cold and allergy medications. They argued that it was Pfizer‘s ethical responsibility to either stop using ingredients in their cold and allergy medications that can be used to make meth or to compensate the government for the amount it spends closing down meth labs. (See Ethics and the Role of Business, Ethical Principles and Philosophies, and Making Ethical Business Decisions.) 48. The first group will outline Pfizer‘s ethical responsibility under the corporate social responsibility doctrine. To whom does Pfizer owe duties? Solution It could be argued that the defendants have an ethical responsibility to society to voluntarily take steps to reduce the availability of their products to meth makers. This might have become a more certain obligation once the defendants were aware that their products were used in the manufacture of meth. Retailers might have been asked to place the products behind the counter or lock them in display cases and limit sales or require consumers to sign for purchases. Retailers might have been educated about the suspicious behavior of buyers with illegal intent. (These measures were imposed as federal regulations in 2005.) The defendants might have developed alternative medications that did not contain ephedrine or pseudoephedrine. 49. The second group will formulate an argument on behalf of Pfizer that the company has not breached any of its ethical responsibilities. Solution It could also be argued that the defendants have an ethical responsibility to their shareholders and other stakeholders in their companies to fight regulatory efforts to limit the availability of their products so they could continue making profits. The central purpose of their businesses is to make money, not to affect social change. And the effects on society of the meth epidemic are not the natural and foreseeable consequences of the sales of the defendants‘ products. In other words, the company could effectively argue that it has not breached any of its ethical responsibilities. 50. The third group will assume that they work for Pfizer and that the company is trying to determine the best course of action to prevent its medications from being used to make meth. The group will apply the IDDR approach and explain the steps in the reasoning used. Solution After applying the IDDR approach to determine the best course of action to prevent its medications from being used to make meth, the conclusion might be that the company should advise and encourage retailers at the point of sale to spot and stop buyers who appear to intend that purpose.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 03: Ethics in Business

The IDDR approach has four steps, which begin with an Inquiry to express the issue, identify the stakeholders, and indicate potential ethical standards. Here, the question is what a manufacturer might do to prevent its products from being put to illegal uses. The stakeholders include the company, its owners, officers, employees, and customers, and society. Applicable standards derive from the company‘s situation—it makes and markets the product, which would suggest a duty to guard against its illegal use. The second step of the IDDR approach is a Discussion that considers actions to address the issue. Factors include the strengths and weaknesses of the actions, and the consequences and the effects on the stakeholders. How might the manufacturer discourage the illicit use of its product? Some answers to this question depend on the nature of the product. Could harmless additives to the product make its misuse impossible? Could some ingredients be substituted for the illegally used components? Should the company stop making the product altogether? Technically, additives or substitutes may not be possible—they may not be available, they could dilute the medicinal effects, or they might be cost prohibitive. Removing the product from the market would benefit none of the stakeholders (except, of course, those suffering the consequences of the product‘s illegal use, which might impact only a relatively small part of the community). The third step of the approach is to come to a Decision and state the reasons. In the eyes of the public, the company could benefit by taking some action to prevent its product‘s misuse. This action might be to advise and encourage retailers at the point of sale to spot and stop buyers who appear to intend that misuse. This could enhance the value of the company to those who own it and work for it, as well as its image to its customers and society. And this action can actually improve the situation within the community by limiting the ability of those who would misuse the product to do so. The last step of the approach is a Review of the success or failure of the action to resolve the issue, and satisfy the stakeholders. No action would be completely successful, but a failure to take any action would guaranty a failure to protect the interests of at least some of the stakeholders. This supports the company‘s obligation to do something, such as the choice suggested in this answer. 51. The fourth group will adopt a utilitarian point of view and perform a cost-benefit analysis to determine what the company should do. Specifically, should the company pay compensation to the state, or should it stop using certain ingredients in its medications? Solution In the actual case on which this problem is based, the court compared the counties‘ claims to other plaintiffs‘ attempts to recover from gun manufacturers the costs associated with the criminal use of guns. In terms of legal liability, the circumstances connecting the sales of the medications to the provision of government services were too weak for the counties to recoup their costs from the defendants on a theory of implied contract. Also, the sales of the medications were legal, the operations of the STLs were not, the latter were not likely consequences of the former, and thus, in terms of proximate cause for tort liability, the costs to the counties were not reasonably foreseeable. The suit was dismissed. This result indicates that applying the minimal ethical standard—compliance with the law—and a cost-benefit analysis shows the connection between the actions of the company and the consequences in the community to be too tenuous to mandate either of the steps suggested in

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

the question. That is, it might be said that the benefits of the products outweigh the costs that might be imposed on the company.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

Table of Contents Critical Thinking Questions in Features ............................................................................................................... 37 Adapting the Law to the Online Environment ......................................................................................... 37 Critical Thinking Questions in Cases ..................................................................................................................... 37 Case 4.1 ................................................................................................................................................... 37 Case 4.2 ................................................................................................................................................... 38 Case 4.3 ................................................................................................................................................... 38 Chapter Review ............................................................................................................................................................. 39 Practice and Review ................................................................................................................................ 39 Practice and Review: Debate This ........................................................................................................... 40 Issue Spotters .......................................................................................................................................... 40 Business Scenarios and Case Problems ................................................................................................... 41 Critical Thinking and Writing Assignments .............................................................................................. 47

Critical Thinking Questions in Features Adapting the Law to the Online Environment 52. In our connected world, is there any way a defendant could avoid service of process via social media? Solution Yes, there is one way. That defendant could have to have no social media accounts whatsoever. Increasingly, though, fewer and fewer individuals are not connected to others via social media.

Critical Thinking Questions in Cases Case 4.1 53. Suppose that Gucci had not presented evidence that Huoqing made one actual sale through his website to a resident of the court‘s district (the private investigator). Would the court still have found that it had personal jurisdiction over Huoqing? Why or why not? Solution The single sale to a resident of the district, Gucci‘s private investigator, helped the plaintiff establish that the defendant‘s website was interactive and that the defendant used the website to sell goods to residents in the court‘s district. It is possible that without proof of such a sale, the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

court would not have found that it had personal jurisdiction over the foreign defendant. The reason is that courts cannot exercise jurisdiction over foreign defendants unless they can show the defendants had minimum contacts with the forum, such as by selling goods within the forum.

Case 4.2 54. Should an appellate court‘s review of the amount of damages awarded at trial be subject to the principle that limits appellate review of other evidence? Why or why not? Solution Yes, an appellate court‘s review of the amount of damages awarded at trial should be—and is— subject to the same rule that limits the court‘s review of other evidence. An appellate court determines whether the factual findings of a trial court are supported by competent evidence. Only if the findings of fact are not supported by competent evidence in the record will there will be a reversal. This principle applies to an assessment of damages. Unless it clearly appears that the amount awarded resulted from partiality, caprice, prejudice, corruption, or some other improper influence, an appellate court should not interfere with it. In other words, as long as there is a reasonable relationship between the amount of an award and its proof, it is not the function of a court to substitute its judgment for that of a fact-finder. In the Oxford case, Christophe and Frenchie‘s provided documentation in support of their counterclaim at the trial that, in the view of the appellate court, supported the fact-finder‘s determination of the amount awarded. Of course, constructive eviction caused by the sewage and water erupting from the pipe, and the landlord‘s failure to remedy the problem, was the legal basis for the award. 55. A judge or a jury can decide a question of fact, but only a judge can rule on a question of law. Why? Solution A question of fact is decided by a trier of fact. In a jury trial, this is the jury. In a nonjury trial, this is the judge. A ruling on a question of law is made only by a judge, not a jury, which generally consists of laypersons. A question of fact concerns what really happened with respect to a dispute being tried—such as, in the Oxford case, whether a certain act violated a contract. A question of law concerns the application or interpretation of the law—such as, again in the Oxford case, whether an act that violated a contract also violated the law. One of the reasons for the distinction between those who can decide questions of fact and those who can decide questions of law is that judges have special training and expertise to make decisions on questions of law that the typical lay member of a jury lacks.

Case 4.3 56. Should the cost of corrective discovery efforts be imposed on an uncooperative party if those efforts turn up nothing of real value to the case? Explain. Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

Yes, the cost of corrective discovery efforts should be imposed on an uncooperative party even if those efforts turn up nothing of real value to the case. A party‘s uncooperative behavior can make it reasonable to undertake expensive corrective discovery efforts. Those costs should be imposed on the uncooperative party to deter others from destroying, hiding, or stubbornly refusing to reveal materials that are required to be retained and disclosed. There is no way to know beforehand whether such tactics are actually concealing relevant information. But a persistent refusal to comply with a discovery request provides a sufficient ground to suspect that there is value in the hidden evidence. 57. Should it be inferred from a business‘s failure to keep backup copies of its database that the business must therefore have destroyed the data? Discuss. Solution No, a business‘s failure to keep backup copies of its database does not necessarily indicate that the business destroyed the data. There are other, less culpable reasons that backup copies may not be available. For example, they may have been inadvertently destroyed or lost. Or they may not have been created in the first place. Such a failure does not equate with the willful misconduct that occurred in the Klipsch case. There, it could be reasonably inferred from ePRO‘s actions that the missing documents and data were relevant and that their absence harmed Klipsch.

Chapter Review Practice and Review Stan Garner resides in Illinois and promotes boxing matches for SuperSports, Inc., an Illinois corporation. Garner created the promotional concept of the ―Ages‖ fights—a series of three boxing matches pitting an older fighter (George Foreman) against a younger fighter, such as John Ruiz or Riddick Bowe. The concept included titles for each of the three fights (―Challenge of the Ages,‖ ―Battle of the Ages,‖ and ―Fight of the Ages‖), as well as promotional epithets to characterize the two fighters (―the Foreman Factor‖). Garner contacted George Foreman and his manager, who both reside in Texas, to sell the idea, and they arranged a meeting at Caesar‘s Palace in Las Vegas, Nevada. At some point in the negotiations, Foreman‘s manager signed a nondisclosure agreement prohibiting him from disclosing Garner‘s promotional concepts unless they signed a contract. Nevertheless, after negotiations between Garner and Foreman fell through, Foreman used Garner‘s ―Battle of the Ages‖ concept to promote a subsequent fight. Garner filed a lawsuit against Foreman and his manager in a federal district court in Illinois, alleging breach of contract. Using the information presented in the chapter, answer the following questions. 58. On what basis might the federal district court in Illinois exercise jurisdiction in this case? Solution The federal district court can exercise jurisdiction in this case because the case involves diversity of citizenship. Diversity jurisdiction requires that the plaintiff and defendant be from different states and that the dollar amount of the controversy exceed $75,000. Here, Garner resides in Illinois, and Foreman and his manager live in Texas. Because the dispute involved the promotion of a series of boxing matches with George Foreman, the amount in controversy likely exceeded the required threshold amount.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

59. Does the federal district court have original or appellate jurisdiction? Solution Original jurisdiction, because the case was initiated in that court and that is where the trial will take place. Courts having original jurisdiction are courts of the first instance, or trial courts—that is courts in which lawsuits begin, trials take place, and evidence is presented. In the federal court system, the district courts are the trial courts, so the federal district court has original jurisdiction. 60. Suppose that Garner had filed his action in an Illinois state court. Could an Illinois state court have exercised personal jurisdiction over Foreman or his manager? Why or why not? Solution No, because the defendants lacked minimum contacts with the state of Illinois. Because the defendants were located out of the state, the court would have to determine whether they had sufficient contacts with the state for the Illinois to exercise jurisdiction based on a long arm statute. Here, the defendants never came to Illinois, and the contract that they are alleged to have breached was not formed in Illinois. Thus, it is unlikely that an Illinois state court would find that sufficient minimum contacts existed to exercise jurisdiction. 61. What if Garner had filed his action in a Nevada state court? Would that court have had personal jurisdiction over Foreman or his manager? Explain. Solution Yes, because the defendants met with Garner and formed a contract in the state of Nevada. A state can exercise jurisdiction over out-of-state defendants under a long arm statute if the defendants had sufficient contacts with the state. Here, the parties met and negotiated their contract in Nevada, and a court would likely hold that these activities were sufficient to justify a Nevada court‘s exercising personal jurisdiction.

Practice and Review: Debate This 62. In this age of the Internet, when people communicate via e-mail, tweets, social media, and Skype, is the concept of jurisdiction losing its meaning? Solution Many believe that yes, the idea of determining jurisdiction based on individuals‘ and companies‘ physical locations no longer has much meaning. Increasingly, contracts are formed via online communications. Does it matter where one of the parties has a physical presence? Does it matter where the e-mail server or webpage server is located? Probably not. In contrast, in one sense, jurisdiction still has to be decided when conflicts arise. Slowly, but ever so surely, courts are developing rules to determine where jurisdiction lies when one or both parties used online systems to sell or buy goods or services. In the final analysis, a specific court in a specific physical location has to try each case.

Issue Spotters 63. At the trial, after Sue calls her witnesses, offers her evidence, and otherwise presents her side of the case, Tom has at least two choices between courses of actions. Tom can call his first witness. What else might he do? Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

Tom could file a motion for a directed verdict. This motion asks the judge to direct a verdict for Tom on the ground that Sue presented no evidence that would justify granting Jan relief. The judge grants the motion if there is insufficient evidence to raise an issue of fact. 64. Lexi contracts with Theo to deliver a quantity of computers to Lexi‘s Computer Store. They disagree over the amount, the delivery date, the price, and the quality. Lexi files a suit against Theo in a state court. Their state requires that their dispute be submitted to mediation or nonbinding arbitration. If the dispute is not resolved, or if either party disagrees with the decision of the mediator or arbitrator, will a court hear the case? Explain. Solution Yes. Submission of the dispute to mediation or nonbinding arbitration is mandatory, but compliance with the decision of the mediator or arbitrator is voluntary.

Business Scenarios and Case Problems 65. Standing to Sue. Jack and Maggie Turton bought a house in Jefferson County, Idaho, located directly across the street from a gravel pit. A few years later, the county converted the pit to a landfill. The landfill accepted many kinds of trash that cause harm to the environment, including major appliances, animal carcasses, containers with hazardous content warnings, leaking car batteries, and waste oil. The Turtons complained to the county, but the county did nothing. The Turtons then filed a lawsuit against the county alleging violations of federal environmental laws pertaining to groundwater contamination and other pollution. Do the Turtons have standing to sue? Why or why not? (See Basic Judicial Requirements.) Solution This problem concerns standing to sue. As you read in the chapter, to have standing to sue, a party must have a legally protected, tangible interest at stake. Parties must show that they have been injured, or are likely to be injured, by the actions of the parties that they seek to sue. In this problem, the issue is whether the Turtons had been injured, or were likely to be injured, by the county‘s landfill operations. Clearly, one could argue that the injuries that the Turtons complained of directly resulted from the county‘s violations of environmental laws while operating the landfill. The Turtons lived directly across from the landfill, and they were experiencing the specific types of harms (fires, scavenger problems, groundwater contamination) that those laws were enacted to address. Thus, the Turtons would have standing to bring their suit. 66. Discovery. Advance Technology Consultants, Inc. (ATC), contracted with RoadTrac, LLC, to provide software and client software systems for products using global positioning satellite (GPS) technology being developed by RoadTrac. RoadTrac agreed to provide ATC with hardware with which ATC‘s software would interface. Problems soon arose, however, and RoadTrac filed a lawsuit against ATC alleging breach of contract. During discovery, RoadTrac requested ATC‘s customer lists and marketing procedures. ATC objected to providing this information because RoadTrac and ATC had become competitors in the GPS industry. Should a party to a lawsuit have to hand over its confidential business secrets as part of a discovery request? Why or why not? What limitations might a court consider imposing before requiring ATC to produce this material? (See Following a State Court Case.) Solution Under the work-product rule, attorneys are allowed to protect information that they have gathered as a result of their own skill and diligence. For example, an attorney for a party involved

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

in an auto accident can go out to the scene of the accident and observe the fact that there is a stop sign missing without being under any obligation to divulge such information to his opponent in the lawsuit. Similarly, attorneys who discover recently decided case decisions supporting their theories are under no obligation to share these discoveries with opposing attorneys. If attorneys had to share everything, they would be less inclined to expend efforts on behalf of their clients because, in essence, they would be working for both sides at once. 67. Arbitration. Horton Automatics and the Industrial Division of the Communications Workers of America—the union that represented Horton‘s workers—negotiated a collective bargaining agreement. If an employee‘s discharge for a workplace-rule violation was submitted to arbitration, the agreement limited the arbitrator to determining whether the rule was reasonable and whether the employee had violated it. When Horton discharged its employee Ruben de la Garza, the union appealed to arbitration. The arbitrator found that de la Garza had violated a reasonable safety rule, but ―was not totally convinced‖ that Horton should have treated the violation more seriously than other rule violations. The arbitrator ordered de la Garza reinstated to his job. Can a court set aside this order from the arbitrator? Explain. [Horton Automatics v. The Industrial Division of the Communications Workers of America, AFL-CIO, 506 Fed. Appx. 253 (5th Cir. 2013)] (See Alternative Dispute Resolution.) Solution Yes, a court can set aside this order. The parties to an arbitration proceeding can appeal an arbitrator‘s decision, but court‘s review of the decision may be more restricted in scope than an appellate court‘s review of a trial court‘s decision. In fact, the arbitrator‘s decision is usually the final word on a matter. A court will set aside an award if the arbitrator exceeded any powers—that is, arbitrated issues that the parties did not agree to submit to arbitration. In this problem, Horton discharged its employee de la Garza, whose union appealed the discharge to arbitration. Under the parties‘ arbitration agreement, the arbitrator was limited to determining whether the rule was reasonable and whether the employee violated it. The arbitrator found that de la Garza had violated a reasonable safety rule, but ―was not totally convinced‖ that the employer should have treated the violation more seriously than other rule violations and ordered de la Garza reinstated. This order exceeded the arbitrator‘s authority under the parties‘ agreement. This was a ground for setting aside the order. In the actual case on which this problem is based, on the reasoning stated here, the U.S. Court of Appeals for the Fifth Circuit reached the same conclusion. 68. Discovery. Jessica Lester died from injuries suffered in an auto accident caused by the driver of a truck owned by Allied Concrete Co. Jessica‘s widower, Isaiah, filed a suit against Allied for damages. The defendant requested copies of all of Isaiah‘s Facebook photos and other postings. Before responding, Isaiah ―cleaned up‖ his Facebook page. Allied suspected that some of the items had been deleted, including a photo of Isaiah holding a beer can while wearing a T-shirt that declared ―I [heart] hotmoms.‖ Can this material be recovered? If so, how? What effect might Isaiah‘s ―misconduct‖ have on the result in this case? Discuss. [Allied Concrete Co. v. Lester, 736 S.E.2d 699 (Va. 2013)] (See Following a State Court Case.) Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

Yes, the items that were deleted from a Facebook page can be recovered. Normally, a party must hire an expert to recover material in an electronic format, and this can be time consuming and expensive. Electronic evidence, or e-evidence, consists of all computer-generated or electronically recorded information, such as posts on Facebook and other social media sites. The effect that e-evidence can have in a case depends on its relevance and what it reveals. In the facts presented in this problem, Isaiah should be sanctioned—he should be required to cover Allied‘s cost to hire the recovery expert and attorney‘s fees to confront the misconduct. In a jury trial, the court might also instruct the jury to presume that any missing items are harmful to Isaiah‘s case. If all of the material is retrieved and presented at the trial, any prejudice to Allied‘s case might thereby be mitigated. If not, of course, the court might go so far as to order a new trial. In the actual case on which this problem is based, Allied hired an expert, who determined that Isaiah had in fact removed some photos and other items from his Facebook page. After the expert testified about the missing material, Isaiah provided Allied with all of it, including the photos that he had deleted. Allied sought a retrial, but the court instead reduced the amount of Isaiah‘s damages by the amount that it cost Allied to address his ―misconduct.‖ 69. Electronic Filing. Betsy Faden worked for the U.S. Department of Veterans Affairs. Faden was removed from her position in April 2012 and was given until May 29 to appeal the removal decision. She submitted an appeal through the Merit Systems Protection Board‘s e-filing system seven days after the deadline. Ordered to show good cause for the delay, Faden testified that she had attempted to e-file the appeal while the board‘s system was down. The board acknowledged that its system had not been functioning on May 27, 28, and 29. Was Faden sufficiently diligent in ensuring a timely filing? Discuss. [Faden v. Merit Systems Protection Board, 553 Fed. Appx. 991 (Fed. Cir. 2014)] (See Courts Online.) Solution No, Faden was not sufficiently diligent in ensuring a timely filing. Diligence in this context requires carefulness and persistence. Excusable delay might be evidenced by proof of circumstances beyond a party‘s control that prevents a timely filing. From the facts as stated, it appears that Faden attempted to file her appeal only at the end of the relevant period when the Board‘s e-filing system was down. But there is no indication that anything prevented her from e-filing at a time when the Board‘s system was not down, or from mailing or faxing her appeal at any time, before the deadline. Thus, Faden appears to have been neither timely nor diligent in filing her appeal before the deadline. In the actual case on which this problem is based, the Merit Systems Protection Board dismissed Faden‘s appeal. The Board found that she was not reasonably diligent in ensuring timely filing. On her further appeal, the U.S. Court of Appeals for the Federal Circuit affirmed. 70. Business Case Problem with Sample Answer—Corporate Contacts. LG Electronics, Inc., a South Korean company, and nineteen other foreign companies participated in the global market for cathode ray tube (CRT) products. CRTs were components in consumer goods, including television sets, and sold for many years in high volume in the United States, including the state of Washington. The state filed a suit against LG and the others, alleging a conspiracy to raise prices and set production levels in the market for CRTs in violation of a state consumer protection statute. The defendants filed a motion to dismiss the suit for lack of personal jurisdiction. Should

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

this motion be granted? Explain your answer. [State of Washington v. LG Electronics, Inc., 185 Wash. App. 394, 341 P.3d 346 (2015)] (See Basic Judicial Requirements.) —For a sample answer to Problem 4–6, go to Appendix E. Solution No, the defendants‘ motion to dismiss the suit for lack of personal jurisdiction should not be granted. A corporation normally is subject to jurisdiction in a state in which it is doing business. A court applies the minimum-contacts test to determine whether it can exercise jurisdiction over an out-of-state corporation. This requirement is met if the corporation sells its products within the state or places its goods in the ―stream of commerce‖ with the intent that the goods be sold in the state. In this problem, the state of Washington filed a suit in a Washington state court against LG Electronics, Inc., and nineteen other foreign companies that participated in the global market for cathode ray tube (CRT) products. The state alleged a conspiracy to raise prices and set production levels in the market for CRTs in violation of a state consumer protection statute. The defendants filed a motion to dismiss the suit for lack of personal jurisdiction. These goods were sold for many years in high volume in the United States, including the state of Washington. In other words, the corporations purposefully established minimum contacts in the state of Washington. This is a sufficient basis for a Washington state court to assert personal jurisdiction over the defendants. In the actual case on which this problem is based, the court dismissed the suit for lack of personal jurisdiction. On appeal, a state intermediate appellate court reversed on the reasoning stated above. 71. Appellate, or Reviewing, Courts. Angelica Westbrook was employed as a collector for Franklin Collection Service, Inc. During a collection call, Westbrook told a debtor that a $15 processing fee was an ―interest‖ charge. This violated company policy, and Westbrook was fired. She filed a claim for unemployment benefits, which the Mississippi Department of Employment Security (MDES) approved. Franklin objected. At an MDES hearing, a Franklin supervisor testified that she had heard Westbrook make the false statement, although she admitted that there had been no similar incidents with Westbrook. Westbrook denied making the statement but added that, if she had said it, she did not remember it. The agency found that Franklin‘s reason for terminating Westbrook did not amount to the misconduct required to disqualify her for benefits and upheld the approval. Franklin appealed to a state intermediate appellate court. Is the court likely to uphold the agency‘s findings of fact? Explain. [Franklin Collection Service, Inc. v. Mississippi Department of Employment Security, 184 So.3d 330 (Miss.App. 2016)] (See The State and Federal Court Systems.) Solution Yes, the state intermediate appellate court is likely to uphold the agency‘s findings of fact. Appellate courts normally defer to lower tribunals‘ findings on questions of fact because those forums‘ decision makers are in a better position to evaluate testimony. A trial court judge or jury, for example, can directly observe witnesses‘ gestures, demeanor, and other nonverbal conduct during a trial. A judge or justice sitting on an appellate court cannot. In this problem, Angelica Westbrook, an employee of Franklin Collection Service, Inc., allegedly made a statement during a call to a debtor that violated company policy. Westbrook was fired, and applied for unemployment benefits. Benefits were approved, but Franklin objected. Witnesses

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

at an administrative hearing on the dispute included a Franklin supervisor who testified that she heard Westbrook make the false statement, although she admitted that Westbrook had not been involved in any similar incidents. Westbrook denied making the statement, but added that if she had said it, she did not remember it. The agency found that Franklin‘s reason for terminating Westbrook did not amount to the misconduct required to disqualify her for benefits and upheld the approval. Franklin appealed. Under the standard for appellate review of findings of fact, the appellate court will likely affirm the agency‘s findings. In the actual case on which this problem is based, the state intermediate appellate court to which Franklin appealed the MDES‘s approval of Johnson‘s claim upheld the agency‘s decision. 72. Service of Process. Bentley Bay Retail, LLC, filed a suit in a Florida state court against Soho Bay Restaurant LLC, and its corporate officers, Luiz and Karine Queiroz, in their individual capacities. The charge against the Queirozes was for a breach of their personal guaranty for Soho Bay‘s debt to Bentley Bay. The plaintiff filed notices with the court to depose the Queirozes, who reside in Brazil. The Queirozes argued that they could not be deposed in Brazil. The court ordered them to appear in Florida to provide depositions in their corporate capacity. Witnesses appearing in court outside the jurisdiction of their residence are immune from service of process while in court. On the Queirozes‘ appearance in Florida, can they be served with process in their individual capacities? Explain. [Queiroz v. Bentley Bay Retail, LLC, 43 Fla. L. Weekly D85, 27 So.3d 1108 (3 Dist. 2018)] (See The State and Federal Court Systems.) Solution No, on the Queriozes‘ appearance in Florida to provide depositions in their corporate capacities, they cannot be served with process in their individual capacities. As stated in the problem, witnesses appearing in court outside the jurisdiction of their residence are immune from service of process while in court. The Queirozes reside in Brazil. Bentley Bay filed a suit in a Florida state court against the Queriozes‘ company, Soho Bay Restaurant LLC, and against the Queriozes, as its corporate officers, in their individual capacities. The charge was for breach of a personal guaranty. Bentley Bay sought to depose the Queirozes. The court ordered them to appear in Florida to be deposed in their corporate capacity. These circumstances would not support serving them with process in their individual capacities. In the actual case on which this problem is based, Bentley Bay served the Queriozes in Florida with a copy of the summons and complaint. They moved to quash service, arguing that they were immune from service because they were appearing in the jurisdiction in their corporate capacities. The court denied the motion. A state intermediate appellate court reversed, on the principle stated above. 73. A Question of Ethics—The IDDR Approach and Complaints. John Verble worked as a financial advisor for Morgan Stanley Smith Barney, LLC. After nearly seven years, Verble was fired. He filed a suit in a federal district court against his ex-employer. In his complaint, Verble alleged that he had learned of illegal activity by Morgan Stanley and its clients. He claimed that he had reported the activity to the Federal Bureau of Investigation, and that he was fired in retaliation. His complaint contained no additional facts. [Verble v. Morgan Stanley Smith Barney LLC, 676 Fed. Appx. 421 (6th Cir. 2017)] (See Following a State Court Case.)

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

1. To avoid a dismissal of his suit, does Verble have a legal obligation to support his claims with more facts? Explain. 2. Does Verble owe an ethical duty to back up his claims with more facts? Use the IDDR approach to express your answer. Solution 1. A suit begins when a plaintiff files a complaint in a court with appropriate jurisdiction. A complaint must include a statement of facts necessary to show that the plaintiff is entitled to a remedy. In this problem, John Verble, a financial advisor for Morgan Stanley Smith Barney, LLC for nearly seven years, was terminated. He filed a complaint in a federal district court against Morgan Stanley. Verble alleged that he learned of illegal activity by his employer and its clients. He claimed that he reported this to the Federal Bureau of Investigation and was fired in retaliation. His complaint contained no additional facts. From a legal standpoint, Verble clearly needed to provide more facts to support his conclusory allegations. His complaint should have contained facts that showed he was engaged in a protected activity, that he acted to stop a specific illegal activity by Morgan Stanley and its clients, and that he was fired in retaliation. A claim is plausible when a plaintiff pleads facts that allow a court to draw a reasonable inference that the defendant is liable for the alleged misconduct. Here, without additional facts, it is within the discretion of the court to dismiss Verble‘s complaint. 2. Yes, Verble has an ethical duty to supply additional facts to back up his claims. Not doing so fails to meet even the minimal ethical standard in this case. The steps in the IDDR approach begin with an Inquiry that identifies the ethical issue, the stakeholders, and relevant ethical theories. Here, the issue is whether Verble has a duty to support the claims in his complaint with more facts. Besides Verble, the stakeholders include the court and other litigants. The applicable ethical concepts include the categorical imperative—that individuals should evaluate their actions in light of the consequences that would follow if everyone in society acted the same way. The second step discusses possible actions. Factors include the strengths and weaknesses of each, considering the consequences and the impacts on stakeholders. Verble might choose to proceed without supporting his claims, or he could decide to go ahead only with added facts. A party has a legal duty to allege sufficient facts in a complaint to state a plausible claim for relief. This is an ethical duty, at a minimum. Thus, choosing to proceed without sufficient factual support presents almost no advantage. In the face of an unsupported complaint, for example, an opponent who might otherwise be willing to settle would have little motivation to do so. A failure to meet the legal standard undercuts credibility, jeopardizes a case, wastes judicial resources, and affects the ability of other litigants to timely present their cases. If everyone chose to present their complaints in the same way, the courts would be clogged with insufficient complaints, and even legitimate claims would not be redressed. The IDDR approach‘s third step is to make a decision and provide reasons for it. In all cases, it seems that the best decision would be to support a claim with sufficient facts. This would

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 04: Courts and Alternative Dispute Resolution

comport with the legal duty, meet the minimal ethical standard, and avoid the negative effects of doing otherwise. The last step is to review the chosen action to determine its success or failure in terms of the issue and the stakeholders. Plaintiffs have a legal and ethical responsibility to properly plead their cases. Litigation requires the parties to invest time and money, and a court to expend its own limited time and money. Vague, unsupported allegations can waste everyone‘s resources. Therefore, choosing to present sufficient facts to state a plausible claim is clearly the best ethical act.

Critical Thinking and Writing Assignments 74. Time-Limited Group Assignment—Access to Courts. Assume that a statute in your state requires that all civil lawsuits involving damages of less than $50,000 be arbitrated. Such a case can be tried in court only if a party is dissatisfied with the arbitrator‘s decision. The statute also provides that if a trial does not result in an improvement of more than 10 percent in the position of the party who demanded the trial, that party must pay the entire cost of the arbitration proceeding. (See Alternative Dispute Resolution.) 1. One group will argue that the state statute violates litigants‘ rights of access to the courts and trial by jury. 2. Another group will argue that the statute does not violate litigants‘ right of access to the courts. 3. A third group will evaluate how the determination on right of access would be changed if the statute was part of a pilot program that affected only a few judicial districts in the state. Solution 1. The statute violates litigants‘ rights of access to the courts and to a jury trial because the imposition of arbitration costs on those who improve their positions by less than 10 percent on an appeal is an unreasonable burden. And the statute forces parties to arbitrate before they litigate—an added step in the process of dispute resolution. The limits on the rights of the parties to appeal the results of their arbitration to a court further impede their rights of access. The arbitration procedures mandated by the statute are not reasonably related to the legitimate governmental interest of attaining less costly resolutions of disputes. 2. The statute does not violate litigants‘ constitutional right of access to the courts because it provides the parties with an opportunity for a court trial in the event either party is dissatisfied with an arbitrator‘s decision. The burdens on a person‘s access to the courts are reasonable. The state judicial system can avoid the expense of a trial in many cases. And parties who cannot improve their positions by more than 10 percent on appeal are arguably wasting everyone‘s time. The assessment of the costs of the arbitration on such parties may discourage appeals in some cases, which allows the courts to further avoid the expense of a trial. The arbitration procedures mandated by the statute are reasonably related to the legitimate governmental interest of attaining speedier and less costly resolution of disputes. 3. The determination on rights of access could be different if the statute was part of a pilot program and affected only a few judicial districts in the state because only parties who fell under the jurisdiction of those districts would be subject to the limits. Opponents might argue that the program violates the due process of the Fifth Amendment because it is not applied fairly throughout the state. Proponents might counter that parties who object to an arbitrator‘s decision have an opportunity to appeal it to a court. Opponents might argue that the program exceeds what the state legislature can impose because it does not reasonably

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

relate to a legitimate governmental objective—it arbitrarily requires only litigants who reside in a few jurisdictions to submit to arbitration. Proponents might counter that this is aimed at the reduction of court costs—that the statute rationally relates to a legitimate governmental end. An equal protection challenge would most likely be subject to a similar rational basis test. Under these and other arguments, the reduction of court costs would be a difficult objective to successfully argue against.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Table of Contents Critical Thinking Questions in Features ............................................................................................................... 37 Adapting the Law to the Online Environment ......................................................................................... 37 Critical Thinking Questions in Cases ..................................................................................................................... 37 Case 4.1 ................................................................................................................................................... 37 Case 4.2 ................................................................................................................................................... 38 Case 4.3 ................................................................................................................................................... 38 Chapter Review ............................................................................................................................................................. 39 Practice and Review ................................................................................................................................ 39 Practice and Review: Debate This ........................................................................................................... 40 Issue Spotters .......................................................................................................................................... 40 Business Scenarios and Case Problems ................................................................................................... 41 Critical Thinking and Writing Assignments .............................................................................................. 47

Critical Thinking Questions in Features Adapting the Law to the Online Environment 75. Why might the appellate court have decided that the evidence did not support Nadia Hussain‘s intentional infliction of emotional distress claim? Solution Because some courts allow claims for intentional infliction of emotional distress only when the victim cannot recover damages for the defendant's conduct under another tort theory. Hussain‘s suit against Patel was based on conduct that was actionable under other tort theories: invasion of privacy and public disclosure of private facts. Therefore, the Texas appellate held that the intentional infliction claim was not available. The court stated that intentional infliction of emotional distress is a ―gap-filler tort, judicially created for the limited purpose of allowing recovery in those rare instances in which a defendant intentionally inflicts severe emotional distress in a manner so unusual that the victim has no other recognized theory of redress.‖

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Critical Thinking Questions in Cases Case 5.1 76. Punitive damages may be awarded in a tort action when a defendant‘s actions show malice— that is, when a person‘s conduct is characterized by hatred, ill will, or a spirit of revenge. Would an award of punitive damages be appropriate in this case? Explain. Solution Yes, an award of punitive damages would be appropriate in the Sky case. The purpose of punitive damages is not to compensate a plaintiff, but to punish and deter a defendant‘s conduct. As noted in the lead up to the question, however, an award of punitive damages is available only on a finding of malice. For an award of punitive damages, malice is the state of mind under which a person‘s conduct is characterized by hatred, ill will, or a spirit of revenge (or, in some cases, a conscious disregard for the rights and safety of other persons that has a great probability of causing substantial harm). Because punitive damages are assessed for punishment and not compensation, a positive element of conscious wrongdoing is required. In the Sky case, the court heard testimony and viewed other evidence that, from the court‘s perspective, established that Van Der Westhuizen acted with malice. The nature of the defamatory statements in the e-mail and online reviews, the recipient to whom the e-mail was directed, and the fact that Sky and Van Der Westhuizen were competing breeders, support a finding of malice and thus an award of punitive damages. 77. Should Van Der Westhuizen make an effort to remove all of the false online statements and reviews of Sky that she posted? Why or why not? Solution Yes, Van Der Westhuizen should make an effort to remove all of the false online statements and reviews of Sky that she posted. Damage to a person‘s reputation cannot be adequately compensated for monetarily, nor can an award of compensatory damages put the person in the same position as before the defamation. Removing the defamatory statements is, however, a step in that direction and will help to prevent further harm. For those reasons, removal is an ethically necessary act. Here, the issue is framed as an ethical question, but it is also a legal one. In both contexts, the removal of the posts can be needed to return the defamed party to the position before the defamatory statements. In the Sky case, the trial court issued a permanent injunction to require Van Der Westhuizen to remove any online posts, reviews, and other defamatory statements concerning Sky, including statements on social media and other websites, and to prevent any such later acts by the defendant. The court‘s reasons were as stated above.

Case 5.2 78. The NIU Chapter invited nonmember sorority women to participate in the hazing event by filling the pledges‘ cups with vodka and directing them to drink it. Did these women owe a duty of care to the pledges? Discuss.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Solution Yes, the nonmember sorority women who participated in the hazing event owed a duty of care to the pledges. As explained in the Illinois Supreme Court‘s opinion in the Bogenberger case, a hazing injury is reasonably foreseeable and is likely to occur. The magnitude of the burden of guarding against the injury is small. Thus, it is reasonable to impose a duty of care on individuals who actively participate in a hazing event. The nonmember sorority women were invited to participate in the NIU Chapter‘s hazing event, and willingly agreed. They took part by filling the pledges‘ cups with vodka and directing them to drink it. The women were more than guests encouraging the pledges to drink. They were an integral part of the event with as much influence over the pledges as the NIU Chapter and its officers. Hazing is illegal, and those individuals who choose to participate in such acts should bear the consequences. Under the circumstances stated in the question, the nonmember women owed a duty to the pledges, including of course David Bogenberger. 79. Suppose that the pledges‘ attendance at the hazing event had been optional, and the NIU Chapter had furnished alcohol, but not required its consumption. Would the result have been different? Explain. Solution Yes, if the facts stated in the question had been the facts in the actual case, there would have been a difference in the result. In normal circumstances, there is no basis for liability in the sale or gift of alcoholic beverages (except under a dram shop law). The difference between the hazing event in the Bogenberger case and a ―social host‖ situation is that in the former the consumption of alcohol was required to gain admission to the NIU Chapter. This led directly to the injury that served as the basis for the plaintiff‘s complaint. This required consumption was in violation of the state hazing statute, the university‘s rules, and the national Pi Kappa Alpha organization‘s policy, furnishing a further ground for the imposition of liability here.

Case 5.3 80. Would the result in this case have been different if Taylor‘s minor son, rather than Taylor herself, had been struck by the ball? Should courts apply the doctrine of assumption of risk to children? Discuss. Solution There is no legal bar to applying assumption of risk to children. Children are expected to use the degree of caution required of a child of like age and intelligence under similar circumstances. The courts have therefore applied the doctrine of assumption of the risk in numerous cases, such as when a child was injured while playing on a trampoline, swinging from a rope swing, or diving into a swimming pool. The key is whether the child knew of the danger, was able to appreciate the risks associated with it, and voluntarily chose to run the risk. Normally, it is up to a jury (or a judge in a bench trial) to decide if the facts indicate that the child voluntarily undertook the risk.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Chapter Review Practice and Review Elaine Sweeney went to Ragged Mountain Ski Resort in New Hampshire with a friend. Elaine went snow tubing down a run designed exclusively for snow tubers. No Ragged Mountain employees were present in the snow-tube area to instruct Elaine on the proper use of a snow tube. On her fourth run down the trail, Elaine crossed over the center line between snow-tube lanes, collided with another snow tuber, and was injured. Elaine filed a negligence action against Ragged Mountain seeking compensation for the injuries that she sustained. Two years earlier, the New Hampshire state legislature had enacted a statute that prohibited a person who participates in the sport of skiing from suing a ski-area operator for injuries caused by the risks inherent in skiing. Using the information presented in the chapter, answer the following questions. 81. What defense will Ragged Mountain probably assert? Solution The strongest defense will be assumption of the risk, which is common in sports. That defense is strengthened by the state statute that formalizes the defense. 82. The central question in this case is whether the state statute establishing that skiers assume the risks inherent in the sport applies to Elaine‘s suit. What would your decision be on this issue? Why? Solution Yes, because the statute strengthened the traditional common law rule. The legislature can change or limit common law rules, such as those for liability. Here the legislature strengthened the rule of assumption of the risk, which makes it very difficult for a plaintiff to overcome. 83. Suppose that the court concludes that the statute applies only to skiing and not to snow tubing. Will Elaine‘s lawsuit be successful? Explain. Solution No, because of assumption of the risk. The defense of assumption of the risk would still likely be a successful defense for the ski resort. That rule generally applies to participants in sporting events unless the host creates unreasonably dangerous conditions and does not warn clients. 84. Now suppose that the jury concludes that Elaine was partly at fault for the accident. Under what theory might her damages be reduced in proportion to how much her actions contributed to the accident and her resulting injuries? Solution Comparative negligence allows the jury to compute the contributions of both parties to the situation. This results in the reduction or elimination of the plaintiff‘s recovery, depending on the state rule and the percent of negligence contributed.

Practice and Review: Debate This 85. Each time a state legislature enacts a law that applies the assumption of risk doctrine to a particular sport, participants in that sport suffer. Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

The argument is that the less liability imposed on a sports-activity operator, the less that operator will take care to maintain the sports terrain and equipment. In other words, using the example of a ski area, a law that exempts the ski area from liability for skiing accidents will result in the ski area owner investing less in maintaining the trail system as well in the signage indicating hidden hazards. Additionally, ski area owner will pay for fewer ski patrollers who force fast skiers to slow down in congested areas or areas reserved for beginners. In contrast, there may be an upside to applying the assumption of risk doctrine to sports that are obviously not always safe. The benefit to all of those who participate is that tickets for such sports as Alpine skiing will be cheaper. There is competition among ski resorts. Therefore, if the ski resort owner pays less in liability insurance because of the state law under study in this debate topic, at least part of the savings will be passed on to ticket buyers. Also, when participants know that they can‘t sue for accidents, some may ski less recklessly.

Issue Spotters 86. Jana leaves her truck‘s motor running while she enters a Kwik-Pik Store. The truck‘s transmission engages, and the vehicle crashes into a gas pump, starting a fire that spreads to a warehouse on the next block. The warehouse collapses, causing its billboard to fall and injure Lou, a bystander. Can Lou recover from Jana? Why or why not? Solution Probably. To recover on the basis of negligence, the injured party as a plaintiff must show that the truck‘s owner owed the plaintiff a duty of care, that the owner breached that duty, that the plaintiff was injured, and that the breach caused the injury. In this problem, the owner‘s actions breached the duty of reasonable care. The billboard falling on the plaintiff was the direct cause of the injury, not the plaintiff‘s own negligence. Thus, liability turns on whether the plaintiff can connect the breach of duty to the injury. This involves the test of proximate cause—the question of foreseeability. The consequences to the injured party must have been a foreseeable result of the owner‘s carelessness. 87. A water pipe bursts, flooding a Metal Fabrication Company utility room and tripping the circuit breakers on a panel in the room. Metal Fabrication contacts Nouri, a licensed electrician with five years‘ experience, to check the damage and turn the breakers back on. Without testing for short circuits, which Nouri knows that he should do, he tries to switch on a breaker. He is electrocuted and his wife sues Metal Fabrication for damages, alleging negligence. What might the firm successfully claim in defense? Solution The company might defend against this electrician‘s claim by asserting that the electrician should have known of the risk and, therefore, the company had no duty to warn. According to the problem, the danger is common knowledge in the electrician‘s field and should have been apparent to this electrician, given his years of training and experience. In other words, the company most likely had no need to warn the electrician of the risk. The firm could also raise comparative negligence. Both parties‘ negligence, if any, could be weighed and the liability distributed proportionately. The defendant could also assert assumption of risk, claiming that the electrician voluntarily entered into a dangerous situation, knowing the risk involved.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Business Scenarios and Case Problems 88. Defamation. Richard is an employee of the Dun Construction Corp. While delivering materials to a construction site, he carelessly backs Dun‘s truck into a passenger vehicle driven by Green. This is Richard‘s second accident in six months. When the company owner, Dun, learns of this latest accident, a heated discussion ensues, and Dun fires Richard. Dun is so angry that he immediately writes a letter to the union of which Richard is a member and to all other construction companies in the community. In it, Dun states that Richard is the ―worst driver in the city‖ and that ―anyone who hires him is asking for legal liability.‖ Richard files a suit against Dun, alleging libel on the basis of the statements made in the letters. Discuss. (See Intentional Torts against Persons.) Solution The legal issue is whether Dun has libeled Richard‘s character. For Richard to recover in a legal action, he must prove the following elements: (a) that the defendant‘s writing contained a false statement, not privileged, presented as fact (called a false statement of fact), or a statement of opinion that was overpublicized, or even a true statement of fact that was overpublicized; (b) that the writing was made known to others besides the plaintiff (called publication); and (c) that damage occurred, if damages are sought by plaintiff. In this case, the writing of the letter and its distribution could not be considered privileged. One could argue that privilege may be extended to Dun if a union contract required that specific notice and reasons for firing union members be given to union officials. Such privilege, however, would not extend to the other construction businesses. Dun could also argue that the statements were true. Truth is a defense against a defamation suit. Richard would then argue that the statements were presented as facts, not merely opinion, and were false, or that even if they were true, they were overpublicized. Proof of publication is already established. Finally, if Richard cannot secure comparable work because of the letters, he might be able to recover lost wages. (Note here that if compensatory damages are proved, Richard will probably also be awarded punitive damages.) 89. Liability to Business Invitees. Kim went to Ling‘s Market to pick up a few items for dinner. It was a stormy day, and the wind had blown water through the market‘s door each time it opened. As Kim entered through the door, she slipped and fell in the rainwater that had accumulated on the floor. The manager knew of the weather conditions but had not posted any sign to warn customers of the water hazard. Kim injured her back as a result of the fall and sued Ling‘s for damages. Can Ling‘s be held liable for negligence? Discuss. (See Negligence.) Solution Yes. An occupier of the premises has a duty to use ordinary care to keep its premises in a reasonably safe condition and to warn customers of any foreseeable hazards. What constitutes a foreseeable hazard depends on whether a reasonably prudent person would conclude that harm could likely result from the conditions. Here, the manager knew of the storm conditions, knew that water accumulated rapidly on the floor, and knew or should have known that the water created a hazard. A court could find that the manager‘s failure to remove the water constituted negligence, and the manager could be held liable for Kim‘s injuries.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

90. Spotlight on Intentional Torts—Defamation. Sharon Yeagle was an assistant to the vice president of student affairs at Virginia Polytechnic Institute and State University (Virginia Tech). As part of her duties, Yeagle helped students participate in the Governor‘s Fellows Program. The Collegiate Times, Virginia Tech‘s student newspaper, published an article about the university‘s success in placing students in the program. The article‘s text surrounded a block quotation attributed to Yeagle with the phrase ―Director of Butt Licking‖ under her name. Yeagle sued the Collegiate Times for defamation. She argued that the phrase implied the commission of sodomy and was therefore actionable. What is Collegiate Times’s defense to this claim? [Yeagle v. Collegiate Times, 497 S.E.2d 136 (Va. 1998)] (See Intentional Torts against Persons.) Solution The newspaper‘s defense was that the statement was not actionable defamation because it did not convey any factual information about Sharon Yeagle. The court noted that the phrase was disgusting and in extremely bad taste, but agreed with the newspaper. The phrase was no more than ―rhetorical hyperbole‖ and could not be understood as stating an actual fact about Yeagle. Considering the article as a whole, which generally presented a positive view of Yeagle‘s efforts, the phrase did not denigrate her job title, her morals, or her conduct in the workplace. 91. Business Case Problem with Sample Answer— Negligence. At the Weatherford Hotel in Flagstaff, Arizona, in Room 59, a balcony extends across thirty inches of the room‘s only window, leaving a twelveinch gap with a three-story drop to the concrete below. A sign prohibits smoking in the room but invites guests to ―step out onto the balcony‖ to smoke. Toni Lucario was a guest in Room 59 when she climbed out of the window and fell to her death. Patrick McMurtry, her estate‘s personal representative, filed a suit against the Weatherford. Did the hotel breach a duty of care to Lucario? What might the Weatherford assert in its defense? Explain. [McMurtry v. Weatherford Hotel, Inc., 293 P.3d 520 (Ariz. App. 2013)] (See Negligence.) —For a sample answer to Problem 5–4, go to Appendix E. Solution Negligence requires proof that (1) the defendant owed a duty of care to the plaintiff; (2) the defendant breached that duty; (3) the defendant's breach caused the plaintiff‘s injury; and (4) the plaintiff suffered a legally recognizable injury. With respect to the duty of care, a business owner has a duty to use reasonable care to protect business invitees. This duty includes an obligation to discover and correct or warn of unreasonably dangerous conditions that the owner of the premises should reasonably foresee might endanger an invitee. Some risks are so obvious that an owner need not warn of them. But even if a risk is obvious, a business owner may not be excused from the duty to protect its customers from foreseeable harm. Because Lucario was the Weatherford‘s business invitee, the hotel owed her a duty of reasonable care to make its premises safe for her use. The balcony ran nearly the entire width of the window in Lucario‘s room. She could have reasonably believed that the window was a means of access to the balcony. The window/balcony configuration was dangerous, however, because the window opened wide enough for an adult to climb out, but the twelve-inch gap between one side of the window and the balcony was unprotected, and this unprotected gap opened to a drop of more than three stories to a concrete surface below. Should the hotel have anticipated the potential harm to a guest opening the window in Room 59 and attempting to access the balcony? The hotel encouraged guests to ―step out onto the balcony‖ to smoke. The dangerous condition of the window/balcony configuration could have

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

been remedied at a minimal cost. These circumstances could be perceived as creating an ―unreasonably dangerous‖ condition. And it could be concluded that the hotel created or knew of the condition and failed to take reasonable steps to warn of it or correct it. Of course, the Weatherford might argue that the window/balcony configuration was so obvious that the hotel was not liable for Lucario‘s fall. In the actual case on which this problem is based, the court concluded that the Weatherford did not breach its duty of care to Lucario. On McMurtry‘s appeal, a state intermediate appellate court held that this conclusion was in error, vacated the lower court‘s judgment in favor of the hotel on this issue, and remanded the case. 92. Negligence. Ronald Rawls and Zabian Bailey were in an auto accident in Bridgeport, Connecticut. Bailey rear-ended Rawls at a stoplight. Evidence showed it was more likely than not that Bailey failed to apply his brakes in time to avoid the collision, failed to turn his vehicle to avoid the collision, failed to keep his vehicle under control, and was inattentive to his surroundings. Rawls filed a suit in a Connecticut state court against his insurance company, Progressive Northern Insurance Co., to obtain benefits under an underinsured motorist clause, alleging that Bailey had been negligent. Could Rawls collect? Discuss. [Rawls v. Progressive Northern Insurance Co., 310 Conn. 768, 83 A.3d 576 (2014)] (See Negligence.) Solution Yes, Rawls could obtain benefits from Progressive Northern Insurance Co. under an underinsured motorist clause, on the ground that Bailey had been negligent. To succeed in a negligence action, the plaintiff must prove that (1) the defendant owed a duty of care to the injured party (plaintiff), (2) the defendant breached that duty, (3) the breach was the cause of harm to the plaintiff, and (4) the harm to the plaintiff was a legally recognizable injury. The duty must be such that a reasonable person engaging in the same activity would anticipate a risk of the negative consequences and guard against it. In this problem, Zabian Bailey rear-ended Rawls at a stoplight. According to the facts, the evidence showed it was more likely than not that Bailey failed to apply his brakes in time to avoid the collision, failed to turn his vehicle to avoid the collision, failed to keep his vehicle under control, and was inattentive to his surroundings. Bailey‘s duty to Rawls included any and all of thee precautions—braking in time, turning the vehicle, keeping the vehicle under control, and remaining attentive to the surroundings. Clearly, Bailey breached this duty, and the breach caused whatever harm Rawls suffered—damage to his vehicle and injury to himself. Depending on whether Bailey was grossly negligent, punitive damages might be appropriate. In the actual case on which this problem is based, a jury found in Rawls‘s favor, and the court entered a judgment against Progressive. On the insurer‘s appeal, a state intermediate appellate court reversed, but on further appeal the state supreme court reversed again, holding that the evidence supported the jury‘s findings in Rawls‘s favor. 93. Negligence. Charles Robison, an employee of West Star Transportation, Inc., was ordered to cover an unevenly loaded flatbed trailer with a 150-pound tarpaulin. The load included uncrated equipment and pallet crates of different heights, about thirteen feet off the ground at its highest point. While standing on the load, manipulating the tarpaulin without safety equipment or assistance, Robison fell headfirst and sustained a traumatic head injury. He filed a suit against West Star to recover for his injury. Was West Star ―negligent in failing to provide a reasonably safe

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

place to work,‖ as Robison claimed? Explain. [West Star Transportation, Inc. v. Robison, 457 S.W.3d 178 (Tex.App.— Amarillo 2015)] (See Negligence.) Solution Yes, West Star was negligent in failing to provide a reasonably safe place to work. Central to the tort of negligence is the concept of duty of care. Tort law measures duty by the reasonable person standard—how a reasonable person would have acted in the same circumstances. But the degree of care to be exercised varies, depending on the person‘s profession, the person‘s relationship with the injured party, and other factors—in other words, it is what a reasonable person in the position of the defendant in a negligence case would have done in the particular circumstances. In this problem, West Star Transportation, Inc., ordered its employee Charles Robison to cover an unevenly loaded flatbed trailer with a heavy tarpaulin. The load was ungainly, uneven, and about thirteen feet above the ground at its highest point. Manipulating the tarpaulin without safety equipment or assistance, Charles fell from the load and sustained a head injury. West Star owed a duty to its employee to exercise reasonable care, but West Star did not do what a shipper of ordinary prudence would have done under the same or similar circumstances. West Star should have refused to handle a load requiring unreasonably dangerous tarping or the company should have taken appropriate safety precautions. In the actual case on which this problem is based, a jury found that West Star's negligence proximately caused the incident. On West Star‘s appeal, a state intermediate appellate court affirmed. 94. Negligence. DSC Industrial Supply and Road Rider Supply are located in North Kitsap Business Park in Seattle, Washington. Both firms are owned by Paul and Suzanne Marshall. The Marshalls had outstanding commercial loans from Frontier Bank. The bank dispatched one of its employees, Suzette Gould, to North Kitsap to ―spread Christmas cheer‖ to the Marshalls as an expression of appreciation for their business. Approaching the entry to Road Rider, Gould tripped over a concrete ―wheel stop‖ and fell, suffering a broken arm and a dislocated elbow. The stop was not clearly visible, it had not been painted a contrasting color, and it was not marked with a sign. Gould had not been aware of the stop before she tripped over it. Is North Kitsap liable to Gould for negligence? Explain. [Gould v. North Kitsap Business Park Management, LLC, 192 Wash. App. 1021 (2016)] (See Negligence.) Solution Yes, North Kitsap is liable to Gould in the circumstances of this problem for negligence. To succeed in an action for negligence, a plaintiff must prove that the defendant owed a duty of care to the plaintiff, the defendant breached the duty, the breach caused an injury to the plaintiff, and the plaintiff thereby suffered a legally recognizable injury. In this problem, Frontier Bank sent one of its employees, Suzette Gould, to North Kitsap Business Park in Seattle, Washington, to ―spread Christmas cheer‖ to a couple of the bank‘s customers, Paul and Suzanne Marshall, as an expression of appreciation for their business. The Marshalls owned DSC Industrial Supply and Road Rider Supply, which were located in North Kitsap. Approaching the entry to Road Rider, Gould tripped over a concrete ―wheel stop‖ and fell, suffering a broken arm and a dislocated elbow.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

Applying the principles of negligence theory to these facts, North Kitsap owed Gould a duty as a business invitee of the Marshalls (and thus of North Kitsap) to protect her from dangerous conditions on the premises. Gould was not aware of the wheel stop, which was a dangerous condition because it was not clearly visible, and not painted a contrasting color or marked with a sign. North Kitsap breached its duty by not making the stop safer. This breach was the proximate cause of Gould‘s injuries. In the actual case on which this problem is based, Gould filed a suit in a Washington state court against North Kitsap, alleging negligence. The court issued a judgment in her favor. A state intermediate appellate court affirmed the judgment, on the reasoning stated here. 95. Defamation. Jonathan Martin, an offensive lineman with the Miami Dolphins, abruptly quit the team and checked himself into a hospital seeking psychological treatment. Later, he explained that he left because of persistent taunting from other Dolphins players. The National Football League hired attorney Theodore Wells to investigate Martin‘s allegations of bullying. After receiving Wells‘s report, the Dolphins fired their offensive line coach, James Turner. Turner was a prominent person on the Dolphins team, and during his career he chose to thrust himself further into the public arena. He was the subject of articles discussing his coaching philosophy, and the focus of one season of HBO‘s ―Hard Knocks,‖ showcasing his coaching style. Turner filed a suit in a federal district court against Wells, alleging defamation. He charged that Wells had failed to properly analyze certain information. Is Turner likely to succeed on his claim? Explain. [Turner v. Wells, 879 F.3d 1254 (11th Cir. 2018)] (See Intentional Torts against Persons.) Solution No, Turner is not likely to succeed on his claim for defamation. Persons in the public eye are public figures. Generally, false statements that appear in the media, or otherwise, about public figures do not constitute defamation unless the statements are made with actual malice. In other words, to succeed on a claim for defamation, a public figure has to prove malice. To be made with malice, a false statement must be made with knowledge of its falsity or a reckless disregard for its truth. In this problem, Turner qualifies as a public figure. He was a prominent person—the offensive line coach—on the Miami Dolphins. During his career, he chose to thrust himself further into the public arena. For instance, he was the subject of articles discussing his coaching philosophy, and the focus of one season of HBO‘s ―Hard Knocks,‖ showcasing his coaching style. Thus, to prove his claim against Wells, Turner would have to prove malice. Wells investigated allegations of bullying among the Dolphins. After receiving Wells‘ report, the team fired Turner. He claimed defamation, charging that Wells, in his report, failed to properly analyze certain information. But this is not proof of malice. In fact, this is not even an allegation of malice. In the actual case on which this problem is based, the court dismissed Turner‘s suit. The U.S. Court of Appeals for the Eleventh Circuit affirmed. ―Turner is a public figure who has failed to adequately plead that the Defendants acted with malice in drafting and publishing the Report.‖ 96. A Question of Ethics—The IDDR Approach and Wrongful Interference. Julie Whitchurch was an employee of Vizant Technologies, LLC. After she was fired, she created a website falsely accusing Vizant of fraud and mismanagement to discourage others from doing business with the company. Vizant filed a suit in a federal district court against her, alleging wrongful interference with a business relationship. The court concluded that Whitchurch‘s online criticism of Vizant

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

adversely affected its employees and operations, forced it to accept reduced compensation to obtain business, and deterred outside investment. The court ordered Whitchurch to stop her online efforts to discourage others from doing business with Vizant. [Vizant Technologies, LLC v. Whitchurch, 675 Fed. Appx. 201 (3d Cir. 2017)] (See Intentional Torts against Persons.) 3. How does the motivation for Whitchurch‘s conduct differ from that in other cases involving wrongful interference? What does this suggest about the ethics in this situation? Discuss. 4. Another group will argue that the statute does not violate litigants‘ right of access to the courts. Using the IDDR approach, analyze and evaluate Vizant‘s decision to file a suit against Whitchurch.

Solution 1. Wrongful interference with another‘s business rights can be divided into two categories— wrongful interference with a contractual relationship and wrongful interference with a business relationship. The typical case of wrongful interference involves a scheme to attract another‘s employee or customer to work for or do business with the party who commits the tort. In either circumstance, the motivation is normally to gain or increase a share of a market. In this problem, Julie Whitchurch worked for Vizant Technologies. After she was terminated, she created a website falsely accusing Vizant of fraud and mismanagement. Her purpose was to discourage others from doing business with her ex-employer. Vizant sued Whitchurch, alleging wrongful interference with a business relationship. The court concluded that Whitchurch‘s disparagement of Vizant adversely affected its employees and operations, forced it to accept lower compensation to attract business, and deterred outside investment in the company. The results of Whitchurch‘s action may be similar to the results in other cases of wrongful interference. But her motivation was not to gain or increase a share of a market. Her motive appears to have been revenge. This suggests that Whitchurch suffered from a greater lack of ethics than the typical defendant accused of wrongful interference. From a utilitarian perspective, an attempt to gain or increase a market share can have arguably positive results. A desire to exact revenge, however, is almost wholly gratuitous, especially in the circumstances of this case. In the actual case on which this problem is based, the court issued a judgment in Vizant‘s favor and enjoined Whitchurch from discouraging others to do business with Vizant. The U.S. Court of Appeals for the Third Circuit affirmed the judgment and injunction. 2. Vizant‘s decision to file a suit was probably motivated by a desire to end the impact of Whitchurch‘s criticism of the company. The decision will most likely prove to be a success. Whitchurch created a website to falsely accuse Vizant of fraud and mismanagement. She intended to discourage others from doing business with the company. The disparagement had its intended effect, adversely affecting the firm‘s employees and operations. Vizant was forced to lower its prices to obtain business. Outside investors were deterred from investing in the firm.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

The IDDR approach has four steps—Inquiry, Discussion, Decision, and Review. The purpose of the first step, Inquiry, is to identify the issue, the stakeholders, and applicable ethical theories. In this problem, the impact of Whitchurch‘s accusations likely prompted Vizant to consider actions to curtail them. The company might have chosen to do nothing, or it might have attempted to negotiate with Whitchurch. A third option would be to file a suit against her. Aside from the principal parties, the stakeholders include the company‘s owners, directors, officers, employees, and customers, as well as other members of the firm‘s community. These are the persons who suffer when business is bad. Ethics standards may derive from religious or philosophical principles, the principle-of-rights theory, the categorical imperative, or utilitarianism. The second step, Discussion, involves analyzing possible actions to address the issue. Factors include the strengths and weaknesses of those actions, considering their consequences and their effects on stakeholders. Choosing to do nothing could effectively rob Whitchurch‘s accusations of credibility. Negotiations might lead to a retraction of, and an end to, her comments. Either course would save the cost and publicity of litigation. If these actions were tried and failed, a suit could become the only viable option to stop the criticism. Utilitarianism would seem to be the ethical theory to apply here—a suit would be the proper action if it would produce the greatest good for the most people. Considering the number of stakeholders, there is little doubt that a successful suit against Whitchurch would have the optimal result. The third step is to make a Decision and state the reasons. Clearly, in this case, Vizant decided to proceed with its suit. The reasons include those stated above. After the filing of the complaint and before the trial, there would have been time for the parties to negotiate a quicker, less expensive end to the matter. Of course, this did not happen—Whitchurch continued, even after a loss at trial, up to or perhaps through an appeal. The final step, Review, determines the success or failure of the action to resolve the issue, and satisfy the stakeholders. In the actual case on which this problem is based, the court issued a judgment in Vizant‘s favor and enjoined Whitchurch from discouraging others to do business with Vizant. The U.S. Court of Appeals for the Third Circuit affirmed the judgment and the injunction. This indicates the success of Vizant‘s action to at least temporarily resolve the issue and, assuming a decline in negative effects coincident with the imposition of the injunction, satisfy the stakeholders.

Critical Thinking and Writing Assignments 97. Time-Limited Group Assignment—Negligence. Donald and Gloria Bowden hosted a cookout at their home in South Carolina, inviting mostly business acquaintances. Justin Parks, who was nineteen years old, attended the party. Alcoholic beverages were available to all of the guests, even those who, like Parks, were between the ages of eighteen and twenty-one. Parks consumed alcohol at the party and left with other guests. One of these guests detained Parks at the guest‘s home to give Parks time to ―sober up.‖ Parks then drove himself from this guest‘s home and was killed in a one-car accident. At the time of death, he had a blood alcohol content of 0.291 percent, which exceeded the state‘s limit for driving a motor vehicle. Linda Marcum, Parks‘s mother, filed a suit in a South Carolina state court against the Bowdens and others, alleging negligence. (See Negligence.)

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 05: Tort Law

4. The first group will present arguments in favor of holding the social hosts (Donald and Gloria Bowden) liable in this situation. 5. The second group will formulate arguments against holding the social hosts liable. 6. The states vary widely in assessing liability and imposing sanctions in the circumstances described in this problem. The third group will analyze the possible reasons why some courts treat social hosts who serve alcohol differently than parents who serve alcohol to their underage children. 7. The fourth group will decide whether the guest who detained Parks at his home to give Parks time to sober up could be held liable for negligence. What defense might this guest raise? Solution 1. If there were a statute in South Carolina that could be applied to this set of facts, as there are in some states, it would present a nearly unassailable argument in favor of imposing liability. In the absence of such a specific law, an alcoholic beverage control statute might provide a basis for imposing liability, under limited circumstances, on commercial hosts (the owners of bars, for example). For policy reasons, those circumstances might be limited to the service of alcoholic beverages to an intoxicated adult to whom recovery might be denied. Commercial entities might also be statutorily liable for knowingly selling alcoholic beverages to minors, who may be allowed to recover. It could be argued that liability might extend, under at least the latter statutes, to social hosts. But these statutes would likely not support imposing a common-law negligence duty on a social host with recovery by an underage individual who consumed the alcoholic beverages. Why? Because this would impose a higher standard on the social host than that to which the commercial provider was subject. Or public policy might warrant treating underage individuals as lacking full adult capacity to make informed decisions concerning the ingestion of alcoholic beverages and holding liable adult social hosts who knowingly and intentionally serve, or cause to be served, alcoholic beverages to persons they know or should know to be between the ages of eighteen and twenty. 2. In any situation, it might be argued that underage drinkers who are not minors should be considered the same as other adults, with no liability imposed on their social hosts for torts committed by intoxicated guests. 3. The contrast in liability and punishments among the states is a consequence of conflicting public attitudes about underage drinking. Parents who would not approve of their underage children consuming alcoholic beverages outside their homes, for example, might condone such drinking in their homes. In that situation, the rationalization might be to keep teenagers off the road and out of other kinds of trouble. Some might view this attitude and its supporting ―reasoning‖ as what is sometimes referred to as ―situation ethics.‖ The legal environment might unintentionally lend support to these parents by rarely holding them responsible for allowing teenagers to consume alcohol in their homes. This is in part because it is difficult to prove in such circumstances which adults provided the alcohol or condoned its use. In some states, it is legal for minors to consume alcohol in their parents‘ presence and in other limited circumstances—in conjunction with a religious ceremony, for example. Even parents who might allow their children to drink in their presence might object strongly to other adults making that choice for them. 4. The guest who detained Parks at his home to give Parks time to sober up could be held liable for negligence on the basis that he assumed a duty to Parks by taking this action and

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

breached the duty by letting him drive home. The breach might be construed as the proximate cause of the accident that resulted in Parks‘ death, with his parents suffering emotional injuries for their loss. The defenses to the charge in this scenario that the guest might assert include that he owed no duty, that if he did it was not breached, that if there was a breach of duty, it was not the direct or proximate cause of Parks‘ accident, and that even if those elements of negligence might be proved, his parents suffered no compensable injury. All of these defenses would be predicated on the fact of Parks‘ underage over-consumption of alcohol at the Bowdens‘ party, for which the guest was not responsible. Alternately, the guest might claim that by temporarily detaining Parks to sober up, the guest was acting as a Good Samaritan, and under such a statute one who voluntarily aids another is protected from being held liable for negligence. Or the guest might argue that a state dram shop act designates those who might be liable for injuries caused by intoxicated persons as the sellers or servers who contributed to it—the guest was neither a seller nor a server of alcohol to Parks. The guest might also argue that Parks assumed the risk of his own death by drinking to excess and then driving, or that under either a contributory or comparative negligence theory the guest was entitled to avoid liability for the greater negligence of the hosts or Park himself.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Table of Contents Critical Thinking Questions in Features ............................................................................................................... 37 Adapting the Law to the Online Environment ......................................................................................... 37 Critical Thinking Questions in Cases ..................................................................................................................... 37 Case 4.1 ................................................................................................................................................... 37 Case 4.2 ................................................................................................................................................... 38 Case 4.3 ................................................................................................................................................... 38 Chapter Review ............................................................................................................................................................. 39 Practice and Review ................................................................................................................................ 39 Practice and Review: Debate This ........................................................................................................... 40 Issue Spotters .......................................................................................................................................... 40 Business Scenarios and Case Problems ................................................................................................... 41 Critical Thinking and Writing Assignments .............................................................................................. 47

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Critical Thinking Questions in Features Adapting the Law to the Online Environment 98. Security engineers discovered that faulty coding in the Chrysler Jeep‘s entertainment software made the car vulnerable to cyber attacks, conceivably enabling hackers to gain control of the vehicles. The United States Supreme Court has allowed a breach of warranty lawsuit against Chrysler by Jeep owners who contend they would not have purchased the cars had they known about the security defect. Why might the outcome of this case be important for strict product liability law? Solution An important question in the developing field of IoT strict product liability law is: who is liable for product malfunction that results from hacking and causes harm? The hacker, certainly. The manufacturer, perhaps, but only if a failed security system qualifies as a defective condition that makes the IoT product ―unreasonably dangerous‖ to consumers or users. Even though it is not a strict product liability case, the Chrysler lawsuit does involve plaintiffs who have been harmed, albeit economically, by a manufacturer‘s failure to protect its product against cyberattacks. Whether or not the plaintiffs prevail, their case will establish a precedent for the extent to which civil law is willing to hold manufacturers responsible for lapses in the cybersecurity embedded in their products.

Managerial Strategy 1. To protect themselves, manufacturers have been forced to include lengthy warnings for their products. What might be the downside of such warnings? Solution A lengthy warning is less likely to be read by a product‘s user. And an injured user who failed to read and heed a warning might not be able to successfully argue as a plaintiff that a defect in the warning caused the injury. 2. Does a manufacturer have to create safety warnings for every product? Why or why not? Solution No. All manufacturers do not have to provide safety warnings for all products. As noted in the text, people know that knives are sharp and can cut fingers, for example, so a warning label on each knife warning consumers of the danger is arguably unnecessary. In fact, most household products are safe when used as intended. This is particularly true when the danger is open and obvious. Warning about such risks would not increase the safety of the product and might detract from it by undercutting the significance of other, less clear risks.

Critical Thinking Questions in Cases Case 6.1 99. In the initial trial, should the jury have found that O‘Bryan was also at fault? How might this finding have affected the award of damages? Explain. Solution Yes, the jury should have found that O‘Bryan was also at fault for the injuries that he received in the collapse of a ladderstand made by Primal Vantage Co. This finding would have reduced the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

maker‘s responsibility for the amount of the award of damages to the percentage of the company‘s fault. O‘Byran was injured—paralyzed from the waist down, and suffering unremitting pain—when he climbed the ladder of the stand to a platform fifteen feet above the ground and the platform collapsed. Attached to a tree for five years without inspection or maintenance, exposed to the elements and the growth of the tree, the deteriorated straps securing the stand to the tree had broken. In O‘Bryan‘s suit against Primal Vantage, alleging product liability, the plaintiff argued that the warnings and instructions accompanying the stand were inadequate. The jury agreed and awarded damages to the plaintiff. Primal Vantage appealed, contending that any inadequacy in this regard was not the proximate cause of the accident—the cause was the failure of the owner of the stand to maintain it in accord with the instructions. A state intermediate appellate court affirmed the judgment of the lower court. ―The negligence of an intervening party does not relieve the manufacturer of the duty to warn adequately.‖ In the actual Primal Vantage case, the jury found that O‘Bryan also failed to comply with his duty of ordinary care and that this failure was a substantial factor in causing the accident. The jury calculated the total damages, and assigned fifty percent of the fault to each party, reducing Primal Vantage‘s obligation by half. 100. During voir dire, a potential juror asked whether the jury would be told how much Primal Vantage‘s insurance company would pay if O‘Bryan were awarded damages. How should the court have responded? Why? Solution In response to a question about the defendant‘s insurance coverage, the court should have told the potential jurors that they would not be told how much Primal Vantage‘s insurance company would pay if O‘Bryan were awarded damages, because the fact and amount of insurance would have no bearing on the decisions they would be asked to make. A court should make this sort of explanation to counteract any prejudice caused by questions about insurance. In theory, the existence and amount of insurance should not affect a determination of liability and damages in a negligence-based product liability suit. In the actual Primal Vantage case, the court explained to the jury, ―If someone‘s liable you should find them liable, regardless of who is going to pay.‖ How much an insurer might pay ―does not affect the amount of the loss.‖ For those reasons, ―insurance does not matter at all when you‘re assessing damages. Insurance does not change how you do the math. * * * You decide on the number based on the evidence.‖

Case 6.2 101.

Why did Janssen downplay the risks of Risperdal in the warnings to physicians? Discuss.

Solution Most likely, Janssen downplayed the risks of Risperdal in its warnings to physicians in order not to discourage its use, which thereby increased the maker‘s return on its investment in the drug.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Developing and testing drugs that may ultimately be approved for use by patients is an extraordinarily expensive endeavor. Taking any step late in this process that would discourage the use of a drug in which its developer has invested so much time, money, and effort could result in a significant economic loss. Of course, the business strategy to understate the risks of the use of a prescription drug can cause negative results. Some patients who might not otherwise have been prescribed the drug may suffer harm from its use, leading to the imposition of liability on its manufacturer, as in the Stange case. And this could further lead to greater losses in human and economic terms than would have occurred if the maker had been upfront about the risks in the first place. 102. Suppose that instead of suffering harm through a prescription drug‘s legitimate use, the plaintiff had been injured by a drug‘s illegal abuse. Would the result have been different? Explain. Solution Yes, if instead of suffering harm through a prescription drug‘s legitimate use, the plaintiff had been injured by a drug‘s illegal abuse, the result would have been different. When an injury is caused to a patient by the use of a prescribed drug, it must be proved that its maker failed to exercise reasonable care to inform the prescribing physician of facts that make the drug likely to be dangerous. And sometimes, liability may arise through a product‘s foreseeable misuse. But if a person is harmed by a drug through its illegal abuse, there is no legal, or even logical, basis on which to impose liability on its maker.

Case 6.3 103. If the public wants to change the policy applied outlined in this case, which branch of the government—and at what level—should be lobbied to make the change? Explain. Solution The statute at the heart of this case is the National Childhood Vaccine Injury Act (NCVIA). The branch of the government that should be lobbied by the advocates for a change in the policy expressed through the statute is the legislative branch. Any change should be sought through the legislative process at the federal level by lobbying Congress. The reason is that the NCVIA is a federal statute. 104.

What is the public policy expressed by the provisions of the NCVIA?

Solution In the Supreme Court‘s interpretation, the NCVIA‘s program balances payment of compensation to victims harmed by vaccines and protection of the vaccine industry from the potentially devastating costs of tort liability. In effect, the Court adds a fourth assumption to the list in the text of the grounds for the public policy underlying the imposition of product liability—the liability imposed on the manufacturers of beneficial products should not be so onerous as to drive them out of business.

Chapter Review Practice and Review Shalene Kolchek bought a Great Lakes Spa from Val Porter, a dealer who was selling spas at the state fair. After Kolchek signed the contract, Porter handed her the manufacturer‘s paperwork and arranged for the spa to be delivered and installed for her. Three months later, Kolchek left her six-

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

year-old daughter, Litisha, alone in the spa. While exploring the spa‘s hydromassage jets, Litisha got her index finger stuck in one of the jet holes. Litisha yanked hard, injuring her finger, and then panicked and screamed for help. Kolchek was unable to remove Litisha‘s finger, and the local police and rescue team were called to assist. After a three-hour operation that included draining the spa, sawing out a section of the spa‘s plastic molding, and slicing the jet casing, Litisha‘s finger was freed. Following this procedure, the spa was no longer functional. Litisha was taken to the local emergency room, where she was told that a bone in her finger was broken in two places. Using the information presented in the chapter, answer the following questions.

105. Under which theories of product liability can Kolchek sue Porter to recover for Litisha‘s injuries? Solution Kolchek may sue the manufacturer Great Lakes for product liability based upon negli gence. Furthermore, she may assert claims against Great Lakes and Porter, as a mem ber of the distributive chain, for strict product liability based upon design defects associ ated with the spa and inadequate warnings with respect to its use. 106. Would privity of contract be required for Kolchek to succeed in a product liability action against Great Lakes? Explain. Solution Injured consumers may bring claims sounding in product liability or strict liability against manufacturers despite the absence of a direct contractual relationship. Potential defendants to such actions include manufacturers, sellers, and lessors. 107. For an action in strict product liability against Great Lakes, what six requirements must Kolchek meet? Solution Plaintiffs in strict product liability cases must show the product was in a defective con dition when it was sold, the defendant sells or distributes such products in the ordinary course of business, the product was unreasonably dangerous, the plaintiff suffered physical harm or injury to property as a result of use of the product, the injury was proximately caused by the defect, and the product was not substantially changed from the time it was sold to the time the injury occurred. 108.

What defenses to product liability might Porter or Great Lakes be able to assert?

Solution Comparative negligence allows the jury to compute the contributions of both parties to the situation. This results in the reduction or elimination of the plaintiff‘s recovery, de pending on the state rule and the percent of negligence contributed. Leaving a six-year-old unattended in the spa may be deemed negligent and thereby reduce the plaintiff‘s ultimate recovery.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Practice and Review: Debate This 109. All liability suits against tobacco companies for causing lung cancer should be thrown out of court now and forever. Solution It is difficult to believe that those who smoked in the past and those who smoke tobacco products today didn‘t or don‘t know about the health dangers of smoking. After all, even 75 years ago, before any research was carried out, kids called cigarettes ―coffin nails.‖ Common sense tells anyone that inhaling smoke into one‘s lungs cannot have a positive effect on one‘s health. Cigarettes are just another product that individuals have the choice to buy or not to buy. There should be no liability issues here. Cigarette companies for years promoted the glamour and even the safety of smok ing, so tobacco manufacturers should be liable for the deaths caused by cigarette smok ing, at least those that occurred in the past. There is uncontroverted proof that the ads for cigarette smoking were misleading because they played down the negative health ef fects of this activity. Any time false advertising is an issue, companies that engage in it should be held liable for the results of such advertising.

Issue Spotters 110. Rim Corporation makes tire rims and sells them to Superior Vehicles, Inc., which installs them on cars. One set of rims is defective, which an in spection would reveal. Superior does not inspect the rims. The car with the defective rims is sold to Town Auto Sales, which sells the car to Uri. Soon, the car is in an accident caused by the defective rims, and Uri is in jured. Is Superior Vehicles liable? Explain your answer. Solution Yes. Those who make, sell, or lease goods are liable for the harm or damages caused by those goods to a consumer, user, or bystander. The maker of component parts may also be liable. In this situation, Rim Corporation makes tires that Superior installs on its vehicles before selling them to dealers. Thus, Superior is the manufacturer, and Rim is the maker of component parts. A manufacturer is liable for its failure to exercise due care to any person who sustains an injury proximately caused by a negligently made (defective) product. Superior‘s failure to inspect and test the tires it installs is a failure to use due care. Thus, Superior is liable to the injured buyer, Uri. Rim Corporation may also be liable. 111. Bensing Company manufactures generic drugs for the treatment of heart disease. A federal law requires generic drug makers to use labels that are identical to the labels on brandname versions of the drugs. Hunter Rothfus purchased Bensing‘s generic drugs in Ohio and wants to sue Bensing for defective labeling based on its failure to comply with Ohio state common law (rather than the federal labeling requirements). What defense might Bensing assert to avoid liability under state law? Solution Bensing can assert the defense of preemption. An injured party may not be able to sue the manufacturer of defective products that are subject to comprehensive federal regulatory schemes (such as medical devices and vaccinations). In this situation, it is likely that a court would conclude that the federal regulations pertaining to drug labeling preempt Ohio‘s common law rules.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Therefore, Bensing would not be liable to Rothfus for defective labeling if it complied with federal law.

Business Scenarios and Case Problems 112. Product Liability. Carmen buys a television set manufactured by AKI Electronics. She is going on vacation, so she takes the set to her mother‘s house for her mother to use. Because the set is defective, it explodes, causing considerable damage to her mother‘s house. Carmen‘s mother sues AKI for the damage to her house. Discuss the theories under which Carmen‘s mother can recover from AKI. (See Product Liability Claims.)

Solution Carmen‘s mother can bring a suit against AKI under a theory of negligence or strict liability. Under negligence theory, Carmen‘s mother would have to show that AKI failed to exercise due care to make the product safe and that this breach of duty was the proximate cause of the damages. If Carmen‘s mother brings a suit under a theory of strict liability, according to the Restatement (Second) of Torts, she needs to establish six basic requirements of strict prod uct li ability, which are as follows: (1) the defendant must sell the product in a defec tive condition; (2) the defendant must normally be engaged in the busi ness of selling the product; (3) the product must be unrea sonably dangerous to the user or consumer because of its defective condition; (4) the plaintiff must incur physi cal harm to self or property by use or consumption of the product; (5) the defec tive condition must be the proximate cause of the in jury or damage; and (6) the goods must not have been substantially changed from the time the product was sold to the time the injury was sustained. Under either theory (negligence or strict liability), privity of con tract is not required. Some courts may not allow re covery for property damage unless personal injury also occurs. 113. Product Liability. Jason Clark, an experienced hunter, bought a paintball gun. Clark practiced

with the gun and knew how to screw in the carbon dioxide cartridge, pump the gun, and use its safety and trigger. Although Clark was aware that he could purchase protective eyewear, he chose not to do so. Clark had taken gun safety courses and understood that it was ―common sense‖ not to shoot anyone in the face. Clark‘s friend, Chris Wright, also owned a paintball gun and was similarly familiar with the gun‘s use and its risks. Clark, Wright, and their friends played a game that involved shooting paintballs at cars whose occupants also had the guns. One night, while Clark and Wright were cruising with their guns, Wright shot at Clark‘s car but hit Clark in the eye. Clark filed a product liability lawsuit against the manufacturer of Wright‘s paintball gun to recover for the injury. Clark claimed that the gun was defectively designed. During the trial, Wright testified that his gun ―never malfunctioned.‖ In whose favor should the court rule? Why? (See Product Liability Claims.) Solution The court should rule in favor of the manufacturer, finding that the gun did not malfunction but performed exactly as Clark and Wright expected. The court should also point out that Clark and

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

Wright appreciated the danger of using the guns without protective eyewear. Clark offered no proof that the paintball gun used in the incident failed to function as expected. He was aware that there was protective eyewear available but he chose not to buy it. He was an active partici pant in shooting paint balls at other vehicles. The evening of the incident Clark carried his paintball gun with him for that purpose. Wright also knew it was dan gerous to shoot someone in the eye with a paintball gun. But the most crucial tes timony was Wright‘s statement that his paintball gun did not malfunction. 114. Product Misuse. Five-year-old Cheyenne Stark was riding in the backseat of her parents‘ Ford

Taurus. Cheyenne was not sitting in a booster seat. Instead, she was using a seatbelt designed by Ford but was wearing the shoulder belt behind her back. The car was involved in a collision. As a result, Cheyenne suffered a spinal cord injury and was paralyzed from the waist down. The family filed a suit against Ford Motor Co., alleging that the seatbelt was defectively designed. Could Ford successfully claim that Cheyenne had misused the seatbelt? Why or why not? [Stark v. Ford Motor Co., 365 N.C. 468, 723 S.E.2d 753 (2012)] (See Defenses to Product Liability.) Solution No, Ford could not succeed on a claim that Cheyenne had misused the seatbelt. Product misuse occurs when a product is used for a purpose that was not in tended. This defense has been severely limited by the courts. It is recognized as a defense only when the particular use was not reasonably foreseeable. Manufacturers and suppliers are required to expect reasonably foreseeable mis uses and to design products that are safe when misused or marketed with a pro tective device, such as a childproof cap. In the facts of this problem, Cheyenne was too young to be negligent, and it is reasonably foreseeable that a child would wear a seatbelt incorrectly without understanding the risks. In the actual case on which this problem is based, the court issued a judg ment in Cheyenne‘s favor. 115. Business Case Problem with Sample Answer—Product Liability. While driving on Interstate

40 in North Carolina, Carroll Jett became distracted by a texting system in the cab of his tractortrailer truck. He smashed into several vehicles that were slowed or stopped in front of him, injuring Barbara and Michael Durkee and others. The injured motorists filed a suit in a federal district court against Geologic Solutions, Inc., the maker of the texting system, alleging product liability. Was the accident caused by Jett‘s inattention or the texting device? Should a manufacturer be required to design a product that is incapable of distracting a driver? Discuss. [Durkee v. Geologic Solutions, Inc., 502 Fed. Appx. 326 (4th Cir. 2013)] (See Product Liability Claims.) —For a sample answer to Problem 6-4, go to Appendix E. Solution Here, the accident was caused by Jett‘s inattention, not by the texting device in the cab of his truck. In a product-liability case based on a design defect, the plaintiff has to prove that the product was defective at the time it left the hands of the seller or lessor. The plaintiff must also show that this defective condition made it ―unreasonably dangerous‖ to the user or consumer. If the product was delivered in a safe condition and subsequent mishandling made it harmful to the user, the seller or lessor normally is not liable. To successfully assert a design defect, a plaintiff has to show that a reasonable alternative design was available and that the defendant failed to use it.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

The plaintiffs could contend that the defendant manufacturer of the texting device owed them a duty of care because injuries to vehicle drivers and passengers, and others on the roads, were reasonably foreseeable due to the product‘s design that (1) required the driver to divert his eyes from the road to view an incoming text from the dispatcher, and (2) permitted the receipt of texts while the vehicle was moving. But manufacturers are not required to design a product incapable of distracting a driver. The duty owed by a manufacturer to the user or consumer of a product does not require guarding against hazards that are commonly known or obvious or protecting against injuries that result from a user's careless conduct. That is what happened here. In the actual case on which this problem is based, the court reached the same conclusion, based on the reasoning stated above, and an intermediate appellate court affirmed the judgment. 116. Strict Product Liability. Medicis Pharmaceutical Corp. makes Solodyn, a prescription oral antibiotic. Medicis warns physicians that ―autoimmune syndromes, including druginduced lupuslike syndrome,‖ may be associated with use of the drug. Amanda Watts had chronic acne. Her physician prescribed Solodyn. Information included with the drug did not mention the risk of autoimmune disorders, and Watts was not otherwise advised of it. She was prescribed the drug twice, each time for twenty weeks. Later, she experienced debilitating joint pain and, after being hospitalized, was diagnosed with lupus. On what basis could Watts recover from Medicis in an action grounded in product liability? Explain. [Watts v. Medicis Pharmaceutical Corp., 236 Ariz. 19, 365 P.3d 944 (2016)] (See Strict Product Liability.) Solution Watts might recover from Medicis in an action grounded in product liability on proven allegations that the drug was unreasonably dangerous because Medicis failed to provide adequate warnings of its known dangers. A product‘s maker or seller is liable for products that are so defective as to be unreasonably dangerous. This exists when a product is dangerous beyond the expectation of the ordinary consumer or a less dangerous alternative was economically feasible, but the maker or seller failed to use it. A product may be deemed unreasonably dangerous because of inadequate instructions or warnings. In the fact of this problem, Medicis Pharmaceutical Corp. made Solodyn, a prescription drug. Medicis warned prescribing physicians that ―autoimmune syndromes, including drug-induced lupus-like syndrome,‖ are possible from the use of the drug. Amanda Watts‘s physician prescribed Solodyn for her acne. An insert included with the drug did not mention the risk of autoimmune disorders, and Watts was not otherwise advised of it. Later, she was diagnosed with lupus. In other words, Medicis did not adequately warn Watts about the risks of Solodyn and the inadequacy of the warning contributed to Watts's injuries. In the actual case on which this problem is based, Watts filed a suit in an Arizona state court against Medicis to recover for her injuries. The court dismissed her complaint. A state intermediate appellate court vacated the dismissal and remanded the case, based in part on the reasoning stated above. 117. Strict Product Liability. Duval Ford, LLC, sold a new Ford F-250 pickup truck to David Sweat. Before taking delivery, Sweat ordered a lift kit to be installed on the truck by a Duval subcontractor. Sweat also replaced the tires and modified the suspension system to increase the towing capacity. Later, through Burkins Chevrolet, Sweat sold the truck to Shaun Lesnick. Sweat had had no problems with the truck‘s steering or suspension, but Lesnick did. He had the

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

steering repaired and made additional changes, including installing a steering stabilizer and replacing the tires. Two months later, Lesnick was driving the truck when the steering and suspension suddenly failed, and the truck flipped over, causing Lesnick severe injuries. Could Lesnick successfully claim that Duval and Burkins had failed to warn him of the risk of a lifted truck? Explain. [Lesnick v. Duval Ford, LLC, 41 Fla.L.Weekly D281, 185 So.3d 577 (1 Dist. 2016)] (See Product Liability Claims.) Solution No, Lesnick could not succeed on a theory of product liability against the sellers of the lifted pickup truck by arguing that they failed to warn him of the risk of a lifted vehicle. A product may be deemed defective because of inadequate warnings. But the defect and its risks must be fore seeable—that is, the seller must know, or have reason to know, of the defect and its risks. Liability would exist if a knowledgeable seller withheld this information from its customers. In this problem, Duval Ford sold a new Ford F–250 pick-up truck to Sweat. Sweat had Duval install a lift kit on the truck, and also modified the suspension system and replaced the tires. Later, through Burkins Chevrolet, Sweat sold the truck to Lesnick. Sweat had had no problems with the truck‘s steering or suspension, but Lesnick did. He had the steering repaired. Lesnick made other changes, including installing a steering stabilizer and again replacing the tires. Lesnick was driving the truck when the steering and suspension suddenly failed, and the truck flipped over, causing him severe injuries. In these facts, the sellers had no duty to warn Lesnick of risks associated with the lifted truck because there is no evidence that there was anything inherently dangerous about the truck when it was sold. Furthermore, Lesnick was well aware that the truck was lifted, and this fact was likely a factor in his decision to buy the truck. In the actual case on which this problem is based, Lesnick filed a suit in a Florida state court against Duval and Burkins, on a theory of product liability, alleging that the sellers failed to warn him of the risk of a lifted vehicle. The court issued a summary judgment in the defendants‘ favor. A state intermediate appellate court affirmed this judgment, on the conclusion stated above. 118. Spotlight on Pfizer, Inc.—Defenses to Product Liability. Prescription drugs in the United

States must be approved by the Food and Drug Administration (FDA) before they can be sold. A drug maker whose product is approved through the FDA‘s ―abbreviated new drug application‖ (ANDA) process cannot later change the label without FDA approval. Pfizer Inc. makes and sells by prescription Depo-T, a testosterone replacement drug classified as an ANDA-approved drug. Rodney Guilbeau filed a claim in a federal district court against Pfizer, alleging that he had experienced a ―cardiovascular event‖ after taking Depo-T. He sought recovery on a state-law product liability theory, arguing that Pfizer had failed to warn patients adequately about the risks. He claimed that after the drug‘s approval its maker had become aware of a higher incidence of heart attacks, strokes, and other cardiovascular events among those who took it but had not added a warning to its label. What is Pfizer‘s best defense to this claim? Explain. [Guilbeau v. Pfizer, Inc., 80 F.3d 304 (7th Cir. 2018)] (See Defenses to Product Liability.) Solution Pfizer‘s best defense to the claim that it failed to add warnings about certain risks to the label of Depo-T is preemption. Federal law can preempt state-law product liability claims, preventing an

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

injured party from suing the maker of a defective product on the basis of a circumstance that is subject to a comprehensive federal regulatory scheme. Here, Pfizer makes and sells Depo-T, a testosterone replacement drug classified as an ANDAapproved drug. In this case, Guilbeau had been prescribed the drug and allegedly suffered a cardiovascular event from its use. He claimed that after the drug‘s approval, Pfizer had learned of a higher incidence of such occurrences among those who took it but had not added a warning to the label. But the maker of a drug approved through the Food and Drug Administration‘s ANDA (abbreviated new drug application) process cannot later change the label without the agency‘s approval. Thus, federal law acted to preempt Guilbeau‘s state law claim. In the actual case on which this problem is based, Pfizer asserted that federal law preempted Guilbeau‘s claim. The court dismissed the suit. The U.S. Court of Appeals for the Seventh Circuit affirmed, stating, ―ANDA holders have an ongoing federal duty of sameness. At all times their drugs‘ labeling must be the same as the . . . labeling that was the basis of the ANDA approval.‖ 119. A Question of Ethics—The IDDR Approach and Product Liability. While replacing screws in a gutter, John Baugh fell off a ladder and landed headfirst on his concrete driveway. He sustained a severe brain injury, which permanently limited his ability to perform routine physical and intellectual functions. He filed a suit in a federal district court against Cuprum S.A. de C.V., the company that designed and made the ladder, alleging a design defect under product liability theories. Baugh weighed nearly 200 pounds, which was the stated weight limit on this ladder. Kevin Smith, a mechanical engineer, testified on Baugh‘s behalf that the gusset (bracket) on the ladder‘s right front side was too short to support Baugh‘s weight. This caused the ladder‘s leg to fail and Baugh to fall. In Smith‘s opinion, a longer gusset would have prevented the accident. Cuprum argued that the accident occurred because Baugh climbed too high on the ladder and stood on its fourth step and pail shelf, neither of which were intended for the purpose. No other person witnessed Baugh using the ladder prior to his fall, however, so there was no evidence to support Cuprum‘s argument. [Baugh v. Cuprum S.A. de C.V., 845 F.3d 838 (7th Cir. 2017)] (See Strict Product Liability.) 1. What is a manufacturer‘s legal and ethical duty when designing and making products for consumers? Did Cuprum meet this standard? Discuss. 2. Did the mechanical engineer‘s testimony establish that a reasonable alternative design was available for Cuprum‘s ladder? Explain. Solution 1. In designing and making a product for consumers, the manufacturer has the duty to make the product reasonably safe so that it does not create an unreasonable risk to the user. This is the legal standard to which product liability law holds the maker in a suit by a consumer, and thereby the minimal ethical standard. This would have been the relevant standard when Cuprum decided to make and market a ladder for consumer use. The company would have wanted to keep the cost as low as possible, in order to enhance profits. The stakeholders would have been Cuprum‘s owners, officers, and employees, as well as its wholesale customers and perhaps the larger community. But the company should also have wanted to avoid foreseeable risks of harm with its product, in order to avoid the negative effects of bad publicity. This would have meant designing the ladder to be at least as safe as other ladders on the market. The stakeholders then would have included, in addition to those listed above, the product‘s consumers.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 06: Product Liability

The ladder could have been designed cheaply without regard for safety. Or it could have been designed for safety without regard to expense. Too far towards either end of this range would impact a subset of stakeholders. A manufacturer would most likely decide to seek a balance between these two objectives to satisfy most stakeholders. For example, Cuprum might have planned its ladder with an eye to keeping manufacturing and shipping costs low, and then included with its product warnings to consumers about potential hazards. The evidence presented in the Baugh case indicated that at least one of the ladder‘s gussets was too short to support its user‘s weight. If so, then Cuprum failed to live up to its ethical and legal duty to make the ladder reasonably safe. The defective design might have resulted from Cuprum‘s attempt to save money. Given the negative consequences—Baugh fell and sustained serious brain injuries for which he sued the company—none of Cuprum‘s stakeholders could have been satisfied by these events. 2. Perhaps, yes. Kevin Smith, a mechanical engineer, testified on Baugh‘s behalf that the gusset on the ladder‘s right front side was too short to support Baugh‘s weight. In his opinion, this short gusset caused the ladder to collapse and Baugh to fall. This testimony was presented to a jury as evidence of causation, and as evidence that a reasonable alternative design—ladders that used a longer gusset—was available. In the actual problem on which this problem is based, a jury found in Baugh‘s favor, and awarded him more than $11 million in damages. On Cuprum‘s appeal, the U.S. Court of Appeals for the Seventh Circuit affirmed the result. The appellate court concluded, ―A rational [jury] could conclude that, based on a preponderance of the evidence, the alleged defect in the ladder was the most probable cause of the accident.‖

Critical Thinking and Writing Assignments Time-Limited Group Assignment. Bret D‘Auguste was an experienced skier when he rented equipment to ski at Hunter Mountain Ski Bowl in New York. When D‘Auguste entered an extremely difficult trail, he noticed immediately that the surface consisted of ice with almost no snow. He tried to exit the steeply declining trail by making a sharp right turn, but in the attempt, his left ski snapped off. D‘Auguste lost his balance, fell, and slid down the mountain, striking his face and head against a fence along the trail. According to a report by a rental shop employee, one of the bindings on D‘Auguste‘s skis had a ―cracked heel housing.‖ D‘Auguste filed a lawsuit against the bindings‘ manufacturer on a theory of strict product liability. The manufacturer filed a motion for summary judgment. (See Product Liability Claims.) 8. The first group will take the position of the manufacturer and develop an argument why the court should grant the summary judgment motion and dismiss the strict product liability claim. 9. The second group will take the position of D‘Auguste and formulate a basis for why the court should deny the motion and allow the strict product liability claim. 10. The third group will evaluate whether D‘Auguste assumed the risk of this type of injury. 11. The fourth group will analyze whether the manufacturer could claim that D‘Auguste‘s negligence (under the comparative negligence doctrine) contributed to his injury. Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

1. The court should grant the manufacturer‘s motion for summary judg ment and dis miss D‘Auguste‘s complaint. There is no proof as to whether the crack in the heel housing was substantial enough to have caused D‘Auguste‘s left ski to come off, whether the crack existed before the accident, or whether the crack resulted from the impact during the accident. In fact, there is no proof that the crack was in the binding at tached to the left ski. In other words, there is no evidence that the crack constituted a defect. Furthermore, the ―snap off‖ of the left ski may have been caused, not by a defect in the binding, but by negligence in the setting of the bindings. 2. The court should deny the manufacturer‘s motion for summary judg ment and allow D‘Auguste‘s claim to proceed. Despite the lack of proof with re spect to the cracked heel housing noted in the previous answer, D‘Auguste could still show that there was a defect in the binding and succeed in his ac tion if he could prove that the product did not perform as intended and exclude all other causes for the product‘s failure that are not attributable to the de fendant. 3. It could be argued that D‘Auguste assumed the risk of his injury by asserting that he was an experienced skier who chose to ski the icy trail on which he was injured. In other words, he recognized the risk and voluntarily assumed it. As a skier, D‘Auguste would have known that injuries occur on ski slopes. As a renter, he would have known that borrowed goods are not always in perfect condition. As a sportsman who selected a difficult trail to descend, he would have been aware of the potential for heightened risks. As an experienced participant who chose to proceed, he would arguably have assumed these risks. D‘Auguste might successfully respond with proof that the defect in the skis was the cause of his injuries, and that he did not assume the risk of that defect. 4. The manufacturer could claim that D‘Auguste‘s negligence, under the comparative negligence doctrine, contributed to his injury. Here, the skier‘s intentional actions—choosing the difficult trail, attempting a sharp turn on an icy slope with borrowed equipment, and perhaps failing to take other proactive steps to prevent his injuries as he slid—might be applied to apportion liability and reduce the manufacturer‘s damages. Of course, D‘Auguste would argue that none of his actions constituted negligence, or that the manufacturer‘s defective skis superseded any negligence on the skier‘s part.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

Practice and Review ................................................................................................................................ 39 Practice and Review: Debate This ........................................................................................................... 40 Issue Spotters .......................................................................................................................................... 40 Business Scenarios and Case Problems ................................................................................................... 41 Critical Thinking and Writing Assignments .............................................................................................. 47

Critical Thinking Questions in Features Managerial Strategy—Business Questions 120. The U.S. Patent and Trademark Office requires that a registered trademark or service mark be put into commercial use within six months. Extensions can be granted but the mark must be put into commercial use within three years after the application has been approved. Why do you think the federal government established this requirement? Solution In the online world, there is something called cybersquatting. Someone registers a domain name that a large company might want to use in the future in this situation. The owner then ―squats‖ on this domain Internet address until offered a large enough price to transfer it to a company that can actually make use of it. The U.S. Patent and Trademark Office clearly is trying to prevent what we could call trademark squatting and service mark squatting. In other words, the federal government wants to make sure that once a trademark or service mark is created, the owner has either to ―use it or lose it.‖ This ―use it or lose it‖ regulation avoids lawsuits in the future, sometimes in the distant future, when someone else creates the same or a similar trademark or service mark. If a registered trademark or service mark is never put into commerce, it is difficult for others to determine that it exists. They might inadvertently use a trademark or service mark that is similar and then face a lawsuit. This would be an inefficient use of resources, particularly for our judicial system. 121. Should trademark protection apply to similarities between non-competing products? Why or why not? Solution As shown in the text‘s coverage of this topic, one of the overriding goals of trademark protection law is to avoid consumer confusion between the nature of two products. If the trademark owner and the party alleged to have infringed on the trademark compete in the same market for goods and services, the court will rarely look beyond the trademark or service mark itself. Cases where the goods or services of the plaintiff and the defendant do not directly compete are more difficult to assess. In general, the court will look at the nature of the goods or services and the context in which they are marketed and sold to determine the likelihood of confusion. Some factors that courts take in account are (1) the strength of the plaintiff‘s mark, (2) the intent of the defendant in adopting the mark, (3) the relationship in consumer‘s minds between the goods and services, and, of course (4) evidence of any actual confusion on the part of consumers

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

Adapting the Law to the Online Environment 122. Beyoncé also used footage from a 2013 documentary called That B.E.A.T. Why might international entertainment stars choose to use sampled words and sampled video footage without permission of the copyright holders? Solution For one thing, the risk of a lawsuit might be seen as small. In many situations, copyright holders choose not to sue for copyright infringement. In other situations, they may sue but not have the financial resources necessary to continue a lawsuit through trial and appeals. In such cases, they may settle for small sums of money. Finally, celebrities who do sample just a few words may truly believe that their actions fall under the fair use doctrine.

Critical Thinking Questions in Cases Case 7.1 123. Suppose that Coca-Cola had been trying to make the public believe that its product contained cocaine. Would the result in the case likely have been different? Explain your answer. Solution Yes. The product in this case did not actually contain cocaine. To advertise that it did would be to commit fraud. A court will refuse to grant relief to a complaining party who commits fraud.

Case 7.2 124. Accompanying LEGO‘s registration of its copyright are images depicting ―Basic Minifigures.‖ Rather than these images, the district court compared ZURU‘s Action Figures to actual LEGO Minifigures, which differ in facial expression and jacket color. Was this, as ZURU alleged, an improper comparison? Why or why not? Solution No, the court‘s comparison of ZURU‘s Action Figures to actual LEGO Minifigures, instead of the ―Basic Minifigures‖ images that accompanied LEGO‘s registration of its copyright, was not an improper comparison. ZURU charged that the court compared allegedly infringing works—the ZURU Action Figures—to unregistered ―derivative works.‖ A derivative work incorporates some or all of a preexisting copyrighted work and adds new original, copyrightable elements to it. But the translation of a copyrighted work to a different medium, such as creating a plastic version of a cast metal coin bank, is not sufficiently original to require additional copyright protection. Applying these principles in the LEGO case, the district court found that the actual LEGO Minifigures were not derivative works. Each image of a ―Basic Minifigure‖ appearing with the copyright registration was, in the court‘s words, ―just that—a basic minifigure wearing a jacket.‖ And the copyrightable elements of the Minifigures in the images and the actual sculptured Minifigures were the same—―apart from the medium in which they are conveyed, there are no material differences between the LEGO Minifigure sculptures and the corresponding copyright images.‖ In other words, although the Minifigure sculptures examined by the court differed from the Minifigure images accompanying the copyright registration in facial expression and jacket color,

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

the court found that the differences were not material. The court‘s comparison of the two toy makers‘ products, therefore, was not improper. 125. On the eve of the trial, ZURU promised to recall its Action Figures from Walmart‘s stores in an effort to defeat LEGO‘s request for an injunction. Could this promise be considered ethical? Explain. Solution From ZURU‘s perspective, the issue could be framed as whether to continue marketing its Action Figures. Stakeholders would include all parties depending on ZURU to stay in business—its directors, employees, shareholders, suppliers, and customers, and members of the broader community relying on those parties—as well as the families related to individuals in these categories. Applicable ethical standards could be as minimal as the short-term bottom line and as maximal as the best long-term interests of as many stakeholders as possible. The choice of action that ZURU‘s decision makers appear to have made initially was to continue selling its allegedly infringing product despite the suit brought against the toymaker by LEGO. This could arguably be in the interest of all stakeholders, at least until an injunction was unavoidable. At the last minute, however, those decision makers may have had a change of heart, as evidenced by their change of strategy, when they pledged to remove their product from Walmart‘s stores. This may have been only a tactic to stay in business, albeit without the sales of their Action Figures in the stores, and,= had it worked, it might have satisfied most of their stakeholders. What was not promised in the facts stated in the question, however, was a commitment to remove the Action Figures from Walmart‘s website. This was not overlooked by LEGO, which proceeded with their cause despite ZURU‘s late promise. Ultimately, ZURU expended funds and effort in a futile attempt to keep its product on the market. This did not likely come to a satisfying end for any of the defendant‘s stakeholders.

Case 7.3 1.

Rimini argued that Oracle was misusing the copyright in its proprietary software to stifle competition. Do you agree? Explain. Solution Of course, the owner of a copyright should not be allowed to leverage the monopoly granted to them by the copyright to control of areas outside the monopoly. In other words, the owner might control the use of the copyright material, but it cannot impose conditions on the use that stifles competition. In the context of the Oracle case, for example, a licensor cannot impose a license agreement that prevents a licensee from using a competing product. Here, Rimini framed Oracle‘s position as foreclosing competition in the market for third-party maintenance. ―It would limit copies made by third parties to those made only for archival and emergency backup purposes and . . . the software could not be serviced simply by making exact copies.‖ Oracle countered that the licenses ―do not preclude third parties from developing competing software or providing competing support services.‖ And the court concluded that the licenses did

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

not preclude Rimini from creating development environments for a licensee for various purposes, including the testing of updates, ―after that licensee has become a customer of Rimini.‖ 2.

Suppose that Rimini had bought one of Oracle‘s licenses for itself. Would the result have been different? Why or why not? Solution No, if Rimini had purchased one of Oracle‘s licenses for its own use, the result would not have been different. The terms of the license would have been the same. It would have permitted Rimini, as the licensee, to maintain the software and make copies of it for this purpose. But it would not have allowed Rimini to use the software to make and modify copies for other customers, or unknown, future customers. Just as in the Oracle case, this use of the software would have violated the exclusive right Oracle enjoyed as the owner of the software copyright to copy or modify it.

Chapter Review Practice and Review Two computer science majors, Trent and Xavier, have an idea for a new video game, which they propose to call ―Hallowed.‖ They form a business and begin developing their idea. Several months later, Trent and Xavier run into a problem with their design and consult with a friend, Brad, who is an expert in creating computer source codes. After the software is completed but before Hallowed is marketed, a video game called Halo 2 is released for both the Xbox and the PlayStation 3 systems. Halo 2 uses source codes similar to those of Hallowed and imitates Hallowed‘s overall look and feel, although not all the features are alike. Using the information presented in the chapter, answer the following questions. 126.

Would the name Hallowed receive protection as a trademark or as trade dress?

Solution The video game, ―Hallowed,‖ would not receive protection as either a trademark or trade dress because game had not been released to the general public for use. The law protects only trademarks that are in use. Trade dress applies to a product‘s distinct image and appearance, but only once the distinctiveness of a product‘s appearance has been established. 127. If Trent and Xavier had obtained a business process patent on Hallowed, would the release of Halo 2 infringe on their patent? Why or why not? Solution No, because all steps of a patented process must be copied to constitute infringement and these two games contain different features. For infringement of a business process patent to exist, all steps or their equivalent must be copied. In this scenario, while Halo 2 uses some of the same source codes as Hallowed, not all features alike, so it does not infringe on Hallowed‘s patent. 128. Based only on the facts presented above, could Trent and Xavier sue the makers of Halo 2 for copyright infringement? Why or why not? Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

Yes, because Halo 2 copies the source codes of Hallowed. Whenever the form or expression of an idea is copied, an infringement of copyright occurs. The courts generally hold that copying the source codes of copyrighted software is infringement. Because Halo 2 used similar source codes as Hallowed, Trent and Xavier can sue for copyright infringement. 129. Suppose that Trent and Xavier discover that Brad took the idea of Hallowed and sold it to the company that produced Halo 2. Which type of intellectual property issue does this raise? Solution The fact that Brad took and sold Trent and Xavier‘s idea to another company raises a trade secret issue, because Brad wrongfully disclosed the idea of a new video game to a competing company. Unlike copyright and trademark protection, protection of trade secrets extends both to ideas and their expression.

Practice and Review: Debate This 130. Congress has amended the Copyright Act several times. Copyright holders now have protection for many decades. Was Congress justified in extending these copyright time periods? Why or why not? Solution Obviously, copyright holders whose copyrights were about to run out benefited from the timeperiod extensions legislated by Congress. Hence, they certainly believe that Congress acted correctly. (It‘s not surprising that major copyright holders such as large movie companies, record labels, and publishing houses did most of the lobbying that led to extensions of copyright protection periods.) In general, one can argue that more effort will go into the creation of intellectual property the longer the period of copyright protection for intellectual property. In other words, for the creation of new original works, the term extension of the copyright protection incentivizes creators of such works to extend more effort. Not everyone is so enamored of the term extensions for copyright protection. In Article I, Section 8, Clause 8, of the Constitution, Congress is given the task of making laws for the protection of copyrights and patents ―To promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.‖ What is a limited time? Today it can last over a hundred years! That hardly seems very limited. Moreover, the term extension for existing works makes no significant contribution to an author‘s economic incentive to create, because the additional compensation was granted after the relevant investment had already been made.

Issue Spotters 131. Roslyn, a food buyer for Organic Cornucopia Food Company, decides to go into business for herself as Roslyn‘s Kitchen. She contacts Organic‘s suppliers, offering to buy their entire harvest for the next year. She also contacts Organic‘s customers, offering to sell her products for less than Organic. Has Roslyn violated any of the intellectual property rights discussed in this chapter? Explain Solution Yes, Roslyn has committed theft of trade secrets. Lists of suppliers and customers cannot be patented, copyrighted, or trademarked, but the information they contain is protected against appropriation by others as trade secrets. Most likely, Roslyn signed a contract agreeing not to use

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

this information outside her employment by Organic. But even without this contract, Organic could make a convincing case against its ex-employee for a theft of trade secrets. 132. Global Products develops, patents, and markets software. World Copies, Inc., sells Global‘s software without the maker‘s permission. Is this patent infringement? If so, how might Global save the cost of suing World for infringement and at the same time profit from World‘s sales? Solution This is patent infringement. A software maker in this situation might best protect its product, save litigation costs, and profit from its patent by the use of a license. In the context of this problem, a license would grant permission to sell a patented item. (A license can be limited to certain purposes and to the licensee only.)

Business Scenarios and Case Problems 133. Patent Infringement. John and Andrew Doney invented a hard-bearing device for balancing rotors. Although they obtained a patent for their invention from the U.S. Patent and Trademark Office, it was never used as an automobile wheel balancer. Some time later, Exetron Corp. produced an automobile wheel balancer that used a hard-bearing device similar to the Doneys‘ device. Given that the Doneys had not used their device for automobile wheel balancing, does Exetron‘s use of a similar device infringe on the Doneys‘ patent? (See Patents.) Solution Yes. A patent is not deemed useless and therefore invalid simply because it has not been used in a particular application. The Doneys' patent was valid, and Exetron Corp. infringed on the patent. 134. Fair Use. Professor Wise is teaching a summer seminar in business torts at State University. Several times during the course, he makes copies of relevant sections from business law texts and distributes them to his students. Wise does not realize that the daughter of one of the textbook authors is a member of his seminar. She tells her father about Wise‘s copying activities, which have taken place without her father‘s or his publisher‘s permission. Her father sues Wise for copyright infringement. Wise claims protection under the fair use doctrine. Who will prevail? Explain. (See Copyrights.) Solution Professor Wise will prevail, as he has not violated federal copyright law. Under Section 107 of the Copyright Act, the reproduction of copyrighted works for teaching purposes (including multiple copies for classroom use) falls under the ―fair use‖ doctrine and is not an infringement of copyright. 135. Spotlight on Macy’s—Copyright Infringement. United Fabrics International, Inc., bought a fabric design from an Italian designer and registered a copyright to the design with the U.S. Copyright Office. When Macy‘s, Inc., began selling garments with a similar design, United filed a copyright infringement suit against Macy‘s. Macy‘s argued that United did not own a valid copyright to the design and so could not claim infringement. Does United have to prove that the copyright is valid to establish infringement? Explain. [United Fabrics International, Inc. v. C & J Wear, Inc., 630 F.3d 1255 (9th Cir. 2011)] (See Copyrights.) Solution Copyrights can be registered with the U.S. Copyright Office in Washington, D.C. Copyright owners protect themselves by registering their copyrights. This registration is evidence that the copyright

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

is valid. Thus, registering a copyright and showing proof of the registration is sufficient to establish the validity of the copyright. Here, United bought a design and registered it with the U.S. Copyright Office. United does not otherwise have to prove that the copyright is valid. If Macy‘s wants to challenges the validity of United‘s registered copyright, Macy‘s will have to present evidence that the copyright is invalid. In the actual case on which this problem is based, the U.S. Court of Appeals for the Ninth Circuit ruled in United‘s favor. 136. Copyright Infringement. SilverEdge Systems Software hired Catherine Conrad to perform a singing telegram. Silver-Edge arranged for James Bendewald to record Conrad‘s performance of her copyrighted song to post on the company‘s website. Conrad agreed to wear a microphone to assist in the recording, told Bendewald what to film, and asked for an additional fee only if SilverEdge used the video for a commercial purpose. Later, the company chose to post a video of a different performer‘s singing telegram instead. Conrad filed a suit in a federal district court against SilverEdge and Bendewald for copyright infringement. Are the defendants liable? Explain. [Conrad v. Bendewald, 500 Fed.Appx. 526 (7th Cir. 2013)] (See Copyrights.) Solution There is no liability for copyright infringement here. Copyright protects the owner of a creative work, including a ―musical work‖ like a song, from its distribution or public display without the owner‘s permission. To show the work, or even to retain a copy without the owner‘s permission, would constitute infringement. It is clear from the facts, however, that SilverEdge and Bendewald had Conrad‘s permission to film the performance of her song. She knew that SilverEdge had arranged with Bendewald to record her performance. She agreed to wear a microphone to assist in the recording, told Bendewald what to film, and asked for an additional fee only if SilverEdge used the video for a commercial purpose. Also, it does not appear that Conrad imposed any condition to have the video returned to her if SilverEdge decided not to pay the fee to use it commercially. In the actual case on which this problem is based, the court issued a judgment against Conrad. On appeal, the U.S Court of Appeals for the Seventh Circuit affirmed, concluding that ―the defendants had permission to film the performance as a matter of law.‖ 137. Business Case Problem with Sample Answer—Patents. The U.S. Patent and Trademark Office (PTO) denied Raymond Gianelli‘s application for a patent for a ―Rowing Machine‖—an exercise machine on which a user pulls on handles to perform a rowing motion against a selected resistance. The PTO considered the device obvious in light of a previously patented ―Chest Press Apparatus for Exercising Regions of the Upper Body‖—an exercise machine on which a user pushes on handles to overcome a selected resistance. On what ground might this result be reversed on appeal? Discuss. [In re Gianelli, 739 F.3d 1375 (Fed. Cir. 2014)] (See Patents.) Solution One ground on which the denial of the patent application in this problem could be reversed on appeal is that the design of Raymond Gianelli‘s ―Rowing Machine‖ is not obvious in light of the design of the ―Chest Press Apparatus for Exercising Regions of the Upper Body.‖ To obtain a patent, an applicant must demonstrate to the satisfaction of the U.S. Patent and Trademark Office (PTO) that the invention, discovery, process, or design is novel, useful, and not obvious in light of current technology. In this problem, the PTO denied Gianelli‘s application for a

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

patent for his ―Rowing Machine‖—an exercise machine on which a user pulls on handles to perform a rowing motion against a selected resistance to strengthen the back muscles. The PTO considered the device obvious in light of a patented ―Chest Press Apparatus for Exercising Regions of the Upper Body‖—a chest press exercise machine on which a user pushes on handles to overcome a selected resistance. But it can be easily argued that it is not obvious to modify a machine with handles designed to be pushed into one with handles designed to be pulled. In fact, anyone who has used exercise machines knows that a way to cause injury is to use a machine in a manner not intended by the manufacturer. In the actual case on which this problem is based, the U.S. Court of Appeals for the Federal Circuit reversed the PTO‘s denial of Gianelli‘s application for a patent, based on the reasoning stated above. 138. Patents. Rodney Klassen was employed by the U.S. Department of Agriculture (USDA). Without the USDA‘s authorization, Klassen gave Jim Ludy, a grape grower, plant material for two unreleased varieties of grapes. For almost two years, most of Ludy‘s plantings bore no usable fruit, none of the grapes were sold, and no plant material was given to any other person. The plantings were visible from publicly accessible roads, but none of the vines were labeled, and the variety could not be identified by simply viewing the vines. Under patent law, an applicant may not obtain a patent for an invention that is in public use more than one year before the date of the application. Could the USDA successfully apply for patents on the two varieties given to Ludy? Explain. [Delano Farms Co. v. California Table Grape Commission, 778 F.3d 1243 (Fed.Cir. 2015)] (See Patents.) Solution Yes, the USDA can obtain patents on the two varieties of grapes given to Ludy. Almost anything is patentable so long as it is novel, useful and not obvious. Plant material can be patented. But under patent law, an applicant may not obtain a patent for an invention that is in public use more than one year before the date of the application. In this problem, a U.S. Department of Agriculture (USDA) employee, without the USDA‘s authorization, gave Jim Ludy, a grape grower, plant material for two unreleased varieties of grapes. For almost two years, most of Ludy‘s plantings bore no usable fruit, none of the grapes were sold, and no plant material was given to any other person. The plantings were visible from publicly accessible roads, but none of the vines were labeled, and the variety could not be identified by simply viewing the vines. This use of the unreleased varieties in these circumstances did not constitute a public use sufficient to prevent the USDA from successfully applying for patents on the grapes. In the actual case on which this problem is based, the USDA obtained patents on the grapes. Delano Farms Co. and other growers filed a suit in a federal district court against the USDA, seeking to invalidate the patents. The court rejected the challenge. ―If members of the public are not informed of, and cannot readily discern, the claimed features of the invention in the allegedly invalidating prior art, the public has not been put in possession of those features.‖ The U.S. Court of Appeals for the Federal Circuit affirmed. 139. Copyright Infringement. Savant Homes, Inc., is a custom home designer and builder. Using what it called the Anders Plan, Savant built a model house in Windsor, Colorado. This was a ranch house with two bedrooms on one side and a master suite on the other, separated by a

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

combined family room, dining room, and kitchen. Ron and Tammie Wagner toured the Savant house. The same month, the Wagners hired builder Douglas Collins and his firm, Douglas Consulting, to build a house for them. After it was built, Savant filed a lawsuit in a federal district court against Collins for copyright infringement, alleging that the builder had copied the Anders Plan in the design and construction of the Wagner house. Collins showed that the Anders Plan consisted of standard elements and standard arrangements of elements. In these circumstances, has infringement occurred? Explain. [Savant Homes, Inc. v. Collins, 809 F.3d 1133 (10th Cir. 2016)] (See Copyrights.) Solution No, in the circumstances of this problem, infringement did not occur. Works that are copyrightable include architectural plans and the products of those plans. The Copyright Act explicitly states that it protects works that fall into this category. Specifically excluded, however, are ideas. The particular way in which an idea is expressed can be protected by copyright law if the expression is original. In other words, one of the key requirements for the protection of a work is originality. If a substantial part of an original expression is copied, infringement has occurred. Here, Savant Homes, using what it called the ―Anders Plan,‖ built a model house—a ranch house with two bedrooms on one side and a master suite on the other, separated by a combined family room, dining room, and kitchen. The Wagners toured the model and then hired Collins, a different builder, to build a house for them. After it was built, Savant charged that Collins had copied the Anders Plan in designing and constructing the Wagner house. Collins showed that the Anders Plan consisted of standard elements and standard arrangements of elements. Standard content receives no copyright protection. To establish copyright infringement, a plaintiff must show ―substantial similarity‖ between protectable elements of a work and an allegedly infringing work. Savant apparently failed to show that the Anders Plan included any protectable elements—that is, an original expression of a standard three-bedroom ranch house with the same floor plan. In the actual case on which this problem is based, the court issued a judgment in Collins‘s favor. The U.S. Court of Appeals for the Tenth Circuit affirmed this judgment, according to the reasoning stated here. 140. Patent Infringement. Finjan, Inc., owns a patent—U.S. Patent No. 7,418,731, or ―the ‗731 patent‖—for a system and method that protect computers from malicious software embedded in websites on the Internet. The system consists of a gateway that compares security profiles associated with requested files to the security policies of requesting users. The method includes scanning an incoming file to create the profile, which comprises a list of computer commands the file is programmed to perform. The ‘731 patent required ―a list of computer commands.‖ Blue Coat Systems, Inc., sold a competing product. Blue Coat‘s product scanned an incoming file for certain commands and created a new file called Cookie2 that contained a field showing whether, and how often, those commands appeared. Finjan filed a suit against Blue Coat, alleging patent infringement. Blue Coat argued that its profiles did not contain the ‘731 patent‘s required ―list of computer commands.‖ Did Blue Coat‘s product infringe Finjan‘s patent? Explain. [Finjan, Inc. v. Blue Cost Systems, Inc., 879 F.3d 1299 (Fed. Cir. 2018)] (See Patents.) Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

Yes, Blue Coat‘s product infringed on Finjan‘s patent. A firm that makes, uses, or sells another‘s patented product or process commits the tort of patent infringement. Infringement may occur even though not all features of the product are copied, but a process cannot be infringed unless all steps or their equivalent are copied. In this case, Finjan owns a patent—the ‗731 patent—for a system and method that provides computer security from malicious software embedded in outside websites. The system features a gateway that compares a security profile associated with a requested file to the security policies of the requesting user. The method includes scanning the file to create the profile, which comprises a list of computer commands the file is programmed to perform. Under the terms of the patent, such a list was required. Blue Coat sold a competing product. This product scanned an incoming file for certain commands and created a new file called Cookie2 that contained a field showing whether, and how often, those commands appeared. Contrary to Blue Coat‘s argument, this field met the ‘731 patent‘s required ―list of computer commands.‖ The patent was infringed. In the actual case on which this problem is based, the court entered a judgment in Finjan‘s favor, awarding damages of $6 million. The U.S. Court of Appeals for the Federal Circuit affirmed, on the reasoning stated above. 141. Copyrights. The ―Jimmy Smith Rap‖ is a copyrighted rap recording asserting the supremacy of jazz over other types of music. Released thirty years later, ―Pound Cake‖ is a hiphop song in which Aubrey Graham and Shawn Carter, professionally known as Drake and Jay-Z, rap about the greatness and authenticity of their work. At the beginning of the seven-minutelong ―Pound Cake‖ is a sampling of thirty-five seconds of the ―Jimmy Smith Rap.‖ Criticizing jazz elitism, ―Pound Cake‖ emphasizes that it is not the genre but the authenticity of the music that matters. The release of ―Pound Cake‖ had no effect on the demand for the ―Jimmy Smith Rap,‖ for which there was no active market at the time. Did Drake and Jay-Z make ―fair use‖ of the ―Jimmy Smith Rap,‖ or were they liable for copyright infringement? Explain. [Estate of Smith v. Graham, 799 FedAppx 36 (2d Cir. 2020)] (See Copyrights.) Solution Drake and Jay-Z made ―fair use‖ of the ―Jimmy Smith Rap‖—they are not liable for copyright infringement. Whenever the form or expression of an idea is copied, an infringement of copyright occurs. The ―fair use‖ doctrine provides an exception to liability (and in certain cases, without even the payment of royalties) when a work is used for such purposes as criticism or comment. Factors for determining whether a particular use qualifies include the purpose and character of the use, and the effect of the use on the market for the copyrighted work. In this case, Drake and Jay-Z sampled thirty-five seconds of the ―Jimmy Smith Rap‖ at the beginning of their seven-minute hip-hop song ―Pound Cake.‖ They used the material for a purpose different from that for which it was created. The ―Jimmy Smith Rap‖ asserts the supremacy of jazz to the disparagement of other types of music. ―Pound Cake‖ criticizes such jazz-elitism, emphasizing that it is not the genre but the authenticity of the music that matters. Drake and Jay-Z rap about the greatness and authenticity of their own work. Courts refer to this type of use of a copyrighted work as transformative. As for the effect of the use on the market for the copyrighted work, according to the facts, ―the release of ‗Pound Cake‘ had no effect on the demand for the ‗Jimmy Smith Rap,‘ for which at the time there was no active market.‖

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

In the actual case on which this problem is based, the owners of the copyright to the ―Jimmy Smith Rap,‖ including Smith‘s estate, filed a suit in a federal district court against Drake and others, alleging copyright infringement. The court granted the defendants‘ motion for summary judgment on the ground of fair use. The U.S. Court of Appeals for the Second Circuit affirmed, in part based on the reasoning stated above. 142. A Question of Ethics—The IDDR Approach and Copyright Infringement. Usenet is an online bulletin board network. A user gains access to Usenet posts through a commercial service, such as Giganews, Inc. Giganews deletes or blocks posts that contain child pornography. Otherwise, the service does not monitor content. Perfect 10, Inc., owns the copyrights to tens of thousands of images, many of which have been illegally posted on Usenet through Giganews. When Perfect 10 notified Giganews of posts that contained infringing images, the service took them down. Despite these efforts, illegal posting continued. Perfect 10 filed a suit in a federal district court against Giganews, alleging copyright infringement. [Perfect 10, Inc. v. Giganews, Inc., 847 F.3d 657 (9th Cir. 2017)] (See Copyrights.) 1. Is Giganews liable for copyright infringement? Do Internet service providers have an ethical duty to do more to prevent infringement? Why or why not? Solution No, Giganews is not liable for copyright infringement. The Digital Millennium Copyright Act (DMCA) protects the owners of copyrights in digital information. But the DMCA also limits the liability of Internet service providers (ISPs). Under the act, an ISP is not liable for copyright infringement by a subscriber unless the ISP is aware of the violation. An ISP may be liable only if it fails to shut down the subscriber after learning of the violation. In this problem, Giganews provided its subscribers with access to Usenet, an online bulletin board network. Giganews does not monitor its users‘ posts except to delete or block posts that contain child pornography. Perfect 10, Inc. owns the copyrights to tens of thousands of images. Many of these have been illegally distributed over Usenet through Giganews. When notified of infringing posts, Giganews removed them. But users continued to post infringing content. Perfect 10 filed a suit in a federal district court against Giganews, accusing the service of copyright infringement. In the circumstances, under the DMCA, Giganews is not liable for its users‘ infringement. ISPs arguably have an ethical duty to do more to prevent copyright infringement. Posting images and other third-party content that a user does not own, or does not have permission to post, is copyright infringement. This is theft. Any party, such as an ISP, that has the capacity to block or delete such posts has an ethical duty to do so. An ISP could at the least clearly notify its users that such posts are violations of the law and maintain a policy that does not tolerate violations. In the actual case on which this problem is based, the court issued a judgment in Giganews‘s favor. The U.S. Court of Appeals for the Ninth Circuit affirmed the judgment. 2.

Using the IDDR approach, decide whether a copyright owner has an ethical duty to protect against infringement.

Solution Yes, a copyright owner has an ethical duty to protect against infringement. Arguably, any party that has the capacity to protect personal property, as a copyright owner most likely does, has an ethical duty to do so.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

The IDDR approach has four steps, which begin with an Inquiry to express the issue, identify the stakeholders, and indicate potential ethical standards. Here, the question is whether an owner of copyrights has an ethical obligation to attempt to prevent a theft of those rights. The stakeholders include the owner, the creators of other copyrightable work, and the public at large. Applicable standards may derive from a specific owner‘s situation—the owner of a copyright in music, for example, may license the music and distribute royalties, which would suggest a correlative duty to guard against its unlicensed use. The second step of the IDDR approach is a Discussion that considers actions to address the issue. Factors include the strengths and weaknesses of the actions, and the consequences and the effects on the stakeholders. How might the owner of a copyright discourage its theft? Some answers to this question depend on the nature of the copyrighted work. Intellectual property protected by copyright may be stored as data on a server, which can be encrypted, firewalled, password-barred, or disconnected from the Internet to guard against thievery. If, as in this problem, an owner holds thousands of copyrights, some of the protected material might be made freely available to make it less tempting to steal. Or one song on an album might be accessible for playback online with an option to buy the song, or the whole album, for playback through other media. The disadvantage of this action is that of course some copyrighted items are available for free, which undercuts the reason for the protection. But this sort of sampling can acquaint a wider market with the work, which might then be more widely purchased, adding to its value. The third step of the approach is to come to a Decision and state the reasons. There seems little doubt that the owner of copyright has an ethical obligation to guard against its theft. This protects the existence of copyright as a principle for the protection of property. It enhances its value to those who own it, those who produced it, and those who might be inspired to create more. These outcomes can improve the life of the community at large by adding opportunities to appreciate products of the mind. The last step of the approach is a Review of the success or failure of the action to resolve the issue, and satisfy the stakeholders. No protective action will be entirely successful, but a failure to take any action will guaranty a failure to protect the interests of the stakeholders. This underscores the ethical obligation of an owner of a copyright to act to protect the property.

Critical Thinking and Writing Assignments 1.

Time-Limited Group Assignment—Patents. After years of research, your company has developed a product that might revolutionize the green (environmentally conscious) building industry. The product is made from relatively inexpensive and widely available materials combined in a unique way that can substantially lower the heating and cooling costs of residential and commercial buildings. The company has registered the trademark it intends to use for the product and has filed a patent application with the U.S. Patent and Trademark Office. (See Patents.) 1. One group will provide three reasons why this product does or does not qualify for patent protection. Solution To obtain a patent, an applicant must show that an invention is novel, useful, and not obvious in light of current technology. Almost anything is patentable—including artistic methods, certain

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 07: Intellectual Property Rights

works of art, the structures of storylines, and hybrid or genetically modified plants, microorganisms, and animals—but not the laws of nature, natural phenomena, and abstract ideas. A product that combines widely available materials with no change in their functions would not be novel or uniquely useful. If a person of ordinary skill in the art would recognize the way in which these materials are combined, then the product is ―obvious in light of current technology.‖ If the materials that are combined are not otherwise modified, they may not qualify for a patent under the exception for ―natural phenomena.” 2.

A second group will develop a four-step plan for how the company can best protect its intellectual property rights (trademark, trade secret, and patent) and prevent domestic and foreign competitors from producing counterfeit goods or cheap knockoffs.

Solution One step that a company can take to fight the theft of its intellectual property rights for the production and sale of counterfeit goods is to seek a court order to shut down the domain names of websites that sell the goods. Shutting down websites, particularly on key shopping days, prevents the sale of some domestic and foreign counterfeit goods. Against those who in bad faith use a domain name that is confusingly similar to a legitimate business‘s name, a plaintiff can collect actual damages and lost profits or statutory damages. Use of a trademark as a meta tag without permission is trademark infringement. Dilution is another possible cause of action (and does not require proof of the likelihood of confusion among consumers). A second step that a company can take is to seek the criminal prosecution of those who traffic in counterfeit labels, stickers, packaging, and the like, whether or not they are attached to goods. The legal owner of the rights to the copied trademarks and other intellectual property should insist on the destruction of the counterfeit products and restitution for any losses. A third possibility to prevent counterfeiting is to license a mark or other property, permitting its use for certain limited purposes. This alternative may be the best choice to realize a return on patented products made and sold in a foreign country because no patent infringement occurs in that circumstance. An injunction, fees and costa, and as much as triple damages may be recouped in a patent infringement suit against domestic violations of patent rights. Damages and criminal penalties may also be available against those who violate copyrights or steal trade secrets. 3.

The third group will list and explain three ways in which the company can utilize licensing.

Solution A license is an agreement permitting the use of a trademark, copyright, patent, or trade secret for certain limited purposes. A licensor might, for example, allow a licensee to use a trademark as part of a company name, or as part of a domain name, but not otherwise use the mark on any products or services. Or the owner of the property might allow a licensee to use the copyrighted, patented, or trademarked property or trade secrets. For example, the Coca-Cola Bottling Company licenses firms worldwide to use its secret formula for the syrup used in its soft drink. A licensor can realize a return on the license through the payment of royalties—a percentage of the income gained from the sale of products using the licensed property.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Table of Contents Critical Thinking Questions in Features ............................................................................................................... 37 Adapting the Law to the Online Environment ......................................................................................... 37 Critical Thinking Questions in Cases ..................................................................................................................... 37 Case 4.1 ................................................................................................................................................... 37 Case 4.2 ................................................................................................................................................... 38 Case 4.3 ................................................................................................................................................... 38 Chapter Review ............................................................................................................................................................. 39 Practice and Review ................................................................................................................................ 39 Practice and Review: Debate This ........................................................................................................... 40 Issue Spotters .......................................................................................................................................... 40 Business Scenarios and Case Problems ................................................................................................... 41 Critical Thinking and Writing Assignments .............................................................................................. 47

Critical Thinking Questions in Features Adapting the Law to the Online Environment 143.

If LoL is free to players, why would a Chinese company want to copy it?

Solution There is usually a charge to download any app. Therefore, copying an extremely popular multiplayer online game can yield a sizable revenue stream from those who download the app. Additionally, anything on the Internet is open to advertising. Advertising leads to revenue streams.

Critical Thinking Questions in Cases Case 8.1 144. Suppose that the candyland.com website had not been sexually explicit but had sold candy. Would the result have been the same? Explain. Solution Probably. In this circumstance, Hasbro could most likely demonstrate a likelihood of prevailing on a claim that the defendant violated the applicable federal and state statutes against trademark dilution. The Hasbro trademark is famous, the defendant would presumably be using it without permission, and that use would arguably diminish the quality of the Hasbro mark. 145. How can companies protect themselves from situations such as the one described in this case? What limits each company‘s ability to be fully protected? Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

To protect themselves from others who create websites that have similar domain names, companies can be vigilant and act quickly and forcefully to enforce their rights. A company‘s ability to be fully protected is limited chiefly by its resources and by the skill of the persons on whom the company relies to protect it.

Case 8.2 146. Should an ISP be liable for copyright infringement by its subscribers regardless of whether the ISP is aware of the violation? Why or why not? Solution No, an ISP should not be liable for the infringement activities of its subscribers unless the ISP is aware of the violations. As under the DMCA, and in the BMG case, an ISP should be liable only if it is aware of the infringement and fails to take reasonably meaningful action to stop it, or at least to terminate the subscriber‘s service. The importance of intellectual property supports the protection of rights to its ownership. Prohibiting infringement is a significant component of this protection. Prosecuting violators is a material part of this prohibition. But the subscribers to ISPs, like the users of other Internet services, can more easily take advantage of those services to engage in illicit conduct, such as copyright infringement, than the providers can quickly police. Those providers should be held liable for failing to discourage such behavior and for failing to act once they know of it. Until they are aware of it, however, it would be unfair to hold them to account. 147. Could Cox legitimately claim that it had no knowledge of subscribers who infringed BMG‘s copyrights, since the ISP was deleting all of BMG‘s infringement notices? Explain. Solution No, Cox could not legitimately claim that by deleting all of BMG‘s infringement notices, it was unaware of the activity of those among its subscribers who infringed the sender‘s copyrights. In fact, the decision to delete all such notices would undercut any contention that it was unaware of any infringement by any subscriber. Of course, in the BMG case, the court reasoned that when Cox decided to delete all infringement notices received from BMG, the ISP dispensed with terminating subscribers who repeatedly infringed BMG‘s copyrights. This was in addition to the ISP‘s general unstated policy to terminate no subscribers for infringement, contrary to its own stated policy. In effect, Cox had no infringement policy.

Case 8.3 3.

Is a violation of an individual‘s right to privacy, without more, enough to sustain a legal cause, or should additional consequences be required to maintain an action? Explain. Solution Yes, an intrusion into an individual‘s privacy is sufficient to sustain a legal cause of action. It constitutes a sufficiently concrete injury to support the cause. Additional consequences are not necessary.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Violations of the right to privacy have long been subject to actions at common law. Historically recognized as an ―unreasonable intrusion upon the seclusion of another,‖ the cause has traditionally been extended to incorporate, among other things, ―tapping‖ landline phone wires and opening others‘ mail. Referred to as the invasion of a ―substantive right,‖ the intrusion itself is enough to impose liability. The Electronic Communications Privacy Act (ECPA), which was the basis for the plaintiffs‘ claim in the Campbell case, codifies privacy torts into a federal statute making the intentional interception of any ―electronic communication‖ a ground for an action. Additional consequences are not required. At common law or under the ECPA, a plaintiff does need not to allege or show any further harm to succeed. 4.

Should Facebook pay the platform‘s users for Facebook‘s use of their private data? Discuss. Solution Yes, Facebook should pay its users for the use of their private data, particularly when those uses include the facilitation of targeted advertising. Users should be viewed as the owner of their data, and Facebook, which is profiting from its use, should be required to pay for it. Further, individuals should have control over their data. They should be asked whether they want their data used, whom they would permit to use it, and the uses to which it would be applied. As with any property, the owners should be able to sell or not sell it as they choose. Conversely, no, Facebook does not need to pay its users for the use of their data. Layers of complexity challenge the categorization of data, such as that collected and used by Facebook, as property subject to the traditional definition of ownership. Its marketability by individual ―owners‖ is doubtful—it is hard for individuals to trade. If it cannot be easily sold, its ownership is arguably incomplete.

Chapter Review Practice and Review While he was in high school, Joel Gibb downloaded numerous songs to his smartphone from an unlicensed file-sharing service. He used portions of the copyrighted songs when he recorded his own band and posted videos on YouTube and Facebook. He also used BitTorrent to download several movies from the Internet. Now Gibb has applied to Boston University. The admissions office has requested access to his Facebook password, and he has complied. Using the information presented in the chapter, answer the following questions.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

148.

What laws, if any, did Gibb violate by downloading music and videos from the Internet?

Solution Technology has vastly increased the potential for copyright infringement. Generally, whenever a party downloads music into a computer‘s random access memory, or RAM, without authorization, a copyright is infringed. Thus, when file-sharing is used to download others‘ stored music files, copyright issues arise. Recording artists and their labels stand to lose large amounts of royalties and revenues if relatively few digital downloads or CDs are purchased and then made available on distributed networks. 149.

Was Gibb‘s use of portions of copyrighted songs in his own music illegal? Explain.

Solution At least one federal court has held that sampling a copyrighted sound recording of any length constitutes copyright infringement. Some other federal courts have not found that digital sampling is always illegal. Some courts have allowed the defense of fair use, while others have not. 150. not?

Can individuals legally post copyrighted content on their Facebook pages? Why or why

Solution Piracy of copyrighted materials online can occur even if posting the materials is ―altruistic‖ in nature—unauthorized copies are posted simply to be shared with others. The law extends criminal liability for the piracy of copyrighted materials to persons who exchange unauthorized copies of copyrighted works without realizing a profit. 151. Did Boston University violate any laws when it asked Joel to provide his Facebook password? Explain. Solution Many states have enacted legislation to protect individuals from having to disclose their social media passwords. The federal government is also considering legislation that would prohibit employers and schools from demanding passwords to social media accounts. If, at the time of the application, however, Massachusetts was not covered by any of these statutes, Boston University would not have violated any law by asking for Gibbs‘s password, which he then voluntarily divulged.

Practice and Review: Debate This 152. Internet service providers should be subject to the same defamation laws as newspapers, magazines, and television and radio stations. Solution Those who support this position argue that it is not fair to those who are defamed by others on the Internet to not have recourse against the ISP. After all, there should be no difference between traditional media outlets and the Internet. Those who are against applying similar defamation law to all media argue that ISPs cannot become censors. They point out the technological inability of ISPs to monitor all of the statements that go through their servers.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Issue Spotters 153. Karl self-publishes a cookbook titled Hole Foods, in which he sets out recipes for donuts, Bundt cakes, tortellini, and other foods with holes. To publicize the book, Karl designs the website holefoods.com. Karl appropriates the key words of other cooking and cookbook sites with more frequent hits so that holefoods.com will appear in the same search engine results as the more popular sites. Has Karl done anything wrong? Explain. Solution Karl may have committed trademark infringement. Search engines compile their results by looking through websites‘ key-word fields. A site that appropriates the key words of other sites with more frequent hits will appear in the same search engine results as the more popular sites. But using another‘s trademark as a key word without the owner‘s permission normally constitutes trademark infringement. Of course, some uses of another‘s trademark as a meta tag may be permissible if the use is reasonably necessary and does not suggest that the owner authorized or sponsored the use. 154. Eagle Corporation began marketing software in 2010 under the mark ―Eagle.‖ In 2019, Eagle.com, Inc., a different company selling different products, begins to use eagle as part of its URL and registers it as a domain name. Can Eagle Corporation stop this use of eagle? If so, what must the company show? Solution Yes. This may be an instance of trademark dilution. Dilution occurs when a trademark is used, without permission, in a way that diminishes the distinctive quality of the mark. Dilution does not require proof that consumers are likely to be confused by the use of the unauthorized mark. The products involved do not have to be similar. Dilution does require, however, that a mark be famous when the dilution occurs.

Business Scenarios and Case Problems 155. Privacy. See You, Inc., is an online social network. SeeYou‘s members develop personalized profiles to share information— photos, videos, stories, activity updates, and other items—with other members. Members post the information that they want to share and decide with whom they want to share it. SeeYou launched a program to allow members to share with others what they do elsewhere online. For example, if a member rents a movie through Netflix, SeeYou will broadcast that information to everyone in the member‘s online network. How can SeeYou avoid complaints that this program violates its members‘ privacy? (See Privacy.) Solution Initially, SeeYou‘s best option in this situation might be to give members the opportunity to prevent the broadcast of any private information by requiring their consent. Otherwise, the members could legitimately complain that the new program was causing publication of private information without their permission. Or SeeYou might allow members to affirmatively opt out of the program altogether. Of course, SeeYou might also discontinue the program. And if any of the members decide to file a suit against SeeYou for violations of federal or state privacy statutes, the firm might offer to settle to avoid further complaints and negative publicity. 156. Copyrights in Digital Information. When she was in college, Jammie Thomas-Rasset wrote a case study on Napster, an online peer-to-peer (P2P) file-sharing network, and knew that it had been shut down because it was illegal. Later, Capitol Records, Inc., which owns the copyrights

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

to a large number of music recordings, discovered that ―tereastarr‖—a user name associated with Thomas-Rasset‘s Internet protocol address— had made twenty-four songs available for distribution on KaZaA, another P2P network. Capitol notified Thomas-Rasset that she had been identified as engaging in the unauthorized trading of music. She replaced the hard drive on her computer with a new drive that did not contain the songs in dispute. Is Thomas-Rasset liable for copyright infringement? Explain. [Capitol Records, Inc. v. Thomas-Rasset, 692 F.3d 899 (8th Cir. 2012)] (See Copyrights in Digital Information.) Solution Yes, Thomas-Rasset is liable for copyright infringement. File-sharing is accomplished through peer-to-peer (P2P) networking. When file-sharing is used to download others‘ stored music files, copyright issues arise. The issue of infringement in file-sharing has been a subject of debate since the cases against Napster, Inc. and Grokster, Ltd., two companies that created software used to share files in infringement of others‘ copyrights. Napster operated a website with free software that enabled users to copy and transfer MP3 files via the Internet. Firms in the recording industry sued Napster. Ultimately, the court held Napster liable for copyright infringement. Here, Thomas-Rasset willfully infringed Capitol‘s intellectual property rights under the Copyright Act by making twenty-four songs available for distribution on an online peer-to-peer network. Her subsequent effort to conceal her actions by changing the hard drive on her computer showed a proclivity for unlawful conduct. This would support imposing an injunction on Thomas-Rasset against making songs or any recordings available for distribution to the public through a P2P or any other online media distribution system. In the actual case on which this problem is based, Capitol filed a suit in a federal district court against Thomas-Rasset, who was found liable for copyright infringement and assessed damages of $54,000. On appeal, the U.S. Court of Appeals for the Eighth Circuit vacated the lower court's judgment, concluding that it should have assessed statutory damages of at least $222,000 and should have enjoined Thomas-Rasset from making copyrighted works available to the public. The appellate court remanded the case with directions to enter a judgment that included those remedies. 157. Privacy. Using special software, South Dakota law enforcement officers found a person who appeared to possess child pornography at a specific Internet protocol address. The officers subpoenaed Midcontinent Communications, the service that assigned the address, for the personal information of its subscriber. With this information, the officers obtained a search warrant for the residence of John Rolfe, where they found a laptop that contained child pornography. Rolfe argued that the subpoenas violated his ―expectation of privacy.‖ Did Rolfe have a privacy interest in the information obtained by the subpoenas issued to Midcontinent? Discuss. [State of South Dakota v. Rolfe, 825 N.W.2d 901 (S.Dak. 2013)] (See Privacy.)

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Solution No, Rolfe did not have a privacy interest in the information obtained by the subpoenas issued to Midcontinent Communications. The courts have held that the right to privacy is guaranteed by the U.S. Constitution‘s Bill of Rights, and some state constitutions contain an explicit guarantee of the right. A person must have a reasonable expectation of privacy, though, to maintain a suit or to assert a successful defense for an invasion of privacy. People clearly have a reasonable expectation of privacy when they enter their personal banking or credit card information online. They also have a reasonable expectation that online companies will follow their own privacy policies. But people do not a reasonable expectation of privacy in statements made on Twitter and other data that they publicly disseminate. In other words, there is no violation of a subscriber‘s right to privacy when a third-party Internet provider receives a subpoena and discloses the subscriber‘s information. Here, Rolfe supplied his e-mail address and other personal information, including his Internet protocol address, to Midcontinent. In other words, Rolfe publicly disseminated this information. Law enforcement officers obtained this information from Midcontinent through the subpoenas issued by the South Dakota state court. Rolfe provided his information to Midcontinent—he has no legitimate expectation of privacy in that information. In the actual case on which this problem is based, Rolfe was charged with, and convicted of, possessing, manufacturing, and distributing child pornography, as well as other crimes. As part of the proceedings, the court found that Rolfe had no expectation of privacy in the information that he made available to Midcontinent. On appeal, the South Dakota Supreme Court upheld the conviction. 158. File-Sharing. Dartmouth College professor M. Eric Johnson, in collaboration with Tiversa, Inc., a company that monitors peer-to-peer networks to provide security services, wrote an article titled ―Data Hemorrhages in the Health-Care Sector.‖ In preparing the article, Johnson and Tiversa searched the networks for data that could be used to commit medical or financial identity theft. They found a document that contained the Social Security numbers, insurance information, and treatment codes for patients of LabMD, Inc. Tiversa notified LabMD of the find in order to solicit its business. Instead of hiring Tiversa, however, LabMD filed a suit in a federal district court against the company, alleging trespass, conversion, and violations of federal statutes. What do these facts indicate about the security of private information? Explain. How should the court rule? [LabMD, Inc. v. Tiversa, Inc., 2013 WL 425983 (11th Cir. 2013)] (See Copyrights in Digital Information.) Solution The facts of this case indicate that the security of private information in any database accessible from the Web is weak. And this information can be easily shared with others through peer-topeer networks, which allow users to place shared computer files in folders that are open for other users to search. As part of the research for their article, Johnson and Tiversa searched the networks for data that could be used to commit medical or financial identity theft. On one of them, they found a document that contained the Social Security numbers, insurance information, and treatment codes for patients of LabMD, Inc. Tiversa notified LabMD of the find. LabMD appeared not to

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

have willingly revealed this information because on learning of its exposure, the company filed a suit against Tiversa. In the actual case on which this problem is based, the court dismissed the suit for lack of personal jurisdiction over Tiversa. On appeal, the U.S Court of Appeals for the Eleventh Circuit affirmed. LabMD asserted jurisdiction under a long-arm statute of Georgia. But Tiversa was not registered to do business in Georgia, had no employees or customers in Georgia, derived no revenue from business activities in Georgia, owned no Georgia property, and paid no Georgia taxes. Furthermore, although accessible in Georgia, Tiversa‘s website merely advertised its services, and did not offer products or services for purchase online. Tiversa's entire contact with Georgia consisted of one phone call and nine e-mails to LabMD. This was not sufficient. 159. Business Case Problem with Sample Answer—Social Media. Mohammad Omar Aly Hassan and nine others were indicted in a federal district court on charges of conspiring to advance violent jihad (holy war against enemies of Islam) and other offenses related to terrorism. The evidence at Hassan‘s trial included postings he made on Facebook concerning his adherence to violent jihadist ideology. Convicted, Hassan appealed, contending that the Facebook items had not been properly authenticated (established as his own comments). How might the government show the connection between postings on Facebook and those who post them? Discuss. [United States v. Hassan, 742 F.3d 104 (4th Cir. 2014)] (See Social Media.) —For a sample answer to Problem 8–5, go to Appendix E. Solution As stated in the text, law enforcement can use social media to detect and prosecute suspected criminals. But there must be an authenticated connection between the suspects and the posts. To make this connection, law enforcement officials can present the testimony or certification of authoritative representatives of the social media site or other experts. The posts can be traced from the pages on which they are displayed and the accounts of the ―owners‖ of the pages to the posters through Internet Protocol (IP) addresses. An IP address can reveal the e-mail address, and even the mailing address, of an otherwise anonymous poster. The custodians of Facebook, for example, can verify Facebook pages and posts because they maintain those items as business records in the course of regularly conducted business activities. From those sources, the prosecution in Hassan‘s case could have tracked the IP address to discover his identity. In the actual case on which this problem is based, on Hassan‘s appeal of his conviction, the U.S. Court of Appeals for the Fourth Circuit affirmed. 160. Social Media. Kenneth Wheeler was angry at certain police officers in Grand Junction, Colorado, because of a driving-under- the-influence arrest that he viewed as unjust. While in Italy, Wheeler posted a statement to his Facebook page urging his ―religious followers‖ to ―kill cops, drown them in the blood of their children, hunt them down and kill their entire bloodlines‖ and provided names. Later, Wheeler added a post to ―commit a massacre in the Stepping Stones Preschool and day care, just walk in and kill everybody.‖ Could a reasonable person conclude that Wheeler‘s posts were true threats? How might law enforcement officers use Wheeler‘s posts? Explain. [United States v. Wheeler, 776 F.3d 736 (10th Cir. 2015)] (See Social Media.) Solution

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Yes, a reasonable person could conclude that Wheeler‘s posts were ―true‖ threats. Law enforcement uses social media to detect and prosecute criminals. Police may also use social media to help them to locate a particular suspect or to determine the suspect‘s identity. In this problem, Kenneth Wheeler was angry at police officers in Grand Junction, Colorado, due to a driving-under-the-influence arrest that he viewed as a set-up. While in Italy, Wheeler posted a statement to his Facebook page urging his ―religious followers‖ to ―kill cops, drown them in the blood of their children, hunt them down and kill their entire bloodlines‖ and provided names. Later, Wheeler added a post to ―commit a massacre in the stepping stones preschool and day care, just walk in and kill everybody.‖ In determining whether a ―true‖ threat has been made, a court asks whether those who hear or read the threat reasonably consider that an actual threat has been made. Exhortations to unspecified others to commit violence can amount to true threats, so as to support a criminal prosecution based on those threats, especially if a reasonable person might believe the individuals ordered to take violent action are subject to the will of the threatening party. Law enforcement officers might use Wheeler‘s posts to detect, investigate, and prosecute any crimes. Police may also use the posts to help them to determine Wheeler‘s identity and his location. In the actual case on which this problem is based, Wheeler was convicted of transmitting a threat and sentenced to forty months' imprisonment. On appeal, the U.S. Court of Appeals for the Tenth Circuit held that a reasonable person could interpret Wheeler‘s statements to be ―true‖ threats. The court remanded the case for a new trial on other grounds. 161. Social Media. Irvin Smith was charged in a Georgia state court with burglary and theft. Before the trial, during the selection of the jury, the state prosecutor asked the prospective jurors whether they knew Smith. No one responded affirmatively. Jurors were chosen and sworn in, without objection. After the trial, during deliberations, the jurors indicated to the court that they were deadlocked. The court charged them to try again. Meanwhile, the prosecutor learned that ―Juror 4‖ appeared as a friend on the defendant‘s Facebook page and filed a motion to dismiss her. The court replaced Juror 4 with an alternate. Was this an appropriate action, or was it an ―abuse of discretion‖? Should the court have admitted evidence that Facebook friends do not always actually know each other? Discuss. [Smith v. State of Georgia, 335 Ga.App. 497, 782 S.E.2d 305 (2016)] (See Social Media.) Solution The action by the court in replacing Juror 4 with an alternate was not an abuse of discretion. Nor did the court err in not admitting evidence that in general Facebook friends do not always actually know each other. In this problem, Smith was charged with burglary and theft by taking a motor vehicle. Before the trial, during voir dire—the selection of the jury panel— the state prosecutor asked the prospective jurors, whether they knew Smith. No one indicated that they did. Jurors were chosen and sworn in, without objection. After the trial, during deliberations, the prosecutor learned that ―Juror 4‖ appeared as a friend on Smith‘s Facebook page and filed a motion to dismiss her from the jury. The court granted the motion and replaced Juror 4 with an alternate. This was not an abuse of the court‘s discretion because Juror 4 was connected to Smith in some way and her failure to disclose the connection during voir dire placed in doubt her ability to determine his guilt or innocence impartially.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

As for whether evidence should be admitted to the effect that Facebook friends might not actually know each other, it would not be abuse of discretion to exclude it. Such evidence would not relevant to Juror 4‘s unique situation, her ―personal style‖—that is, whether she actually knew the defendant and if so, in what way. In the actual case on which this problem is based, after the juror was replaced with an alternate, the jury returned a guilty verdict. A state intermediate appellate court affirmed this result, after a review of the issues focused on here. 162. Internet Law. Jason Smathers, an employee of America Online (AOL), misappropriated an AOL customer list with 92 million screen names. He sold the list for $28,000 to Sean Dunaway, who sold it to Braden Bournival. Bournival used it to send AOL customers more than 3 billion unsolicited, deceptive e-mail ads. AOL estimated the cost of processing the ads to be at least $300,000. Convicted of conspiring to relay deceptive e-mail in violation of federal law, Smathers was ordered to pay AOL restitution of $84,000 (treble the amount for which he had sold the AOL customer list). Smathers appealed, seeking to reduce the amount. He cited a judgment in a civil suit for a different offense against Bournival and others for which AOL had collected $95,000. Smathers also argued that his obligation should be reduced by restitution payments made by Dunaway. Which federal law did Smathers violate? Should the amount of his restitution be reduced? Explain. [United States v. Smathers, 879 F.3d 453 (2d. Cir. 2018)] (See Internet Law.) Solution Smathers was charged with, and convicted of, violating the federal CAN-SPAM Act. This law applies to the sending of unsolicited ―junk‖ e-mail, prohibiting the use of false, misleading, or deceptive information. Smathers, an employee of America Online (AOL), misappropriated an AOL customer list with 92 million screen names. He sold the list for $28,000 to Sean Dunaway, who sold it to Braden Bournival. Bournival used it to send AOL customers more than 3 billion unsolicited, deceptive email ads. AOL estimated the cost of processing the ads to be at least $300,000. Smathers was convicted of conspiring to relay deceptive e-mail in violation of the CAN-SPAM Act, which applied to the sending of the ads. Smathers was ordered to pay AOL restitution of $84,000. He sought to reduce this amount by citing a judgment in a civil suit against Bournival and others for which AOL had collected $95,000. He also argued that the amount should be reduced by restitution payments made by Dunaway. As indicated by the facts, however, he was not a party to the Bournival litigation, which involved a different offense. And AOL‘s total loss was at least $300,000. Payments by Smathers and Dunaway together are not likely to reach that figure, much less the $84,000 that Smathers was ordered to pay. In the actual case on which this problem is based, the U.S. Court of Appeals for the Second Circuit affirmed the restitution order, concluding that Smathers‘s contentions were ―without merit.‖ 163. A Question of Ethics—The IDDR Approach and Social Media. One August morning, around 6:30 a.m., a fire occurred at Ray and Christine Nixon‘s home in West Monroe, Louisiana. The Nixons told Detective Gary Gilley of the Ouachita Parish Sheriff‘s Department that they believed the fire was deliberately set by Matthew Alexander, a former employee of Ray‘s company. Ray gave Alexander‘s phone number to Gilley, who contacted the number‘s service

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

provider, Verizon Wireless Services, L.L.C. Gilley said that he was investigating a house fire that had been started with the victims inside the dwelling, and wanted to know where the number‘s subscriber had been that day. He did not present a warrant, but he did certify that Verizon‘s response would be considered an ―emergency disclosure.‖ [Alexander v. Verizon Wireless Services, L.L.C., 875 F.3d 243 (5th Cir. 2017)] (See Social Media.) 1.

Using the Inquiry and Discussion steps in the IDDR approach, identify the ethical dilemma that Verizon faced in this situation and actions that the company might have taken to resolve that issue.

Solution The ethical dilemma that Verizon faced in this case is whether to provide a police officer with the information that he asked for. With no warrant or other court order, Verizon had a substantial legal basis to refuse. If disclosure had been legally required, however, would the company have had an ethical basis to refuse? Or, did the company have an ethical obligation to respond, regardless of whether it was legally required to do so? The IDDR approach begins with an Inquiry that sets out the ethical dilemma and identifies the stakeholders and the relevant ethical standards in a set of facts. The Discussion step covers actions to address the issue, the actions‘ strengths and weaknesses, and their consequences and effects. Here, Ray and Christine Nixon told Sheriff‘s Detective Gary Gilley that they believed a fire in their home had been set by Matthew Alexander. Ray gave Alexander‘s phone number to Gilley, who contacted the number‘s service provider, Verizon. Gilley said that he was investigating a house fire that may have intentionally started with the victims inside, and wanted to know where the number‘s subscriber had been that day. He did not present a warrant, but he did certify that Verizon‘s response would be considered an ―emergency disclosure.‖ The stakeholders in this situation include all of the immediate parties—the Nixons, Alexander, Gilley, and Verizon—as well as other police officers, service providers, the public generally, and most importantly other potential victims if in the fact the fire had been arson. Verizon can choose to reveal all of its information concerning its subscriber, none of the data, or some part of it. This choice might be affected by the company‘s guidelines on what information to reveal, whom it may be disclosed to, and when it should be released. It might also be influenced by an altruistic motive to help others in distress (the NIxons), in need (the police), or in harm‘s way (unwitting potential victims). There may also be a perceived overriding ethical duty to protect privacy rights. The strengths and weaknesses of the actions exist in their consequences. Refusing to disclose the information could protect the privacy of Verizon‘s subscribers, and ultimately, contribute to the protection of the privacy for all. But it would impede a police investigation of a possible crime, which could result in the Nixons or others being further victimized. Disclosing all, or at least some, of the information could prevent the negative consequences of revealing none of it. Relying on the detective‘s ―certification‖ that this response would be considered an ―emergency disclosure‖ would lend moral, and possibly legal, support to this decision. Finally, revealing only where the subscriber had been that day, without disclosing content (no texts, e-mails, or conversations), could arguably protect privacy rights.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 08: Internet Law, Social Media, and Privacy

Suppose that Verizon gave Gilley the requested information, and that later Alexander filed a suit against the provider, alleging a violation of the Stored Communications Act. Could Verizon successfully plead ―good faith‖ in its defense?

Solution Yes, if Verizon gave Gilley the requested information, and later Alexander filed a suit against the company, under the Stored Communications Act (SCA), the defendant could successfully plead ―good faith‖ in its defense. The SCA prohibits the intentional and unauthorized access to stored electronic communications. The act also prevents providers of communications services from disclosing private communications to certain entities and individuals. There are civil sanctions for violations. Thus, in the circumstances of this case, as a provider, Verizon might violate the act by responding to Gilley‘s request with the information that he sought—where the subscriber to a certain phone number had been that day. Gilley did not present Verizon with a warrant, but he stated the purpose for his request and certified that the provider‘s response would be considered an ―emergency disclosure.‖ The company could believe in good faith, then, that an emergency involving a risk of serious injury or other harm to a person mandated the disclosure of the data. This would most likely serve as a sufficient legal defense to a suit by the party whose information was disclosed. In ethical terms, as related in the answer to the question above, there are also significant altruistic and other moralistic reasons to support the disclosure of the information. In the actual case on which this problem is based, Verizon provided Gilley with the information. Alexander was charged in a Louisiana state court with arson. The court suppressed the records obtained from Verizon, finding no exigent circumstances to justify Gilley acting without a warrant. Alexander filed a suit in a federal district court against Verizon, alleging a violation of the SCA. The court dismissed the suit. The U.S. Court of Appeals for the Fifth Circuit affirmed the dismissal. ―Verizon acted reasonably in concluding that there was an emergency . . . that required Verizon to act without delay.‖

Critical Thinking and Writing Assignments 2.

Time-Limited Group Assignment—File-Sharing. James, Chang, and Braden are roommates. They are music fans and frequently listen to the same artists and songs. They regularly exchange MP3 music files that contain songs from their favorite artists. (See Copyrights in Digital Information.) 4. One group of students will decide whether the fact that the roommates are transferring files among themselves for no monetary benefit protects them from being subject to copyright law. Solution Just because the three roommates are not profiting from their file-sharing actions does not mean that they wouldn‘t be subject to copyright law. A copyright violation can occur in the absences of any monetary benefit. Congress extended liability under copyright law to persons who exchange unauthorized copyrighted words without realizing a profit.

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

The second group will consider whether it would be legal for each roommate to buy music on CD and then, after downloading a copy on to their hard drive, give the CD to the other roommates to do the same. Does this violate copyright law? Is it the same as file-sharing digital music? Explain.

Solution The purchaser of a CD has the right to loan or sell that CD to anyone else. If the roommates each rip the CD to their own hard drives, generally, there will be no copyright violation. 6.

A third group will consider streaming music services. If one roommate subscribes to a streaming service and the other roommates use the service for free, would this violate copyright law? Why or why not?

Solution If one roommate subscribes to a streaming service and the other roommates use the service for free, this would violate copyright law if it violates the terms of the service agreement or the service‘s policy. Copyright is the most important form of intellectual property protection on the Internet. Because most, if not all, of the material is copyrighted, simply transferring it online is copying it in violation of copyright law. Thus, sharing the stored music files of others, especially those of the owner of the copyright to the music, raises copyright issues. Some companies have aggressively pursued who shared the firms‘ property. Others have not, perhaps to avoid bad publicity or to attract new customers. If the streaming service in the question opposes the sharing of its service, then doing so clearly infringes on the company‘s copyrights. This is both a criminal and a civil violation of copyright law. Penalties and sanctions include damages and injunctions. A user might argue the innocent infringer defense—being unaware that the actions constituted copyright infringement. The application of these principles is for the determination of a court. Of course, if a steaming service turns a blind eye to the sharing of its material, there are not likely to be negative consequences to those who do it.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Chapter Review ........................................................................................................................................................... 102 Practice and Review .............................................................................................................................. 102 Practice and Review: Debate This ......................................................................................................... 103 Issue Spotters ........................................................................................................................................ 104 Business Scenarios and Case Problems ................................................................................................. 104 Critical Thinking and Writing Assignments ............................................................................................ 109

Critical Thinking Questions in Features Adapting the Law to the Online Environment 164. Despite Bitcoin‘s oversized presence on the dark web, only about 1 percent of all transactions using the cryptocurrency involve an illegal exchange of goods. How does this fact impact arguments in favor of banning Bitcoin? Solution The relatively low level of illegal activity actually associated with Bitcoin argues against its prohibition. As a society, we accept the widespread use of many items that, under certain circumstances, can be used to further a criminal goal. To use the most obvious example for this topic, even though cash is used in a great many crimes—far more than Bitcoin—nobody would suggest banning the use of cash. Interestingly, several European countries have limited the amount of cash that can be legally used in any single transaction, primarily to combat money laundering and other forms of tax evasion. In these situations, one could argue that the funds themselves are part of the actus reus of the crime. In most cases not involving counterfeiting, however, the actus reus of a crime that involves the exchange of illegal goods is the exchange, not the currency used.

Managerial Strategy—Business Questions Why might a corporation‘s managers agree to pay a large fine rather than to be indicted and proceed to trial? Solution Most corporate managers choose to pay the fine because they worry that a criminal indictment will harm their corporation‘s reputation, its profitability, and ultimately, its existence. 165. How do managers determine the optimal amount of legal research to undertake to prevent their companies from violating the many thousands of federal regulations? Solution Every manager is faced with the task of determining how best to use the limited resources at their disposal. Clearly, no manager in a small company would decide to devote 50 percent of the company‘s annual costs to preventing violations of federal regulations. Hence, each manager must weigh the potential costs of violating federal rules and regulations with the legal fees that must be incurred to learn about those regulations.

100

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Cybersecurity and the Law—Critical Thinking 166. One suggestion for alleviating the problem of ―fraud sourced‖ money is to require proof of identity from anyone who wants to trade virtual items on online gaming platforms. Do you think this strategy would be successful? Why or why not? Solution The reasoning behind an identification requirement seems sound. Cybercriminals thrive on anonymity. If there is a record linking them to any suspicious activity, it will deter that activity. It also gives companies like Valve and Epic Games, which owns Fortnite, the ability to monitor the behavior of specific players and traders, and, if this activity becomes suspicious, report it to law enforcement. At the same time, cyber criminals are skilled in hiding their identities, and would certainly put this expertise to use on online gaming markets if given an incentive to do so. Furthermore, the identification requirement is not necessarily fair to legitimate gamers, who may want to operate in anonymity for privacy reasons. Many such players would switch from online gaming platforms that did require identification to those that did not, therefore causing economic hardship to those companies trying to do the ―right thing.‖

Critical Thinking Questions in Cases Case 9.1 167. Could Crabtree have successfully avoided her conviction by arguing that her only ―crime‖ was ―naively trusting her co-workers?‖ Why or why not? Solution No, Crabtree is not likely to have avoided her conviction by arguing that her only ―crime‖ was ―naively trusting her co-workers.‖ This claim would have been refuted by the same evidence that supported the jury‘s finding of her knowledge of, and voluntary participation in, the fraud with which she was charged. This evidence included the testimony of HCSN employees that Crabtree complied with their requests to modify patient notes to satisfy Medicare qualifications. Further, Crabtree acknowledged in conversation that some of the patients suffered from conditions that were unsuitable for treatment at HCSN. In addition, there was the evidence that Crabtree fulfilled requests to change and falsify notes for billing and Medicare purposes. This supported the finding that she voluntarily joined the conspiracy. 168. It seems reasonable to assume that one of the purposes of any business is to ―maximize billing potential.‖ When does conduct to accomplish that purpose become unethical? Solution Conduct to ―maximize billing potential,‖ or to realize any other financial objective, becomes unethical when decisions and actions fail to reflect ―good corporate citizenship.‖ In the Crabtree case, for example, the defendant (and, of course, others who participated in the fraud with which she was charged) failed to evaluate—at a minimum—the legal implications of their conduct before engaging in it. Most importantly, Crabtree should have taken into account the health needs of the patients whose therapy she vouched for. She might also have given

101

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

thought to the possible consequences of her ill-conceived actions on her family and her reputation, as well as within the healthcare community generally.

Case 9.2 169. Why was Sisuphan convicted of embezzlement instead of larceny? What is the difference between these two crimes? Solution One of the key differences between embezzlement and larceny has to do with the element of possession. Larceny involves the wrongful taking of property in the possession of another, as does robbery (the latter crime involves the violent taking of the property). Embezzlement, in contrast, involves the wrongful appropriation of property that has been entrusted to the person appropriating it, typically an employee. In other words, the property is already in the perpetrator‘s possession. Thus, Sisuphan was convicted of embezzlement instead of larceny because, as a dealership employee, he was in legitimate possession of the money until he took the added step of keeping it.

Chapter Review Practice and Review Edward Hanousek worked for Pacific & Arctic Railway and Navigation Company (P&A) as a roadmaster of the White Pass & Yukon Railroad in Alaska. As an officer of the corporation, Hanousek was responsible ―for every detail of the safe and efficient maintenance and construction of track, structures, and marine facilities of the entire railroad,‖ including special projects. One project was a rock quarry, known as ―6-mile,‖ above the Skagway River. Next to the quarry, and just beneath the surface, ran a high-pressure oil pipeline owned by Pacific & Arctic Pipeline, Inc., P&A‘s sister company. When the quarry‘s backhoe operator punctured the pipeline, an estimated one thousand to five thousand gallons of oil were discharged into the river. Hanousek was charged with negligently discharging a harmful quantity of oil into a navigable water of the United States in violation of the criminal provisions of the Clean Water Act (CWA). Using the information presented in the chapter, answer the following questions. 170. Did Hanousek have the required mental state (mens rea) to be convicted of a crime? Why or why not? Solution Yes, because he was the corporate officer responsible for the project and had the power to prevent the criminal violation. Corporate directors and officers are personally liable for the crimes they commit, and can also be held liable for the crimes of employees under their supervision. Because Hanousek was the corporate officer responsible for every detail of the ―6-mile‖ quarry, he had the power to prevent the criminal violation. Therefore, Hanousek can be held criminally negligent for the backhoe operator puncturing the pipeline. 171. Which theory discussed in the chapter would enable a court to hold Hanousek criminally liable for violating the statute regardless of whether he participated in, directed, or even knew about the specific violation? Solution

102

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Under the responsible corporate officer doctrine, a corporate officer can be held liable for a crime because he was in a responsible relationship to the corporation and could have prevented the violation. The corporate officer does not have to intend the crime or even know about it, to incur liability under this doctrine. 172. Could the backhoe operator who punctured the pipeline also be charged with a crime in this situation? Explain. Solution No, because he did not have the required mental state (mens rea) and was not a corporate officer in a responsible position to prevent the criminal violation. Criminal liability requires a guilty act at the same time as the defendant had a wrongful mental state. In this situation, the backhoe operator did pierce the pipeline (the guilty act), but he did not have a wrongful mental state because he was unaware that the pipeline was there. As an employee, a court would not use the same standard as if he were a responsible corporate officer who ―knew or should have known‖ of the existence of the pipeline. Because both elements of criminal liability (guilty act and wrongful mental state) did not occur, the backhoe operator could not be charged with a crime. 173. Suppose that, at trial, Hanousek argued that he could not be convicted because he was not aware of the requirements of the CWA. Would this defense be successful? Why or why not? Solution No, because Hanousek was the corporate officer responsible for the project and should have known the requirements of the law. Because Hanousek was in a responsible position at the corporation and specifically in charge of the 6-mile quarry, a court would find that he ―should have known‖ of the requirements of the law. Therefore, lack of knowledge of the requirements of the Clean Water Act would not operate as a defense in his case.

Practice and Review: Debate This 174. Because of overcriminalization, particularly by the federal government, Americans may be breaking the law regularly without knowing it. Should Congress rescind many of the more than four thousand federal crimes now on the books? Solution Drastic times require drastic measures. This nation now has more than three hundred million residents who move frequently. Moreover, the pervasiveness of the Internet means that business fraud is increasing at a rapid rate. Consequently, the federal government must step in to make sure that criminal actions do not go unpunished. That‘s why so many new federal crimes have been added to the body of criminal statutes. The Constitution reserves for the states police powers for activities within state boarders. Crimes have always been defined by state and local governments. Just because we have a larger population that has access to the Internet does not mean that Congress should be in the business of creating so many federal crimes. Moreover, many new federal criminal statutes do not require intent—a cornerstone of the prosecution of most crimes for ages.

103

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Issue Spotters 175. Dana takes her roommate‘s credit card, intending to charge expenses that she incurs on a vacation. Her first stop is a gas station, where she uses the card to pay for gas. With respect to the gas station, has she committed a crime? If so, what is it? Solution Yes. With respect to the gas station, she has obtained goods by false pretenses. She might also be charged with larceny and forgery, and most states have special statutes covering illegal use of credit cards. 176. Without permission, Ben downloads consumer credit files from a computer belonging to Consumer Credit Agency. He then sells the data to Dawn. Has Ben committed a crime? If so, what is it? Solution Yes. The Counterfeit Access Device and Computer Fraud and Abuse Act provides that a person who accesses a computer online, without permission, to obtain classified data—such as consumer credit files in a credit agency‘s database—is subject to criminal prosecution. The crime has two elements: (1) accessing the computer without permission and (2) taking data. It is a felony if done for private financial gain. Penalties include fines and imprisonment for up to twenty years. The victim of the theft can also bring a civil suit against the criminal to obtain damages and other relief.

Business Scenarios and Case Problems 1.

Types of Cyber Crimes. The following situations are similar, but each represents a variation of a particular crime. Identify the crime and point out the differences in the variations. (See Cyber Crime.) 1. Chen, posing fraudulently as Diamond Credit Card Co., sends an e-mail to Emily, stating that the company has observed suspicious activity in her account and has frozen the account. The e-mail asks her to reregister her credit card number and password to reopen the account. Solution This is a form of identity theft. The traditional crimes of theft (robbery, burglary, larceny, and other) consist of wrongfully taking and carrying away another‘s personal property with the intent of depriving the owner permanently of it. Unique to crimes of identity theft is that they involve taking another‘s identity, and unique to cyber variations of the offense is that the criminal acts are committed with computers, often online. A stolen identity is typically used to commit more crimes. 2.

Claiming falsely to be Big Buy Retail Finance Co., Conner sends an e-mail to Dino, asking him to confirm or update his personal security information to prevent his Big Buy account from being discontinued.

Solution As in the previous problem, this is a form of identity theft. This problem describes a factual situation referred to as phishing. In such a set of circumstances, once an unsuspecting individual responds by entering the requested information, the phisher can use it to pose as that person or to steal the funds in the victim‘s bank or other account.

104

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Cyber Scam. Kayla, a student at Learnwell University, owes $20,000 in unpaid tuition. If Kayla does not pay the tuition, Learnwell will not allow her to graduate. To obtain the funds to pay the debt, she sends e-mails to people that she does not know asking them for financial help to send her child, who has a disability, to a special school. In reality, Kayla has no children. Is this a crime? If so, which one? (See Cyber Crime.) Solution Kayla has committed fraud in an e-mail sent via the Internet. The elements of the tort of fraud are as follows: 1. The misrepresentation of material facts or conditions was made with knowledge that they were false or with reckless disregard for the truth. 2. There was an intent to induce another to rely on the misrepresentation. 3. There was justifiable reliance on the misrepresentation by the deceived party. 4. Damages were suffered as a result of the reliance. 5. There was a causal connection between the misrepresentation and the injury. If any of Kayla‘s recipients reply to her false plea with cash, it is likely that all of these requirements for fraud will have been met.

Business Case Problem with Sample Answer—White-Collar Crime. Matthew Simpson and others created and operated a series of corporate entities to defraud telecommunications companies, creditors, credit reporting agencies, and others. Through these entities, Simpson and his confederates used routing codes and spoofing services to make long-distance calls appear to be local. They stole other firms‘ network capacity and diverted payments to themselves. They leased goods and services without paying for them. To hide their association with their corporate entities and with each other, they used false identities, addresses, and credit histories, and issued false bills, invoices, financial statements, and credit references. Did these acts constitute mail and wire fraud? Discuss. [United States v. Simpson, 741 F.3d 539 (5th Cir. 2014)] (See Types of Crimes.) Solution Yes, the acts committed by Matthew Simpson and the others, and described in this problem, constitute wire and mail fraud. Federal law makes it a crime to devise any scheme that uses the U.S. mail, commercial carriers (FedEx, UPS), or wire (telegraph, telephone, television, the Internet, e-mail) with the intent to defraud the public. Here, as stated in the facts, Simpson and his cohorts created and operated a series of corporate entities to defraud telecommunications companies, creditors, credit reporting agencies, and others. Through these entities, Simpson and the others used routing codes and spoofing services to make long distance calls appear to be local. They stole other firms‘ network capacity and diverted payments to themselves. They leased goods and services without paying for them. And they assumed false identities, addresses, and credit histories, and issued false bills, invoices, financial statements, and credit references, in order to hide their association with their entities and with each other. The ―scheme‖ was to defraud telecommunications companies and other members of the public to the perpetrators‘ gain of a variety of goods and services. Wire services—the Internet, and presumably phones and other qualifying services—were used to further the scheme. In the actual case on which this problem is based, a federal district court convicted Simpson of participating in a wire and mail fraud conspiracy (and other crimes). On appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed the conviction.

105

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

Defenses to Criminal Liability. George Castro told Ambrosio Medrano that a bribe to a certain corrupt Los Angeles County official would buy a contract with the county hospitals. To share in the deal, Medrano recruited Gustavo Buenrostro. In turn, Buenrostro contacted his friend James Barta, the owner of Sav–Rx, which provides prescription benefit management services. Barta was asked to pay a ―finder‘s fee‖ to Castro. He did not pay, even after frequent e-mails and calls with deadlines and ultimatums delivered over a period of months. Eventually, Barta wrote Castro a Sav–Rx check for $6,500, saying that it was to help his friend Buenrostro. Castro was an FBI agent, and the county official and contract were fictional. Barta was charged with conspiracy to commit bribery. At trial, the government conceded that Barta was not predisposed to commit the crime. Could he be absolved of the charge on a defense of entrapment? Explain. [United States v. Barta, 776 F.3d 931 (7th Cir. 2015)] (See Defenses to Criminal Liability.) Solution Yes, Barta could be absolved of the charge of conspiracy to commit bribery on a defense of entrapment. This defense is designed to prevent police officers and other government agents from enticing persons to commit crimes so that they can later be prosecuted for criminal acts. For entrapment to succeed as a defense, both the suggestion and the inducement to commit the crime must take place. The critical question is whether the person who is charged with the commission of a crime was predisposed to commit it or did so only because the officer induced it. In this problem, the government, through its agent George Castro, entrapped Barta into participating in a conspiracy to bribe a fictional county official. The government conceded at Barta‘s trial that he was not predisposed to conspire to commit bribery. Castro frequently emailed and called Barta over a period of months, with no response from him, even when the messages included deadlines and ultimatums. And Barta‘s statement, when he eventually did write a check on his company‘s account to Castro, that it was to help his friend gave the government reason to believe that Barta was making a deal only to benefit his friend. In the actual case on which this problem is based, Barta was arrested, charged, and tried for conspiracy to commit bribery. He pleaded entrapment but was convicted. The U.S. Court of Appeals for the Seventh Circuit reversed his conviction, on the reasoning stated above.

Fourth Amendment Protections. Federal officers obtained a warrant to arrest Kateena Norman on charges of credit card fraud and identity theft. Evidence of the crime included videos, photos, and a fingerprint on a fraudulent check. A previous search of Norman‘s house had uncovered credit cards, new merchandise, and identifying information for other persons. An Internet account registered to the address had been used to apply for fraudulent credit cards, and a fraudulently obtained rental car was parked on the property. As the officers arrested Norman outside her house, they saw another woman and a caged pit bull inside. They further believed that Norman‘s boyfriend, who had a criminal record and was also suspected of identify theft, could be there. In less than a minute, the officers searched only those areas within the house in which a person could hide. Would it be reasonable to admit evidence revealed in this ―protective sweep‖ during Norman‘s trial on the arrest charges? Discuss. [United States v. Norman, 637 Fed. Appx. 934 (11th Cir. 2016)] (See Constitutional Safeguards.) Solution Yes, it would be reasonable to admit evidence revealed in the ―protective sweep‖ of the defendant‘s house in this problem during Norman‘s trial on the arrest charges.

106

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

The Fourth Amendment to the U.S. Constitution protects the ―right of the people to be secure in their persons, houses, papers, and effects.‖ Under this amendment, before searching private property, law enforcement officers must obtain a search warrant. Evidence obtained in violation of this requirement is not admissible at trial. But a warrantless search can be reasonable when probable cause and exigent circumstances exist. Thus, when an officer possesses a reasonable belief based on specific facts that an individual posing a danger is hidden inside a certain location, a search for the individual—a ―protective sweep‖— confined to those places on site in which a person might be hiding would be reasonable. In this problem, from outside a house belonging to Kateena Norman, during the execution of a warrant for the arrest of Norman on charges of credit-card fraud and identity theft, federal officers saw another woman and a caged pit bull inside. The officers further believed that Norman‘s boyfriend, who had a criminal record and was also suspected of identify theft, could be inside. In less than a minute, the officers searched only those areas within the house in which a person could hide. Under these circumstances, the warrantless search was reasonable and therefore any evidence discovered in the search would be admissible during her trial on the arrest charges. In the actual case on which this problem is based, Norman filed a motion to suppress this evidence, which the court denied. The U.S. Court of Appeals for the Eleventh Circuit affirmed. ―The protective sweep was reasonable.‖ 6.

Types of Crimes. In Texas, Chigger Ridge Ranch, L.P., operated a 700-acre commercial hunting area called Coyote Crossing Ranch (CCR). Chigger Ridge leased CCR and its assets for twelve months to George Briscoe‘s company, VPW Management, LLC. The lease identified all of the vehicles and equipment that belonged to Chigger Ridge, which VPW could use in the course of business, but the lease did not convey any ownership interest. During the lease term, however, Briscoe told his employees to sell some of the vehicles and equipment. Briscoe did nothing to correct the buyers‘ false impression that he owned the property and was authorized to sell it. The buyers paid with checks, which were deposited into an account to which only Briscoe and his spouse had access. Which crime, if any, did Briscoe commit? Explain. [Briscoe v. State of Texas, 2018 WL 792255 (Tex.App.—Texarkana 2018)] (See Types of Crimes.) Solution Briscoe committed the crime of obtaining property by false pretense. This is a crime in which the goal is economic gain through the acquisition of another‘s money, services, or property. This type of theft is accomplished by trickery or fraud. In the Briscoe case, Briscoe leased Chigger Ridge Ranch for twelve months. The lease delineated the vehicles and equipment that belonged to the ranch, and which VPW could use for the term, but the lease did not convey any ownership interest. Despite the lack of ownership rights, Briscoe had his employees sell some of the vehicles and equipment. The buyers had the impression that Briscoe either owned the property or was authorized to sell it, and he did nothing to correct their false impression of this pretense. The buyers paid with checks, which Briscoe deposited in his own account. The goal of this scheme was to acquire the buyers‘ money. The theft was accomplished by fraud.

107

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

In the actual case on which this problem is based, Briscoe was convicted in a Texas state court of giving a false statement to obtain property. A state intermediate appellate court affirmed. ―Briscoe obtained the checks by deception—that is, by failing to correct [the buyers‘] impression that he . . . owned the equipment or was authorized to sell it.‖ 7.

A Question of Ethics—The IDDR Approach and Identity Theft. Heesham Broussard obtained counterfeit money instruments. To distribute them, he used account information and numbers on compromised FedEx accounts procured from hackers. Text messages from Broussard indicated that he had participated previously in a similar scam and that he knew the packages would be delivered only if the FedEx accounts were ―good.‖ For his use of the accounts, Broussard was charged with identity theft. In defense, he argued that the government could not prove he knew the misappropriated accounts belonged to real persons or businesses. [United States v. Broussard, 675 Fed.Appx. 454 (5th Cir. 2017)] (See Cyber Crime.) 1. Does the evidence support Broussard‘s assertion? From an ethical perspective, does it matter whether he knew that the accounts belonged to real customers? Why or why not? Solution No, the evidence does not support Broussard‘s assertion. In fact, it suggests the opposite—that Broussard knew what was going on. In this problem, Heesham Broussard obtained counterfeit money instruments. To distribute the items, he used FedEx account information and numbers misappropriated by hackers. Broussard‘s text messages indicated that he had participated in an earlier, similar scam. Further, the messages showed that he knew the packages would be delivered only if the FedEx accounts were ―good.‖ Charged with identity theft, he argued that the government could not prove he knew the FedEx accounts belonged to real persons or businesses. His text messages, however, indicated the contrary. A judge or juror could infer from these statements that he knew the packages would not be delivered successfully unless the account information and numbers belonged to real customers. From an ethical perspective, it does not matter whether Broussard knew that the accounts belonged to real customers. And it does not matter whether he knew the owners of the accounts, whether they knew him, or whether the accounts belonged to persons or businesses. Broussard committed a crime. An accompanying violation of any standard of ethics is certain. Here, he acted dishonestly, with fraudulent intent, misrepresenting himself as the authorized sender of FedEx packages filled with counterfeit money instruments. In the actual case on which this problem is based, the court convicted Broussard of the charge of identity theft. The U.S. Court of Appeals for the Fifth Circuit affirmed the conviction, responding to his argument on appeal according to the reasoning stated above. 2.

Assuming that FedEx knew its customers‘ account information had been compromised, use the IDDR approach to consider whether the company had an ethical obligation to take steps to protect those customers from theft.

Solution The conclusion seems foregone—if FedEx knew that its customers‘ account information had been compromised, the company had an ethical obligation to take steps to protect those customers from theft.

108

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

The first step of the IDDR approach is an Inquiry—identify the issue, the stakeholders, and ethical standards. In the facts of this question, hackers stole the account information of FedEx customers. Was FedEx obligated to act to protect those customers from theft? Besides those customers and FedEx, the stakeholders could include the owners and employees of the company, as well as the society as a whole. Relevant ethical standards could derive from the company‘s policies, or from religious, philosophical, or other standards. These would include such general principles as acting for the benefit of the most people. The second step of the approach is a Discussion to analyze actions that might address the issue. Factors include the strengths and weaknesses of those actions, considering their consequences and the effects on stakeholders. To protect against theft through the use of stolen account information, FedEx might have to do as little as assign its customers new account names, numbers, or passwords. If the information could be used for illicit purposes other than fraudulent delivery charges, FedEx could notify its customers, publicize the theft, and alert law enforcement. The company might offer to pay to monitor victimized customers‘ credit information. None of these actions would seem to be weak or costly, and their results and effects could be almost entirely beneficial—customers might feel protected, society‘s interest in the reliability of FedEx accounts could be reassured, and the owners and employees of the company might believe more strongly in its continued success. The third step of the IDDR approach is to make a Decision and state the reasons. The decision is clear—FedEx should act to protect its customers and the other stakeholders. The actions the company should take include those discussed above. The reasons for this conclusion are also stated above—to benefit those customers, the owners and employees of the company, and the public generally. This would further assure these stakeholders of the commitment of the firm to the continuing viability of its business. The final step of this approach is a Review to weigh the success or failure of the action to resolve the issue, and satisfy the stakeholders. According to the facts, FedEx policy is to deliver packages only if an account is ―good.‖ Thus, if FedEx were to take the steps indicated above, its actions would likely prove successful. The stolen data would not be able to initiate FedEx deliveries, and would become potentially useless for almost any other purpose. These results could satisfy all of the stakeholders.

Critical Thinking and Writing Assignments 3.

Critical Legal Thinking. Ray steals a purse from an unattended car at a gas station. Because the purse contains money and a handgun, Ray is convicted of grand theft of property (cash) and grand theft of a firearm. On appeal, Ray claims that he is not guilty of grand theft of a firearm because he did not know that the purse contained a gun. Can Ray be convicted of grand theft of a firearm even though he did not know that the gun was in the purse? Explain. (See Types of Crimes.) Solution No. A separate crime occurs only when there are separate distinct acts of seizing the property of another. In the circumstances described in the question, Ray committed the crime of grand theft because of the value of property in the purse, including the value of the gun. Only one crime of

109

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 09: Criminal Law and Cyber Crime

theft occurred, however. Ray saw the purse and took it without knowing what it contained: there was one intent and one act. 4.

Time-Limited Group Assignment—Cyber Crime. Cyber crime costs consumers millions of dollars every year. It costs businesses, including banks and other credit card issuers, even more. Nonetheless, when cyber criminals are caught and convicted, they are rarely ordered to pay restitution or sentenced to long prison terms. (See Cyber Crime.) 1. One group should formulate an argument that stiffer sentences would reduce the amount of cyber crime. Solution It goes without saying that the higher the anticipated cost of engaging in cyber crime activity, the lower will be the amount demanded. In other words, heavy fines and long jail sentences would have some deterrent effect. The real question is by how much. Many hackers who bring down corporate and government computer systems are teenagers. They cost businesses billions of dollars yet gain no monetary reward for their hacking—they do it to prove that they are as good or better than other hackers. If caught, they could not engage in much meaningful restitution to their corporate victims. In contrast, adult cyber criminals who engage in identity theft, credit-card fraud, and online auction fraud often make large sums of money from this criminal activity. They could be forced to engage in meaningful restitution to their victims. They could be sentenced to long jail terms, just as we routinely do for traditional thieves. Restitution and long jail terms might serve as a deterrent to such cyber criminal activities. U.S. authorities, though, cannot easily arrest, try, convict, and sentence cyber criminals living and operating in, say, Russia. 2.

A second group should determine how businesspersons can best protect themselves from cyber crime and avoid the associated costs.

Solution Protection against cyber crime starts with the awareness at management and staff levels of the potential harm that could result. Even the temporary loss of a system‘s functions while its software is replaced due to a virus‘s infection or other destructive event could prove costly. Thus, management should make appropriate funds available to pay for security, impose procedures to identify the system‘s vulnerability, require the use of security hardware and software, and conduct security audits on an ongoing basis. The use of passwords among those with access to the system is also an important step when used correctly. Backed-up data can be key, and storing the backed-up data off-site can be even more effective. 3.

A third group should decide how and when a court should order cyber criminals to pay restitution to their victims. Should victims whose computers have been infected with worms or viruses be entitled to restitution, or only victims of theft who have experienced financial loss? What should the measure of restitution be? Should large companies that are victims of cyber crime be entitled to the same restitution as individuals?

Solution Cyber criminals could and should arguably be ordered to pay restitution to their victims whenever those persons or businesses suffer a financial loss. The victims whose computers are infected with worms or viruses most likely must pay for cleansing software or a security sweep, or more, to clear their data of the infections. Victims of theft of course experience financial loss.

110

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

The measure of the restitution might include the value of what was taken, the cost to recover it, the expense of repair, and the price of the investigation that it may have taken to discover the illegal breach. There is no reason why large companies—such as Facebook, Apple, Netflix, or Alphabet—should not be entitled to the same restitution as other victims.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 111 Case 10.1 ............................................................................................................................................... 111 Case 10.2 ............................................................................................................................................... 112 Case 10.3 ............................................................................................................................................... 113 Chapter Review ........................................................................................................................................................... 113 Practice and Review .............................................................................................................................. 113 Practice and Review: Debate This ......................................................................................................... 114 Issue Spotters ........................................................................................................................................ 115 Business Scenarios and Case Problems ................................................................................................. 115 Critical Thinking and Writing Assignments ............................................................................................ 122

Critical Thinking Questions in Cases Case 10.1 177. As a principle of contract interpretation, courts consistently strive to interpret contracts in accord with common sense. Does the application of this principle to the facts in this case support or undercut the decision of the Maryland Court of Appeals? Explain. Solution Applying the principle that a contract should accord with common sense supports the decision of the Maryland Court of Appeals in the Credible case. Interpreting the promissory note to require repayment only if an employee quits, as the lower courts did, defies common sense. The lower courts‘ interpretation of the repayment term of the note, making its repayment dependent on whether an employee was fired or quit, would result in disparate treatment. In those courts‘ view, an employee fired by Credible would not be required to repay the loan, while an employee who quits would be required to repay. There is no reason why, with respect to repayment of the loan, an employee who is fired should be treated more favorably than one who

111

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

quits. In the words of the Maryland Court of Appeals, this interpretation ―strains credulity, * * * is untenable and runs contrary to common sense.‖ In addition to according with common sense, the interpretation of the state‘s highest court of the two provisions referred to in the ―Reason‖ section of the case brief aligns the meaning and substance of those provisions, showing clearly that the parties intended the loan to be repaid regardless of whether an employee quits or is fired. 178. What consequences might Credible have suffered if the Maryland Court of Appeals had interpreted the terms of the note to require repayment only when an employee quit employment, not when that employee was fired? Discuss. Solution In the Credible case, Credible argues that the terms of the promissory note memorializing an agreement between the employer and its employee, as part of the employer‘s tuition loan program, requires repayment regardless of whether the employee quits or is fired. According to the note, this is the intent of the parties—Credible and the employee—who agree to those terms. The Maryland Court of Appeals holds that this contention is a reasonable interpretation, in contrast to the argument of Credible‘s employee-borrower, Emmanuel Johnson, who posits that the terms of the note requires repayment only if an employee quits the job. If the court had agreed with Johnson, however, the consequences to Credible might have begun with the way in which its other employees subsequently regarded their employment and its termination. An involuntary discharge could mean that a fired employee would reap a windfall in terms of the repayment of a tuition loan. This circumstance would seem to encourage employees to obtain the loans and, when they wished to change their employment or desired simply to avoid repayment of what, given the cost of tuition, could be a substantial amount (plus interest), act in a manner so as to be fired. The result would not only be the cost to Credible of the loss of the amount of the loan, but havoc in the workplace, due to the employee‘s effort to get fired. This sort of misconduct would create disharmony in the workplace, lowering productivity, and undermining the economic and social objectives of the business.

Case 10.2 179. Could Panera have successfully argued that a drop in its revenue allowed it to impose the cap? Why or why not? Solution No, a drop in Panera‘s revenue would not have supported the employer‘s decision to change the terms of its unilateral contract to pay bonuses to its managers. Panera might have argued that such an economic downturn allowed it to impose a cap on the amount of the bonuses because the purpose of the contract with the managers had been commercially frustrated. But an economic downturn is a foreseeable event that an employer should anticipate when making a bonus offer. For example, Panera could have accounted for this possibility when it devised the bonus program and used different criteria to determine the amounts. Under the circumstances, Panera bore the risk of changes in revenue. Similarly, the decline in general business conditions that on which Panera based its action in the Boswell case was foreseeable. Business is risky. Markets can be undependable.

112

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

180. Does the fact that the managers continued to work for Panera after it imposed the cap undercut their claim? Explain. Solution No. Panera‘s imposition of the cap on the amount of the bonuses was a repudiation of its original offer. That is, the modification of the terms of the promise after the managers had begun to perform was a breach of the deal. But, in such a circumstance, the managers were free to continue performing. They did not have to regard the repudiation as an immediate breach. They could continue to perform until they were convinced that their employer was not going to restore the original term, at which time they could, as they did, file a suit for breach. By simply continuing to work, the managers could be held to have accepted the modification of their contract with their employer. In this case, silence is not acceptance. Something more than simply continuing to work would be needed to show the managers‘ acceptance of their employer‘s unilateral modification.

Case 10.3 1.

How might the result in this case have been different if the court had allowed Wagner‘s extrinsic evidence of a prior contract regarding Love Song to be used as evidence in this dispute? Solution In this circumstance, the court might have construed the language of the ―Charlie‘s Angels‖ contract to the same effect. But because Columbia acquired the movie rights to the property independent of any right it might have had in relation to the television series, the court might still have considered the acquisition separate from the exploitation rights covered by the Wagner contract, and the result would have been the same.

Chapter Review Practice and Review Mitsui Bank hired Ross Duncan as a branch manager in one of its Southern California locations. At that time, Duncan received an employee handbook informing him that Mitsui would review his performance and salary level annually. In 2020, Mitsui decided to create a new lending program to help financially troubled businesses stay afloat. It promoted Duncan to be the credit development officer (CDO) and gave him a written compensation plan. Duncan‘s compensation was to be based on the new program‘s success and involved a bonus and commissions based on new loans and sales volume. The written plan also stated, ―This compensation plan will be reviewed and potentially amended after one year and will be subject to such review and amendment annually thereafter.‖ Duncan‘s efforts as CDO were successful, and the business-lending program he developed grew to represent 25 percent of Mitsui‘s business in 2021 and 40 percent by 2023. Nevertheless, Mitsui refused to give Duncan a raise in 2021. Mitsui also amended Duncan‘s compensation plan to significantly reduce his compensation and to change his performance evaluation schedule to every six months. When he had still not received a raise by 2023, Duncan resigned as CDO and filed a lawsuit claiming breach of contract. Using the information presented in the chapter, answer the following questions. 181.

What are the four requirements of a valid contract?

113

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

Solution The four requirements for any contract to be valid are agreement, consideration, capacity, and legality. 182. Did Duncan have a valid contract with Mitsui for employment as credit development officer? If so, was it a bilateral or a unilateral contract? Solution Yes, Duncan had a valid contract with Mitsui for employment as credit development officer. The contract was bilateral because it was a promise for a promise—to work in exchange for compensation. No performance was necessary. The contract existed as soon as the promises were exchanged. The contract was valid because the parties had an agreement, consideration (employment in exchange for payment), capacity (presumed, especially with businesses and businesspersons), and the agreement was legal. 183.

What are the requirements of an implied contract?

Solution Implied contracts are contracts formed by the parties‘ conduct rather than by their words. For an implied contract to exist, the plaintiff must furnish some property or service to the defendant expecting to be paid, the defendant must know or should know that the plaintiff expects to be paid, and the defendant must have a chance to reject the property or service and does not. 184. Can Duncan establish an implied contract based on the employment manual or the written compensation plan? Why or why not? Solution To establish an implied contract in these circumstances, the plaintiff must have furnished a service to the defendant expecting to be paid, the defendant must have known that the plaintiff expected to be paid, and the defendant must have had a chance to reject the service. Here, Duncan provided service as a credit development officer to Mitsui, who hired and agreed to pay him for this service and accepted the service as it was rendered. Presumably, the initial hiring and duties of the position were discussed between the parties, if not put in writing, and were thus express, not implied. But the terms set out in the employment manual and written compensation plan were clearly express, not implied, as indicated by the quote from the plan.

Practice and Review: Debate This 185. Companies should be able to make or break employment contracts whenever and however they wish. Solution Companies, especially large corporations, hold all of the cards with respect to their actual and future employees. Absent statutes and case law that limits their abilities to break employment contracts on a whim, employees would have no protections. Employees would face increased uncertainty about the longevity of their jobs, which ultimately would reduce their productivity. There would be more turnover in jobs, and more unemployment. Contracts are not made to be broken, but rather upheld—and that is where the courts come in. The courts must be there to protect the rights of aggrieved former employees.

114

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

Employers, even large corporations, do not ―hold all of the cards,‖ contrary to popular belief. All companies compete for workers. It would be foolish for companies to break employment contracts on a whim. After all, it‘s costly to train new workers. The reality is that good workers are highly valued and companies must pay competitive wages (or more) to keep workers. So, even if companies had no legal constraints about how they honor their contracts with employees, they have a business reason to honor those contracts—lower labor costs, greater employee productivity, and ultimately, higher profits.

Issue Spotters 186. Kerin sends a letter to Joli telling her that he has a book to sell at a certain price. Joli signs and returns the letter. When Kerin delivers the book, Joli sends it back, claiming that they do not have a contract. Kerin claims they do. What standard determines whether these parties have a contract? Solution Under the objective theory of contracts, if a reasonable person would have thought that Joli had accepted Kerin‘s offer when she signed and returned the letter, then a contract was made, and Joli is obligated to buy the book. This depends, in part, on what was said in the letter and what was said in response. For instance, did the letter contain a valid offer, and did the response constitute a valid acceptance? Under any circumstances, the issue is not whether either party subjectively believed that a contract had been made. 187. Dyna tells Ed that she will pay him $1,000 to set fire to her store, so that she can collect under a fire insurance policy. Ed sets fire to the store but Dyna refuses to pay. Can Ed recover? Why or why not? Solution No. This contract, although not fully executed, is for an illegal purpose and therefore is void. A void contract gives rise to no legal obligation on the part of any party. A contract that is void is no contract. There is nothing to enforce.

Business Scenarios and Case Problems 8.

Unilateral Contract. Rocky Mountain Races, Inc., sponsors the ―Pioneer Trail Ultramarathon,‖ with an advertised first prize of $10,000. The rules require the competitors to run one hundred miles from the floor of Blackwater Canyon to the top of Pinnacle Mountain. The rules also provide that Rocky reserves the right to change the terms of the race at any time. Monica enters the race and is declared the winner. Rocky offers her a prize of $1,000 instead of $10,000. Did Rocky and Monica have a contract? Explain. (See Types of Contracts.) Solution Yes, these parties had a contract. Contests, lotteries, and other competitions for prizes are offers for contracts. Here, the offer is phrased so that each competitor can accept only by completing the run. At that point, a contract is formed—a unilateral contract—binding its sponsor to perform as promised. Rocky did not breach the contract when the prize was changed. Under the rules, Rocky could change the terms at any time.

Implied Contract. Janine was hospitalized with severe abdominal pain and placed in an intensive care unit. Her doctor told hospital personnel to order around-the-clock nursing care for Janine. At the hospital‘s request, a nursing services firm, Nursing Services Unlimited, provided two weeks of

115

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

in-hospital care and, after Janine was sent home, two additional weeks of at-home care. During the at-home period of care, Janine was fully aware that she was receiving the benefit of the nursing services. Nursing Services later billed Janine $4,000 for the nursing care, but Janine refused to pay on the ground that she had never contracted for the services, either orally or in writing. In view of the fact that no express contract was ever formed, can Nursing Services recover the $4,000 from Janine? If so, under what legal theory? Discuss. (See Types of Contracts.) Solution Janine was unconscious or otherwise unable to agree to a contract for the nursing services she received while she was in the hospital. Under the doctrine of quasi contract, however, the law will sometimes create a fictional contract in order to prevent one party from unjustly receiving a benefit at the expense of another. Quasi contract provides a basis for Nursing Services to recover the value of the services it provided while Janine was in the hospital. Nursing Services can recover for the at-home services under an implied contract because Janine was aware that the services were being provided for her. Under this type of contract, the conduct of the parties creates and defines the terms. Janine‘s acceptance of the services constitutes her agreement to form a contract, and she will probably be required to pay Nursing Services in full. 10. Contract Classification. For employment with the Firestorm Smokejumpers—a crew of elite paratroopers who parachute into dangerous situations to fight fires—applicants must complete a series of tests. The crew chief sends the most qualified applicants a letter stating that they will be admitted to Firestorm‘s training sessions if they pass a medical exam. Jake Kurzyniec receives the letter and passes the exam, but a new crew chief changes the selection process and rejects him. Is there a contract between Kurzyniec and Firestorm? If there is a contract, what type of contract is it? (See Types of Contracts.) Solution Yes, Firestorm and Scott had a contract. The letter was a unilateral offer phrased so that the offeree could accept only by completing the required performance. The contract was formed when the performance was complete. This was a unilateral contract. Here, Scott accepted the offer by passing the medical exam. Firestorm breached the contract when the new crew chief rejected Scott, who had already received the offer and accepted it. The appropriate remedy would be to allow Scott to attend Firestorm‘s training sessions. 11. Spotlight on Taco Bell—Implied Contract. Thomas Rinks and Joseph Shields developed Psycho Chihuahua, a caricature of a Chihuahua dog with a ―do-notback-down‖ attitude. They promoted and marketed the character through their company, Wrench, LLC. Ed Alfaro and Rudy Pollak, representatives of Taco Bell Corp., learned of Psycho Chihuahua and met with Rinks and Shields to talk about using the character as a Taco Bell ―icon.‖ Wrench sent artwork, merchandise, and marketing ideas to Alfaro, who promoted the character within Taco Bell. Alfaro asked Wrench to propose terms for Taco Bell‘s use of Psycho Chihuahua. Taco Bell did not accept Wrench‘s terms, but Alfaro continued to promote the character within the company. Meanwhile, Taco Bell hired a new advertising agency, which proposed an advertising campaign involving a Chihuahua. When Alfaro learned of this proposal, he sent the Psycho Chihuahua materials to the agency. Taco Bell made a Chihuahua the focus of its marketing but paid nothing to Wrench. Wrench filed a suit against Taco Bell in a federal court claiming that it had an implied contract with Taco Bell and that Taco Bell breached that contract. Do these facts satisfy the

116

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

requirements for an implied contract? Why or why not? [Wrench, LLC. v. Taco Bell Corp., 256 F.3d 446 (6th Cir. 2001), cert. denied, 534 U.S. 1114, 122 S.Ct. 921, 151 L.Ed.2d 805 (2002)] (See Types of Contracts.) Solution The court held that Wrench submitted sufficient evidence of an implied contract to survive Taco Bell‘s motion for summary judgment on the issue. ―Implied in fact contracts often arise where one accepts a benefit from another for which compensation is customarily expected. Thus, where evidence shows that the parties understood that compensation would be paid for services rendered, a promise to pay fair value may be implied, even if no agreement was reached as to price, duration, or other terms of the contract.‖ Here, ―Taco Bell concedes that there is sufficient evidence in the record to support Plaintiff‘s allegation that the parties had a basic understanding that if Taco Bell used the Psycho Chihuahua idea, concept, or image, that Taco Bell would compensate Plaintiffs for the fair value of such use.‖ Furthermore, ―[t] he cases establish that a plaintiff may support a claim of implied in fact contract by showing that the plaintiff disclosed an idea to the defendant at the defendant‘s request and the defendant understood that the plaintiff expected compensation for use of his ideas. Because Taco Bell concedes that there is sufficient evidence to support such an understanding in this case, Taco Bell‘s assertion that Plaintiffs cannot establish an implied in fact contract must be rejected.‖ The court ruled against Wrench on other grounds. Wrench appealed to the U.S. Court of Appeals for the Fifth Circuit, which agreed with the lower court‘s holding on Wrench‘s implied contract claim (but reversed the ruling on the other grounds). 12. Business Case Problem with Sample Answer—Implied Contracts. Ralph Ramsey insured his car with Allstate Insurance Co. He also owned a house on which he maintained a homeowner‘s insurance policy with Allstate. Bank of America had a mortgage on the house and paid the insurance premiums on the homeowner‘s policy from Ralph‘s account. After Ralph died, Allstate canceled the car insurance. Ralph‘s son Douglas inherited the house. The bank continued to pay the premiums on the homeowner‘s policy, but from Douglas‘s account, and Allstate continued to renew the insurance. When a fire destroyed the house, Allstate denied coverage, however, claiming that the policy was still in Ralph‘s name. Douglas filed a suit in a federal district court against the insurer. Was Allstate liable under the homeowner‘s policy? Explain. [Ramsey v. Allstate Insurance Co., 514 Fed.Appx. 554 (6th Cir. 2013)] (See Types of Contracts.)

117

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

Solution Yes, Allstate was liable under the homeowner‘s policy. A contract that is implied from the conduct of the parties. This type of contract differs from an express contract in that the conduct of the parties, rather than their words, creates and defines the terms of the contract. For an implied contract to exist, a party must furnish a service or property (which includes money), the party must expect to receive something in return for that property or service, and the other party must know or should know of that expectation and had a chance to reject the property or service but did not. Of course, a contract may be a mix of express and implied terms. In this problem, the homeowner‘s policy was a mix of express and implied terms. As for the elements showing the existence of the implied terms, the payments for the premiums on the policy continued after Ralph‘s death, but the amounts were paid from Douglas‘s account. Undoubtedly, Douglas expected to receive coverage under the policy in return for his payments. The insurer Allstate must have known that Douglas expected the coverage—insurance has long been Allstate‘s business, and the company obviously understands the relationship between the payments of premiums and the expectation of insurance coverage. And Allstate had the opportunity to cancel the homeowner‘s policy—as it had with Ralph‘s auto insurance, which was canceled—but did not terminate it. In the actual case on which this problem is based, the court issued a judgment in Allstate‘s favor on the implied contract issue. The U.S. Court of Appeals for the Sixth Circuit reversed this judgment—―A reasonable fact-finder could determine that [Allstate‘s] continuation of the premium payments constituted a contract implied in fact with Douglas.‖ 13. Quasi Contracts. Lawrence M. Clarke, Inc., was the general contractor for construction of a portion of a sanitary sewer system in Billings, Michigan. Clarke accepted Kim Draeger‘s proposal to do the work for a certain price. Draeger arranged with two subcontractors to work on the project. The work provided by Draeger and the subcontractors proved unsatisfactory. All of the work fell under Draeger‘s contract with Clarke. Clarke filed a suit in a Michigan state court against Draeger, seeking to recover damages on a theory of quasi contract. The court awarded Clarke $900,000 in damages on that theory. A state intermediate appellate court reversed this award. Why? [Lawrence M. Clarke, Inc. v. Draeger, 2015 WL 205182 (Mich.App. 2015)] (See Quasi Contracts.) Solution The appellate court reversed the lower court‘s award to Clarke of $900,000 in damages on a quasi contract theory because the dispute fell under Draeger‘s contract with Clarke. The doctrine of quasi contract generally does not apply when an existing contract covers the area in controversy. In that circumstance, the nonbreaching party can sue the breaching party for breach of the contract. Here, Lawrence M. Clarke, Inc., was the general contractor for the construction of a portion of a sanitary sewer system. Kim Draeger proposed to do the work for a certain price, and Clarke accepted. Draeger arranged with two subcontractors to work on the project. But Draeger and the subcontractors provided less than perfect, competent, or complete work. Clarke filed a suit in against Draeger to recover damages on a theory of quasi contract. The court awarded Clarke damages on that theory. An appellate court reversed this award because all of the work and its disputed performance were covered by Draeger‘s contract with Clarke.

118

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

In the actual case on which this problem is based, in Clarke‘s action against Draeger, the court chose to decide the case under the theory of quasi contract. A state intermediate appellate reversed the decision on the ground stated above. 14. Interpretation of Contracts. Lehman Brothers, Inc. (LBI), wrote a letter to Mary Ortegón offering her employment as LBI‘s ―Business Chief Administrative Officer in Its Fixed Income Division.‖ The offer included a salary of $150,000 per year and an annual ―minimum bonus‖ of $350,000. The letter stated that the bonus would be paid unless Ortegón resigned or was terminated for certain causes. In other words, the bonus was not a ―signing‖ bonus—it was clearly tied to her performance on the job. Ortegón accepted the offer. Before she started work, however, LBI rescinded it. Later, LBI filed for bankruptcy in a federal court. Ortegón filed a claim with the court for the amount of the bonus on the ground that LBI had breached its contract with her by not paying it. Can extrinsic evidence be admitted to interpret the meaning of the bonus term? Explain. [Ortegón v. Giddens, 638 Fed.Appx. 47 (2d Cir. 2016)] (See Interpretation of Contracts.) Solution No, extrinsic evidence is not admissible to interpret the meaning of the bonus term in this problem. When a dispute arises over the meaning of a term in a contract, a court will enforce it according to its obvious terms if the contract‘s writing is clear. Under the plain meaning rule, the meaning of the term is determined from the written document alone. If a term is ambiguous, a court can consider extrinsic evidence. In this problem, Lehman Brothers, Inc., (LBI) offered Mary Ortegón a job. The offer included an annual ―minimum bonus‖ of $350,000. The bonus was to be paid unless Ortegón quit or was terminated for certain causes. The bonus was clearly tied to Ortegón‘s performance on the job .It was not a ―signing‖ bonus. Ortegón accepted the offer, but before she started work, LBI rescinded it. Later, LBI filed for bankruptcy. Ortegón filed a claim for the amount of the bonus on the ground that LBI breached its contract with her by not paying it. Because the expressed term concerning the bonus is clear, under the plain meaning rule extrinsic evidence is not admissible to interpret it. The contract clearly provided that the bonus was part of Ortegón‘s compensation for her performance on the job. Ortegón never became LBI‘s employee and never started to perform. Thus Ortegón never had any right to the bonus, and LBI did not breach their contract when it refused to give it to her.‖ In the actual case on which this problem is based, James Giddens, the bankruptcy trustee, denied the claim, and the court issued a judgment in the trustee‘s favor. The U.S. Court of Appeals for the Second Circuit affirmed this judgment on the reasoning stated above. 15. Quasi Contracts. In New Jersey, a patient admitted to a medical care facility through the regular admissions process is responsible for applying to the state for assistance in paying the bill. In contrast, a patient admitted on an emergency basis is not responsible for applying to the state— the facility is. Of course, to obtain assistance, the patient must be indigent. D.B., a diagnosed schizophrenic, experienced a psychotic episode. The Warren County, New Jersey, psychiatric emergency screening service determined that he was a danger to himself and others. He was involuntarily committed to Newton Medical Center, a mental health-care facility. Newton did not apply to the state for financial assistance for D.B.‘s treatment. Instead, Newton billed the patient $6,745.50. D.B., who was indigent, did not pay. Can Newton recover the amount of the unpaid bill from D.B. on a theory of quasi contract? Discuss. [Newton Medical Center v. D.B., 452 N.J.Super. 615, 178 A.3d 1281, 2018 WL 480296 (App.Div. 2018)] (See Quasi Contracts.)

119

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

Solution No, Newton cannot recover the amount of the unpaid bill from D.B. Quasi contracts are equitable in nature, imposed to avoid the unjust enrichment of one party at the expense of another. A quasi contract is not based on an actual agreement, but on the theory that an individual should not profit inequitably at another‘s expense. Of course, a party who confers a benefit through negligence or other misconduct cannot invoke the theory. As stated in the facts of the problem, in New Jersey, state assistance in paying medical bills is available for patients who are indigent. A patient admitted to a care facility via a regular admission process is responsible for applying to the state for that help. In contrast, when a patient is admitted on an emergency basis, this responsibility belongs to the facility, not the patient. In the problem, D.B., an indigent schizophrenic, was involuntarily committed to Newton Medical Center on the determination of a psychiatric emergency screening service that he was a danger to himself or others. After treatment, Newton billed the patient $6,745.50. D.B. did not pay the bill, but the facility did not apply to the state for financial assistance to cover the cost. Due to this carelessness or oversight, the facility is not entitled to recover the unpaid bill on a theory of quasi contract. In the actual case on which this problem is based, the court issued a judgment in Newton‘s favor, but a state intermediate appellate court reversed, on the reasoning stated above. 16. A Question of Ethics—The IDDR Approach and Contract Requirements. Mark Carpenter, a certified financial planner, contracted to recruit investors for GetMoni.com, which owned a defunct gold mine in Arizona. Carpenter then contracted with clients to invest their funds, sending more than $2 million to GetMoni.com. Only about 20 percent of the money went to developing the mine. The rest was used to run a Ponzi scheme. Carpenter collected another $1 million, but instead of sending it to GetMoni.com, he deposited it into his own account. A federal investigation unraveled the scheme. Carpenter was charged with two counts of fraud—one for his deal with GetMoni.com and one for his misrepresentations to clients after he stopped dealing with GetMoni.com. [United States v. Carpenter, 676 Fed.Appx. 397 (6th Cir. 2017)] (See An Overview of Contract Law.) 1. Which elements do Carpenter‘s contracts lack, preventing them from being enforced? Can he argue successfully that he acted ethically? Discuss. Solution The elements that these contracts lack are legality and voluntary consent. Legality is one of the four requirements that must be met for a contract to be valid. A contract‘s purpose must be to accomplish a goal that is legal. Among the defenses to a contract that might otherwise be enforceable is voluntary consent—the consent of both parties must be voluntary. If a contract is formed as a result of fraud, the contract may not be enforceable. In this problem, Mark Carpenter contracted to recruit investors for GetMoni.com, which owned a defunct gold mine in Arizona. Carpenter further contracted with clients to invest their funds in the mine, collecting more than $2 million that he sent to GetMoni.com. He collected another $1 million from the investors, but deposited the money into his own accounts rather than sending it to GetMoni.com. None of the contracts was for a legal purpose. Instead, their purpose was to defraud investors and spend the ill-gotten proceeds other than as represented. And there was no

120

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

voluntary consent. Carpenter entered into all of the contracts with fraudulent intent, keeping investors‘ funds for himself. When investigators uncovered the scheme, Carpenter was charged with two counts of fraud—one for his deal with GetMoni.com and one for his misrepresentations to clients after he stopped dealing with GetMoni.com. With regard to the latter situation, he might argue that he continued to accept client funds without passing them on to GetMoni.com in order to repay some of the investors, not to defraud them. This is the closest contention that he might have to an argument he acted ethically. But it would fail. Even if it were true, he acted with fraudulent intent. Under most standards of ethics, one‘s ultimate motivation is irrelevant. In the actual case on which this problem is based, the court convicted Carpenter of the charges. The U.S. Court of Appeals for the Sixth Circuit affirmed the convictions 2.

Using the IDDR approach, discuss whether certified financial planners have an ethical obligation to contract in the best interests of their clients.

Solution A certified financial planner (CFP) should have an ethical obligation to contract in the best interests of any clients. As with other ethical duties, this may not be enforceable at law. But it should be part of a CFP‘s job description. The IDDR approach starts with an Inquiry to identify the issue, the stakeholders, and the ethical standards. The issue is phrased in the question: Do CFPs have an ethical obligation to contract in the best interests of their clients? The stakeholders include the planner, any clients, other planners, and the larger investment and business communities, as well as the public generally. There may be ethical codes issued by trade and business associations to which a CFP belongs that stipulate the obligation. Religious and philosophical sources include maxims to act in the interest of others. The following step of the IDDR approach is a Discussion to suggest actions that might resolve the issue. The strengths and weaknesses of the actions, and the consequences and the effects on the stakeholders, should also be considered. The facts of the Carpenter case indicate that a CFP who would act in the best interests of clients would not recommend an investment in a fraudulent scheme. Further, the CFP should be forthcoming and truthful about the nature of any investment—particularly its risk and whether there exists any conflict of interest, such as a commission payable to the CFP for selling it. Such advice could erode a CFP‘s income by dissuading clients from choosing investments that might be more profitable to the planner. Ultimately, however, this could increase the level of trust among all of the parties and attract more clients, leading to greater income. The next step of the approach is to state a Decision and its reasons. It appears that if CFPs were to observe an ethical obligation to contract in the best interests of their clients, benefits could be realized by the planners, their clients, other planners, the investment and business communities, and the public. The planners could obtain more business. Other planners might similarly benefit from the enhanced ethics of their occupation. Their clients might invest more funds with more confidence. The investment and business communities would clearly be enriched by an increase in the number of investors and dollars. The public would benefit from an improved business climate and economic growth.

121

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 10: Nature and Classification

The final step of the approach is a Review of the success or failure of the action to resolve the issue, and satisfy the stakeholders. A CFP who is forthcoming and truthful about the nature of any investment with clients would likely fulfill an ethical obligation to act in their best interests. This could also satisfy the other stakeholders.

Critical Thinking and Writing Assignments 5.

Time-Limited Group Assignment—Contracts. Review the basic requirements for a valid contract listed at the beginning of this chapter. Now consider the relationship entered into when a student enrolls in a college or university. (See Elements of a Contract.) 1.

One group should analyze and discuss whether a contract has been formed between the student and the college or university.

Solution The relationship between a college or university and its students is contractual. Under this contract, the University agrees to provide the students with a worthwhile education and the students agree to perform financially (by paying their tuition and other fees), academically (by doing what they are asked to do to follow a course of study), and behaviorally (by obeying the school‘s rules and regulations). 2.

A second group should assume that there is a contract and explain whether it is bilateral or unilateral.

Solution Under a unilateral contract, once performance has occurred, the contract is formed. Students might argue, for example, that their contract with their school is unilateral—once their tuition is paid at the beginning of a semester, their obligation under the contract is complete, but the school has yet to fulfill its promise to provide the semester‘s education. But students‘ obligations are not fulfilled simply by paying tuition. The relationship between a school and its students is ongoing throughout a semester—in other words, students do not fully perform their contract simply by paying tuition. Their contract with their school is thus bilateral, not unilateral. 3.

The third group will consider the documents that each of you signed when enrolling in college. Did you read and understand the provisions? Would the plain meaning rule apply even if you did not understand some parts?

Solution Yes. The plain meaning rule applies even if one of the parties to a contract does not understand some of the language. It is the responsibility all individuals who enter into a contract to be satisfied that they comprehend its terms. Questions can be asked, terms can be negotiated, language can be added or cut, and phrases can be changed before the final agreement. If the language is clear and unequivocal, a court will enforce according to its plain, ordinary, obvious meaning as determined from the face of the instrument. A contract is bound to divine the intent of the parties and to give effect to the deal according to this principle.

122

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Of course, if a party does not understand a term because it is ambiguous, a court can interpret and apply it against the party who drafted the contract. This may occur if the term is subject to more than one reasonable interpretation, there is uncertainty about it, or the intent of the parties cannot be determined from the language.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 123 Adapting the Law to the Online Environment ....................................................................................... 123 Critical Thinking Questions in Cases ................................................................................................................... 124 Case 11.1 ............................................................................................................................................... 124 Case 11.2 ............................................................................................................................................... 124 Case 11.3 ............................................................................................................................................... 124 Chapter Review ........................................................................................................................................................... 125 Practice and Review .............................................................................................................................. 125 Practice and Review: Debate This ......................................................................................................... 127 Issue Spotters ........................................................................................................................................ 127 Business Scenarios and Case Problems ................................................................................................. 128 Critical Thinking and Writing Assignments ............................................................................................ 135

Critical Thinking Questions in Features Adapting the Law to the Online Environment 188. How can a company structure e-mail negotiations to avoid ―accidentally‖ forming a contract? Solution The company should make sure that all e-mail conversations explicitly indicate that they are subject to any relevant conditions and that they are subject to further review and comment by the senders‘ clients or colleagues. All negotiations via e-mail should include appropriate disclaimers such as ―This e-mail is not an offer capable of acceptance.‖ or ―This e-mail does not evidence an intention to enter into an agreement.‖ or ―This e-mail has no operative effect until a definitive agreement is signed in writing by both parties.‖ Another possibility is to indicate that ―No party should act in reliance on this e-mail until a definitive contract is signed in writing by both parties.‖

123

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Critical Thinking Questions in Cases Case 11.1 189. Suppose that after Lucy signed the agreement, he decided that he did not want the farm after all, and that Zehmer sued Lucy to perform the contract. Would this change in the facts alter the court‘s decision that Lucy and Zehmer had created an enforceable contract? Why or why not? Solution No. In fact, this would likely support the court‘s determination that there was an enforceable contract between the parties. In this circumstance, unless Lucy attempted to void the contract on the ground of intoxication, the court might not have addressed the issue at all.

Case 11.2 190. Assume that, instead of exchanging e-mails, the attorneys for both sides had had a phone conversation that included all of the terms to which they actually agreed in their e-mail exchanges. Would the court have ruled differently? Why or why not? Solution Probably not. As the court pointed out, ―the issues [were] whether the . . . terms were sufficiently complete and definite to form an agreement and whether Amazon had intended to be bound by them.‖ Terms expressed orally can be as binding as those expressed in writing. The court also determined that ―the essential circumstance of this disputed agreement is that it concluded a trial.‖ If the trial court had given the same effect to a phone conversation as the court gave to the e-mail exchange, it is unlikely that the appellate court would have interpreted it differently.

Case 11.3 2.

The lottery‘s rules did not provide for entrants to be notified by e-mail, but contracts generally impose on the parties a duty to do everything necessary to carry them out. Did the lottery breach its contract with Bailey by failing to notify him by e-mail? Explain. Solution No. The lottery did not breach its contract with Bailey by failing to notify him by e-mail that his ticket had won the drawing. Bailey might emphasize the principle stated in the question to argue that the lottery did not do everything ―necessary‖ to contact him after his ticket was drawn as the winner. It would likely have been easy to notify him by e-mail that he had won. Bailey might contend that the lottery did not thereby act in good faith. Contracts impose on the parties a duty to do everything necessary to carry them out. But this duty does not prevent a party from exercising its contractual rights. The lottery did not breach any duty of good faith by not transmitting notification by e-mail. This was not a prescribed mode of notification under the lottery‘s rules. Bailey failed to comply with the requirements of the promotion, and under those requirements, the lottery had a contractual right to disqualify his entry from the drawing.

Suppose that Bailey had complied with the lottery‘s rules by keeping his address and phone number current, but that the lottery had not tried to notify him before the expiration of the seven-day period. Would the result have been different? Why or why not?

124

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution Most likely, yes, the result in the Bailey case would have been different if Bailey had complied with the lottery‘s rules by keeping his address and phone number current. The lottery‘s inability to contact him when his ticket was drawn as the winner prompted the lottery to disqualify his entry under the promotion‘s rules. The inability was caused by his Bailey‘s acts or omissions—he did not keep his phone number current, and he did not provide a valid address. The outcome in Bailey‘s rested on these facts. If Bailey had taken the required steps, however, but the lottery had not tried to notify him before the expiration of the seven-day period, the lottery would have violated its rules. This would have placed the lottery at fault and most likely liable to Bailey for the result.

Chapter Review Practice and Review Shane Durbin wanted to have a recording studio custom-built in his home. He sent invitations to a number of local contractors to submit bids on the project. Rory Amstel submitted the lowest bid, which was $20,000 less than any of the other bids Durbin received. Durbin called Amstel to ascertain the type and quality of the materials that were included in the bid and to find out if he could substitute a superior brand of acoustic tiles for the same bid price. Amstel said he would have to check into the price difference. The parties also discussed a possible start date for construction. Two weeks later, Durbin changed his mind and decided not to go forward with his plan to build a recording studio. Amstel filed a suit against Durbin for breach of contract. Using the information presented in the chapter, answer the following questions. 191.

Did Amstel‘s bid meet the requirements of an offer? Explain.

Solution A bid can be an offer if it contains all of the requisite elements: a serious, objective intent on the part of the offeror and an offer communicated to the offeree in certain, definite terms comprehensible to both parties. Amstel‘s bid met the requirements His intent appeared to be that of a serious, reasonable offeree; the terms were sufficiently definite; and the bid was communicated to Durbin. If the price, materials, and start date were left open, these factors might be sufficient to question the status of the bid as an offer. 192.

Was there an acceptance of the offer? Why or why not?

Solution To create a contract, an offer must be accepted unequivocally. Durbin questioned the materials included in the bid and asked about the possibility of substituting different acoustic tiles and discussed a starting date. Although this does not constitute an acceptance of the offer, neither is it a rejection. His questions were inquiries, not a rejection of the bid. Durbin‘s later call to say that he had changed his mind, however, was a rejection. 193. Suppose that the court determines that the parties did not reach an agreement. Further suppose that Amstel, in anticipation of building Durbin‘s studio, had purchased materials and refused other jobs so that he would have time in his schedule for Durbin‘s project. Under what theory discussed in the chapter might Amstel attempt to recover these costs?

125

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

126

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution When individuals rely on promises, as Amstel would have done in this scenario, and the reliance is considered to form a basis for contract rights and duties, under the doctrine of promissory estoppel (or detrimental reliance), the party who has reasonably relied on the promise can often obtain some measure of recovery. 194. How is an offer terminated? Assuming that Durbin did not inform Amstel that he was rejecting the offer, was the offer terminated at any time described here? Explain. Solution Yes, Durbin asked about better quality tiles; until that issue was settled, because it likely changed the price, a contract was never formed, so Durbin had the right to cancel the deal. The contract was still being negotiated because Amstel wanted information about alternative materials, which affected the price. Failure to settle that matter means the offer was never accepted and either party had the right to walk away.

Practice and Review: Debate This 195. The terms and conditions in click-on agreements are so long and detailed that no one ever reads the agreements. Therefore, the act of clicking ―I agree‖ is not really an acceptance. Solution The terms and conditions included in click-on agreements have become so detailed, confusing, and—most importantly—long, that no one would ever take the time to read one. Knowing, though, that one is unable to purchase or license a product or service purchased on the Internet without clicking ―yes‖ means that everyone just clicks ―yes.‖ That is far from what we normally believe is voluntary assent. Indeed, the choice is all or nothing—accept all terms and conditions or do not buy from us. There appears to be no acceptable alternative to click-on agreements when buying a good or service on the Internet. No company would ever eliminate the click-on agreement from its ecommerce system because it would be exposing itself to even more potential lawsuits. The reason such click-on terms and conditions are so numerous is specifically to avoid frivolous and expensive lawsuits. As a result, ultimately, overall costs are lower for e-commerce, and therefore consumers pay lower prices in general.

Issue Spotters 196. Fidelity Corporation offers to hire Ron to replace Monica, who has given Fidelity a month‘s notice of her intent to leave the company. Fidelity gives Ron a week to decide whether to accept. Two days later, Monica decides not to leave and signs an employment contract with Fidelity for another year. The next day, Monica tells Ron of the new contract. Ron immediately emails a formal letter of acceptance to Fidelity. Do Fidelity and Ron have a contract? Why or why not? Solution No. Revocation of an offer may be implied by conduct inconsistent with the offer. When the corporation hired someone else, and the offeree learned of the hiring, the offer was revoked. The acceptance was too late.

127

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

197. Applied Products, Inc., does business with Beltway Distributors, Inc., online. Under the Uniform Electronic Transactions Act (UETA), what determines the effect of the electronic documents evidencing the parties‘ deal? Is a party‘s ―signature‖ necessary? Explain. Solution First, it might be noted that the UETA does not apply unless the parties to a contract agree to use e-commerce in their transaction. In this deal, of course, the parties used e-commerce. The UETA removes barriers to e-commerce by giving the same legal effect to e-records and e-signatures as to paper documents and signatures. The UETA it does not include rules for those transactions, however.

Business Scenarios and Case Problems 17. Offer. Ball writes to Sullivan and inquires how much Sullivan is asking for a specific forty-acre tract of land Sullivan owns. Ball then receives a letter from Sullivan stating, ―I will not take less than $60,000 for the forty-acre tract as specified.‖ Ball immediately sends Sullivan a fax stating, ―I accept your offer for $60,000 for the forty-acre tract as specified.‖ Discuss whether Ball can hold Sullivan to a contract for sale of the land. (See Offer.) Solution For an offer to exist, the offeror must show a definite intention to make and be bound by the offer. Invitations to trade or negotiate or mere statements of intentions to enter into a contract upon further bargaining do not constitute offers but are instead preliminary negotiations. Thus, any attempted acceptance would not bind the parties to a contract as there is no offer in existence to be accepted. Sullivan stated only a price from which to bargain further, not an intention of a definite commitment to sell at $60,000. There is no contract between Sullivan and Ball. 18. Shrink-Wrap Agreements. TracFone Wireless, Inc., sells phones and wireless service. The phones are sold for less than their cost, and TracFone recoups this loss by selling prepaid airtime for their use on its network. Software in the phones prohibits their use on other networks. The phones are sold subject to the condition that the buyer agrees ―not to tamper with or alter the software.‖ This condition is printed on the packaging. Bequator Corp. bought at least 18,616 of the phones, disabled the software so that they could be used on other networks, and resold them. Is Bequator liable for breach of contract? Explain. [TracFone Wireless, Inc. v. Bequator Corp., Ltd., 2011 WL 1427635 (S.D.Fla. 2011)] (See E-Contracts.) Solution Yes. A shrink-wrap agreement is an agreement whose terms are expressed inside the box in which the goods are packaged. Parties who open such boxes may be informed that they agree to the terms by keeping whatever is in the box. In many cases, the courts have enforced the terms of shrink-wrap agreements just as they enforce the terms of other contracts. Sometimes, the courts reason that by including the terms with the product, the seller proposed a contract that the buyer accepted by using the product after having an opportunity to read the terms. The packaging of TracFone's phones contained language that restricted the use of the phones to TracFonse‘s network and prohibited tampering or altering the software in the phone. The phones were sold subject to the condition that the buyer agreed to this term, which was printed on the shrink-wrap packaging. Thus, an enforceable contract existed between TracFone and Bequator

128

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

(the buyer) with respect to Bequator‘s use of the 18,216 phones that it bought. Bequator breached this contract by altering the software in the phones. In the actual case on which this problem is based, the court held that Bequator was liable for breach on the reasoning stated above. 19. Online Acceptances. Heather Reasonover opted to try Internet service from Clearwire Corp. Clearwire sent her a confirmation e-mail that included a link to its website. Clearwire also sent her a modem. In the enclosed written materials, at the bottom of a page, in small type was the website URL. When Reasonover plugged in the modem, an ―I accept terms‖ box appeared. Without clicking on the box, Reasonover quit the page. A clause in Clearwire‘s ―Terms of Service,‖ accessible only through its website, required its subscribers to submit any dispute to arbitration. Is Reasonover bound to this clause? Why or why not? [Kwan v. Clearwire Corp., 2012 WL 32380 (W.D.Wash. 2012)] (See E-Contracts.) Solution No. A shrink-wrap agreement is an agreement whose terms are expressed inside the box in which the goods are packaged. Parties who open such boxes may be informed that they agree to the terms by keeping whatever is in the box. In many cases, the courts have enforced the terms of shrink-wrap agreements just as they enforce the terms of other contracts. But not all of the terms presented in shrink-wrap agreements have been enforced by the courts. One important consideration is whether the buyer had adequate notice of the terms. A click-on agreement is formed when a buyer, completing a transaction on a computer, is required to indicate assent to be bound by the terms of an offer by clicking on a button that says, for example, ―I agree.‖ In Reasonover‘s situation, the confirmation e-mail sent by Clearwire was not adequate notice of its ―Terms of Service‖ (TOS). The e-mail did not contain a direct link to the terms—accessing them required clicks on further links through the firm‘s homepage. The written, shrink-wrap materials accompanying the modem did not provide adequate notice of the TOS. There was only a reference to Clearwire‘s website in small print at the bottom of one page. Similarly, Reasonover‘s access to an ―I accept terms‖ box did not establish notice of the terms. She did not click on the box but quit the page. Even if any of these references were sufficient notice, Reasonover kept the modem only because Clearwire told her that she could not return it. In the actual case on which this problem is based, the court refused to compel arbitration on the basis of the clause in Clearwire‘s TOS. 20. Acceptance. Judy Olsen, Kristy Johnston, and their mother, Joyce Johnston, owned seventy-eight acres of real property on Eagle Creek in Meagher County, Montana. When Joyce died, she left her interest in the property to Kristy. Kristy wrote to Judy, offering to buy Judy‘s interest or to sell her own interest to Judy. She requested that Judy ―please respond to Bruce Townsend.‖ In a letter to Kristy—not to Bruce—Judy accepted the offer to buy Kristy‘s interest in the property. By that time, however, Kristy had offered to sell her interest to their brother, Dave, and he had accepted. Did Judy and Kristy have an enforceable binding contract, entitling Judy to specific performance? Or did Kristy‘s offer so limit its acceptance to one exclusive mode that Judy‘s reply was not effective? Discuss. [Olsen v. Johnston, 368 Mont. 347, 301 P.3d 791 (2013)] (See Acceptance.)

129

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution Judy‘s reply was effective, and Judy and Kristy had an enforceable binding contract—Kristy‘s offer did not limit its acceptance to one exclusive mode. Thus, Judy was entitled to an order of specific performance. Acceptance is a voluntary act by the offeree that shows assent (agreement) to the terms of an offer. The offeree‘s act may consist of words or conduct. The acceptance must be unequivocal and must be communicated to the offeror. A means of communicating acceptance can be expressly authorized by the offeror or impliedly authorized by the facts and circumstances surrounding the situation. When an offeror specifies how acceptance should be made, express authorization exists, and the contract is not formed unless the offeree uses that specified mode of acceptance. If the offeror does not expressly authorize a certain mode of acceptance, then acceptance can be made by any reasonable means. In this problem, Kristy‘s offer did not limit Judy‘s mode of acceptance. Kristy could have used language like ―You must reply to Bruce Townsend to accept this offer,‖ or ―You can accept this offer, if at all, only by responding to Bruce Townsend.‖ This language would have made clear that Judy could accept the offer only by replying to Townsend. But Kristy‘s offer only requested that Judy ―please respond to Bruce Townsend‖—the offer did not include words of limitation. And Kristy did not otherwise make clear through her words and associated conduct that a reply to Townsend represented the exclusive mode of acceptance. In the actual case on which this problem is based, Judy filed a suit in a Montana state court against Kristy and obtained an order of specific performance. On Kristy‘s appeal, the Montana Supreme Court affirmed, according to the reasoning stated above. 21. Acceptance. Amy Kemper was seriously injured when her motorcycle was struck by a vehicle driven by Christopher Brown. Kemper‘s attorney wrote to Statewide Claims Services, the administrator for Brown‘s insurer, asking for ―all the insurance money that Mr. Brown had under his insurance policy.‖ In exchange, the letter indicated that Kemper would sign a ―limited release‖ on Brown‘s liability, provided that it did not include any language requiring her to reimburse Brown or his insurance company for any of their incurred costs. Statewide then sent a check and release form to Kemper, but the release demanded that Kemper ―place money in an escrow account in regards to any and all liens pending.‖ Kemper refused the demand, claiming that Statewide‘s response was a counteroffer rather than an unequivocal acceptance of the settlement offer. Did Statewide and Kemper have an enforceable agreement? Discuss. [Kemper v. Brown, 325 Ga.App. 806, 754 S.E.2d 141 (2014)] (See Acceptance.)

130

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution No, Statewide and Kemper did not have an enforceable agreement. Under the mirror image rule, the offeree‘s acceptance must match the offeror‘s offer exactly. If the acceptance changes or adds to the terms of the original offer, it will be considered a counteroffer. A counteroffer is a rejection of the original offer and the simultaneous making of a new offer. If an offer is rejected, it is terminated. Here, the purported settlement agreement was not enforceable because Statewide‘s response to Kemper‘s offer was not unconditional or identical to her terms. In response, Statewide demanded that Kemper place settlement funds into an escrow account. This change or addition to the terms of the original offer constituted a counteroffer—a rejection of Kemper‘s original offer and the simultaneous making of a new offer. And Kemper refused the new demand. In the actual case on which this problem is based, a court enforced the settlement. On Kemper‘s appeal, a state intermediate appellate court reversed, holding that Statewide‘s response to Kemper‘s offer constituted a counteroffer, which she rejected. 22. Business Case Problem with Sample Answer—Requirements of the Offer. Technical Consumer Products, Inc. (TCP), makes and distributes energy-efficient lighting products. Emily Bahr was TCP‘s district sales manager in Minnesota, North Dakota, and South Dakota when the company announced the details of a bonus plan. District sales managers who achieved 100 percent yearover-year sales growth and a 42 percent gross margin would earn 200 percent of their base salaries as a bonus. TCP retained absolute discretion to modify the plan. Bahr‘s base salary was $42,500. Her final sales results for the year showed 113 percent year-over-year sales growth and a 42 percent gross margin. She anticipated a bonus of $85,945, but TCP could not afford to pay the bonuses as planned, and Bahr received only $34,229. In response to Bahr‘s claim for breach of contract, TCP argued that the bonus plan was too indefinite to be an offer. Is TCP correct? Explain. [Bahr v. Technical Consumer Products, Inc., 601 Fed. Appx. 359 (6th Cir. 2015)] (See Offer.) Solution No, TCP is not correct—the bonus plan was not too indefinite to be an offer. One of the requirements for an effective offer is that its terms must be reasonably definite. This is so a court can determine whether a breach has occurred and award an appropriate remedy. Generally, these terms include an identification of the parties and the object or subject of the contract, the consideration to be paid, and the time of performance. In this problem, TCP provided its employees, including Bahr, with the details of a bonus plan. A district sales manager such as Bahr who achieved 100 percent year-over-year sales growth and a 42 percent gross margin would earn 200 percent of their base salary. TCP added that it retained absolute discretion to modify the plan. Bahr exceeded the goal and expected a bonus commensurate with her performance. TCP paid her less than half what its plan promised, however. In the ensuing litigation, TCP claimed that the bonus plan was too indefinite to constitute an offer, but this was not in fact the case. Clear criteria applied to determine an employee‘s eligibility for a certain amount within a specific deadline. A court asked to apply the plan would have little or no doubt as to the amount an employee would be entitled to. The term that reserved discretion to TCP to modify the plan did not sufficiently undercut the clarity of the offer to prevent the formation of a contract.

131

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

In the actual case on which this problem is based, the court concluded that the reservation of discretion to revoke a plan makes an offer too indefinite and issued a judgment in TCP‘s favor. A state intermediate appellate court reversed this judgment, holding that TCP‘s plan was a sufficiently definite offer. 23. Acceptance. Altisource Portfolio Solutions, Inc., is a global corporation that provides real property owners with services that include property preservation—repairs, debris removal, and so on. Lucas Contracting, Inc., is a small trade contractor in Carrollton, Ohio. On behalf of Altisource, Berghorst Enterprises, LLC, hired Lucas to perform preservation work on certain foreclosed properties in eastern Ohio. When Berghorst did not pay for the work, Lucas filed a suit in an Ohio state court against Altisource. Before the trial, Lucas e-mailed the terms of a settlement. The same day, Altisource e-mailed a response that did not challenge or contradict Lucas‘s proposal and indicated agreement to it. Two days later, however, Altisource forwarded a settlement document that contained additional terms. Which proposal most likely satisfies the element of agreement to establish a contract? Explain. [Lucas Contracting, Inc. v. Altisource Portfolio Solutions, Inc., 2016 Ohio- 474 (2016)] (See Acceptance.) Solution The terms for a settlement that Lucas originally e-mailed to Altisource are most likely to be considered by a court to satisfy the element of agreement to establish a contract. One of the elements for the formation of a valid contract is agreement—mutual assent to the terms of a bargain. Agreement is evidenced by an offer and an acceptance. An offeree‘s acceptance of an offer leads to the creation of an enforceable contract. Acceptance is a voluntary act that shows assent. The act may consist of words or conduct. The acceptance must be unequivocal—it must mirror the terms of the offer. In this problem, Lucas was not paid for work for which it had been hired and which it had performed. The contractor filed a suit against Altisource to recover. Before the trial, Lucas emailed the terms of a settlement to the defendant. Altisource e-mailed a response that did not challenge or contradict the proposal and indicated agreement to it. Two days later, however, Altisource forwarded a different settlement document that contained additional terms. But because Lucas clearly set out the terms of a settlement in its e-mail and Altisource responded without contradiction or challenge, it is most likely that the original proposal would be held to meet the requirement of agreement to establish a valid contract. In the actual case on which this problem is based, on Lucas‘s motion to enforce the original settlement without the additional terms, the court issued a judgment to enforce it. A state intermediate appellate court affirmed the lower court‘s judgment for the reasons stated above. 24. Online Acceptances. Airbnb, Inc., maintains a website that lists, advertises, and takes fees or commissions for property rentals posted on the site. To offer or book accommodations on the site, a party must register and create an account. The sign-up screen states, ―By clicking ‗Sign Up‘ . . . you confirm that you accept the Terms of Service‖ (TOS). The TOS, which are hyperlinked, include a mandatory arbitration provision. Francesco Plazza registered with Airbnb and created an account but did not read the TOS. Later, Plazza filed a suit in a federal district court against Airbnb, alleging that the defendant was acting as an unlicensed real estate broker and committing deceptive trade practices in violation of New York state law. Airbnb filed a motion to compel arbitration, pursuant to the TOS. Can Plazza avoid arbitration? Explain. [Plazza v. Airbnb, Inc., 289 F.Supp.3d 537 (S.D.N.Y. 2018)] (See E-Contracts.)

132

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution Plazza can avoid arbitration only if Airbnb agrees. Otherwise, the court can compel Plazza to engage in arbitration according to Airbnb‘s TOS, in response to the defendant‘s motion. Parties can agree to a contract by any means, including action. In the language of the UCC, a contract ―may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.‖ Thus, for example, online, clicking on an ―I agree‖ box can indicate acceptance. This is enough to bind a party to the terms, which online may be accessible via a hyperlink. A party does not need to have read all of the terms for them to be effective. Here, Airbnb operates a website that features property rentals. To offer or accept a rental posted on the site, a user must register and create an account. The sign-up screen states, ―By clicking ‗Sign Up‘ . . . . you confirm that you accept the Terms of Service‖ (TOS). The TOS are hyperlinked, and include a mandatory arbitration provision. Francesco Plazza registered with Airbnb and created an account, but did not read the TOS. Later, in response to Plazza‘s suit against Airbnb, alleging deceptive trade practices and other violations of New York state law, Airbnb filed a motion to compel arbitration. When Plazza created an account, he agreed to the TOS, whether or not he actually read them. In the actual case on which this problem is based, the court granted Airbnb‘s motion. With respect to ―the terms of the arbitration provision . . . Plazza‘s actions in signing up . . . manifested assent.‖ The court further stayed the suit, pending the outcome of the arbitration. 25. A Question of Ethics—The IDDR Approach and Intention. The Prince Hall Grand Lodge of Washington is a fraternal association incorporated in the state of Washington. The Grand Lodge Constitution provides that the Grand Master ―shall decide all questions of . . . Masonic law.‖ Grand Master Gregory Wraggs suspended the membership of Lonnie Traylor for ―un-Masonic conduct.‖ Traylor asked Wraggs to revoke the suspension and prepared a ―Memo of Understanding.‖ Wraggs agreed to talk but declined to revoke the suspension and did not sign the memo. Traylor filed a suit in a Washington state court against the Grand Lodge and Wraggs, alleging that the Grand Master‘s failure to revoke Traylor‘s suspension was a breach of contract. [Traylor v. Most Worshipful Prince Hall Grand Lodge, 197 Wash.App. 1026 (Div. 2 2017)] (See Offer.) 1. Was it ethical of Wraggs to agree to talk to Traylor but decline to revoke his suspension? Use the IDDR approach to decide.

133

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

Solution Yes. Wraggs acted ethically in agreeing to talk to Traylor but declining to revoke his suspension. The constitution of the Prince Hall Grand Lodge of Washington provides that the Grand Master ―shall decide all questions of . . . Masonic law.‖ Grand Master Wraggs suspended Traylor‘s membership for ―un-Masonic conduct.‖ Traylor asked Wraggs to revoke the suspension and presented a ―Memo of Understanding.‖ Wraggs agreed to talk but declined to revoke the suspension and did not sign the memo. The IDDR approach begins with an Inquiry to identify the ethical dilemma, the stakeholders, and the relevant standards in a set of facts. In the Traylor case, Wraggs‘s dilemma was whether to talk to Traylor and decide what to do with regard to his suspension. Besides the principal parties to the case, the stakeholders included the other Masons. The applicable standards included Wraggs‘s charge as Grand Master to decide all questions of Masonic law. The next step in the IDDR approach is a Discussion of actions to address the issue, the actions‘ strengths and weaknesses, and their consequences and effects. Here, Wraggs could refuse or consent to meet with Traylor. If he refused, he would be setting a precedent for other Grand Masters to ignore entreaties by other Masons in similar circumstances. At times, this could constitute an abuse of authority. If Wraggs consented to meet, however, the precedent would be one of due process, deliberation, and magnanimity. After the Discussion, the IDDR approach encourages a Decision on the actions and a statement of the reasons. The clear decision in this case would be to meet with Traylor. The reasons include the positive effects of this action indicated in the previous paragraph. The final step of the IDDR approach is a Review of the success or failure of the action to resolve the issue, and satisfy the stakeholders. As clear as the choice to meet with Traylor is the likelihood of its success to satisfy the stakeholders. Traylor would get his meeting, Wraggs would fulfill his duty as Grand Master, and the other Masons would gain confidence in the fairness of their organization, and its policies and procedures. 2.

On what basis would the court likely hold that there was no contract between Wraggs and Traylor? Is it unethical of Traylor to assert otherwise? Discuss, using the IDDR approach.

Solution The court is most likely to hold that Traylor and the Grand Master did not enter into a contract. The court could base this conclusion on the ground that their conversation was only a preliminary negotiation. For a contract to exist, there must be mutual assent to the agreement‘s essential terms. Mutual assent generally takes the form of an offer and an acceptance. An offer consists of a promise to perform in exchange for a return promise. A request or invitation to negotiate performance is not an offer. Agreeing to negotiate is not a promise to contract to perform. It is only an expression of a willingness to discuss the possibility of entering into a contract. Here, the constitution of the Prince Hall Grand Lodge of Washington provides that the Grand Master ―shall decide all questions of . . . Masonic law.‖ Grand Master Gregory Wraggs suspended Lonnie Traylor‘s membership for ―un-Masonic conduct.‖ Traylor asked Wraggs to revoke the suspension, and presented a ―Memo of Understanding.‖ Wraggs agreed to talk but declined to

134

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 11: Agreement

revoke the suspension and did not sign the memo. Traylor alleged breach of contract. But according to the principles stated above, there was no contract. Hence, there was no breach. This should have been obvious to Traylor. His refusal to accept the situation, and his choice to file a suit against the Grand Lodge in the face of circumstances that did not support his claim, indicates a lack of ethics. Zealous assertion of an arguably sustainable position can be ethical—in fact, not to take a stand on such a position may be unethical. But to act on a patently false claim, at least in the context of this case, betrays a lack of ethics. In the actual case on which this problem is based, the court granted Grand Lodge‘s motion for summary judgment. On Traylor‘s appeal, a state intermediate appellate court affirmed the judgment.

Critical Thinking and Writing Assignments 6.

Time-Limited Group Assignment—E-Contracts. To download a specific app to your smartphone or tablet device, you usually have to check a box indicating that you agree to the company‘s terms and conditions. Most individuals do so without ever reading those terms and conditions. Print out a specific set of terms and conditions from a downloaded app to use in this assignment. All group members should print out the same set of terms and conditions. (See EContracts.) 1.

One group will determine which of these terms and conditions are favorable to the company.

Solution Terms that most likely favor the business that created them include forum-selection, disputeresolution, limited liability, disclaimer, and remedies provisions. Other favorable terms might include agreements to receive notices, ads, and ―member‖ e-mail electronically. The details of the object or subject matter of the contract, including performance and payment provisions, might also favor the party that drafted the terms. 2.

Another group will determine which of these terms and conditions could conceivably be favorable to the individual.

Solution A privacy statement of terms most likely benefits the individual user or consumer. Other terms can also favor the individual—a provided remedy might be more suitable, for example, or a selected forum might be more convenient, than other, unspecified options. 3.

A third group will determine which terms and conditions, on net, favor the company too much.

Solution Any terms that are onerous, burdensome, or unconscionable from the individual user‘s point of view would favor the company too much. A disclaimer of liability for any injury or damage, whatever its cause, would most likely be unconscionable, for example.

135

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 136 Case 12.1 ............................................................................................................................................... 136 Case 12.2 ............................................................................................................................................... 137 Case 12.3 ............................................................................................................................................... 137 Chapter Review ........................................................................................................................................................... 138 Practice and Review .............................................................................................................................. 138 Practice and Review: Debate This ......................................................................................................... 139 Issue Spotters ........................................................................................................................................ 139 Business Scenarios and Case Problems ................................................................................................. 140 Critical Thinking and Writing Assignments ............................................................................................ 145

Critical Thinking Questions in Cases Case 12.1 198. Fans sometimes catch and keep baseballs hit into the stands. How do these actions differ from the situation described in this case, in which fans were promised and received promotional items for attending games? Does this distinction support or undercut the court‘s ruling? Solution The difference between the promise and receipt of a promotional item for attending a game and a fan‘s catching and keeping a ball hit into the stands is the unexpected, gratuitous nature of the catch of a ball. The promotional items at issue in this case are distinct from unanticipated, generally ―free‖ items that fans might receive when attending a game. When a fan catches and brings home a ball hit by a player—or a t-shirt or other personal item tossed into the stands—the fan has no expectation of receiving the item, nor did the fan buy a ticket assuming that such an item would be provided by the team. In the Cincinnati Reds case, the fans did not receive the promotional items unexpectedly or by chance. Instead, the items were an explicit part of the bargain, along with the right to attend the game, the fans obtained in exchange for buying the ticket.

136

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

199.

What effect does the decision in this case have the state‘s collection of revenue? Discuss.

Solution Obviously, the decision in the Cincinnati Reds case affects the state of Ohio‘s collection of revenue on the distribution of promotional items at the Reds‘ baseball games. If the decision serves as precedent for other sports events for which tickets are sold and promotional items are advertised and distributed, then of course the state could be prevented rom collecting revenue on any of those items. Depending on the number of such events, the amount of lost revenue could be significant. The state legislature might change this situation by amending the tax code. Sports teams might react to such a change by increasing ticket prices to cover the cost of the tax. This might affect attendance at sports events, and if the tax is large enough and well publicized, the members of the legislature who favored it might be voted out.

Case 12.2 200. When a noncompete agreement is entered into after employment has begun, is continued employment sufficient consideration for the agreement? Explain. Solution No. Continued employment does not constitute consideration for a noncompete agreement entered into after employment has begun. The employee who is asked to sign such an agreement is already employed. The agreement requires new consideration for its support. This might consist of, for example, a change to the employment relationship such as a term of duration imposed on previously at-will employment, or additional compensation or another benefit. In the words of the court in the Baugh case, ―When a covenant not to compete is entered into after the inception of employment, separate consideration, in addition to continue at-will employment, is necessary in order for the covenant to be enforceable. There is no consideration when the contract containing the covenant is exacted after several years' employment and the employee's duties and position are left unchanged.‖

Case 12.3 201.

Why would any party agree to a covenant not to sue?

Solution The simple answer is money. When a party believes it to be an advantage to agree to a covenant not to sue, that party is most likely to agree. In the example in the text, the party whose car was damaged in the accident agrees not to sue if the other party will pay for the damage. This agreement saves the time and money that a suit for damages might require for both parties. In the Already case, the covenant not to sue has similar advantages for the parties—both can continue to do business without changing their product lines and without the costs of trademark infringement or invalid trademark litigation.

137

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

202.

Which type of contracts are similar to covenants not to sue? Explain.

Solution Types of contracts that are similar to a covenant not to sue include an accord and satisfaction, and a release. In a covenant not to sue, the parties substitute a contractual obligation for some other type of legal action based on a valid claim. In an accord and satisfaction, a debtor offers to pay, and a creditor accepts, a lesser amount than the creditor originally claimed was owed. When the amount of a debt is not certain, and reasonable persons differ over the amount owed, acceptance of payment of a lesser sum operates as satisfaction of the debt because there is valid consideration—the parties give up a legal right to contest the amount in dispute. A release is a contract in which one party forfeits the right to pursue a legal claim against the other party. The consideration for a release is the legal right that the party forfeits in exchange for the other‘s promise to pay a stipulated amount.

Chapter Review Practice and Review John operates a motorcycle repair shop from his home but finds that his business is limited by the small size of his garage. Driving by a neighbor‘s property, he notices a for-sale sign on a large, metalsided garage. John contacts the neighbor and offers to buy the building, hoping that it can be dismantled and moved to his own property. The neighbor accepts John‘s payment and makes a generous offer in return. If John will help him dismantle the garage, which will take a substantial amount of time, he will help John reassemble it after it has been transported to John‘s property. They agree to have the entire job completed within two weeks. John then spends every day for a week working with his neighbor to disassemble the building. In his rush to acquire a larger workspace, he turns down several lucrative repair jobs. Once the disassembled building has been moved to John‘s property, however, the neighbor refuses to help John reassemble it as he originally promised. Using the information presented in the chapter, answer the following questions. 203. Are the basic elements of consideration present in the neighbor‘s promise to help John reassemble the garage? Why or why not? Solution Yes, there was an offer that was accepted with consideration. The parties agreed to the terms of the deal, which included cash for the building and the labor to take the building down and put it back together. 204. Suppose that the neighbor starts to help John but then realizes that putting the building back together will take much more work than dismantling it. Under which principle might the neighbor be allowed to ask for additional compensation? Solution Under the rule of unforeseen difficulties, a change in the terms may be allowed because of unforeseen difficulties, although that rule is not easy to have applied.

138

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

205. What if John‘s neighbor made his promise to help reassemble the garage at the time he and John were moving it? Suppose he said, ―Since you helped me take it down, I will help you put it back up.‖ Would John be able to enforce this promise? Why or why not? Solution No. John cannot enforce the promise because it is a gift being offered. At this point in their dealings, the neighbor is making a promise with no consideration from John, so it is a gift, not a bargained-for exchange. 206. Under what doctrine might John seek to recover the profits he lost when he turned down repair jobs for one week? Solution Assuming the neighbor knew about the income John was losing by counting on the deal as discussed, John might recover under the doctrine of promissory estoppel, which is when one has reasonably relied on the promise of another.

Practice and Review: Debate This 207.

Courts should not be able to rule on the adequacy of consideration. A deal is a deal.

Solution Courts should not accept to rule on the adequacy of consideration because in so doing, they create a moral hazard situation for anyone who, after the fact, doesn‘t think they ―got a good deal.‖ In other words, if those who enter into agreements know that they can later avoid their contractual obligations by claiming that the consideration was inadequate, they will take less time and resources to determine if the agreement is correct, appropriate, and fair. Sometimes people are tricked into entering into agreements for which they receive grossly unfair consideration. Fraud might be involved. Undue influence (duress) could be another reason. In such situations, these individuals should have access to the court system to redress their grievances. To deny them this access would be unfair.

Issue Spotters 208. In September, Sharyn agrees to work for Totem Productions, Inc., at $500 a week for a year beginning January 1. In October, Sharyn is offered the same work at $600 a week by Umber Shows, Ltd. When Sharyn tells Totem about the other offer, they tear up their contract and agree that Sharyn will be paid $575. Is the new contract binding? Explain. Solution Yes. The original contract was executory. The parties rescinded it and agreed to a new contract. If Sharyn had broken the contract to accept a contract with another employer, she might have been held liable for damages for the breach. 209. Before Maria starts her first year of college, Fred promises to pay her $5,000 when she graduates. She goes to college, borrowing and spending far more than $5,000. At the beginning of the spring semester of her senior year, she reminds Fred of the promise. Fred sends her a note that says, ―I revoke the promise.‖ Is Fred‘s promise binding? Explain. Solution

139

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

Yes. Under the doctrine of detrimental reliance, or promissory estoppel, the promisee is entitled to payment of $5,000 from the promisor on graduation. There was a promise, on which the promisee relied, the reliance was substantial and definite (the promisee went to college for the full term, incurring considerable expenses, and will likely graduate), and it would only be fair to enforce the promise.

Business Scenarios and Case Problems 210. Preexisting Duty. Ben hired Lewis to drive his racing car in a race. Tuan, a friend of Lewis, promised to pay Lewis $3,000 if he won the race. Lewis won the race, but Tuan refused to pay the $3,000. Tuan contended that no legally binding contract had been formed because he had received no consideration from Lewis for his promise to pay the $3,000. Lewis sued Tuan for breach of contract, arguing that winning the race was the consideration given in exchange for Tuan‘s promise to pay the $3,000. What rule of law discussed in this chapter supports Tuan‘s claim? Explain. (See Agreements That Lack Consideration.) Solution Tuan‘s claim that no contract existed because Lewis had given no consideration for Tuan‘s promise is supported by the preexisting duty rule. Lewis was already obligated to Ben to do his best to win the race, and the same consideration (attempting to win the race) could not be used in a second contract with Tuan. Because Lewis had a preexisting duty to try to win the race, a majority of courts would likely hold that Tuan was correct in arguing that no contract existed because Lewis gave no consideration. 211. Accord and Satisfaction. Merrick grows and sells blueberries. Maine Wild Blueberry Co. agreed to buy all of Merrick‘s crop under a contract that left the price unliquidated. Merrick delivered the berries, but a dispute arose over the price. Maine Wild sent Merrick a check with a letter stating that the check was the ―final settlement.‖ Merrick cashed the check but filed a suit for breach of contract, claiming that he was owed more. What will the court likely decide in this case, and why? (See Settlement of Claims.) Solution The accord and satisfaction created by Merrick‘s cashing the check would bar any recovery. An accord and satisfaction is created by cashing a check that is accompanied by a letter with restrictive language. In this case, the language in the letter is unambiguous. The check was the ―final settlement.‖ There is no doubt as to what Maine Wild intended or what should reasonably have been understood by Merrick. Merrick had the choice of accepting the check on these terms or of returning it—he chose to accept it. 212. Rescission. Farrokh and Scheherezade Sharabianlou agreed to buy a building owned by Berenstein Associates for $2 million. They deposited $115,000 toward the purchase. Before the deal closed, an environmental assessment of the property indicated the presence of chemicals used in dry cleaning. This substantially reduced the property‘s value. Do the Sharabianlous have a good argument for the return of their deposit and rescission of the contract? Explain. [Sharabianlou v. Karp, 181 Cal.App.4th 1133, 105 Cal.Rptr.3d 300 (2010)] (See Agreements That Lack Consideration.) Solution

140

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

The reviewing court concluded that ―Rescission is intended to restore the parties as nearly as possible to their former positions and ‗to bring about substantial justice by adjusting the equities between the parties‘.‖ Rescission does not occur if a contract is affirmed; it means the contract is repudiated. Here, rescission is appropriate because the contracting parties were mutually mistaken as to the condition of the property. The environmental contamination substantially reduced its value. When an agreement to purchase property is subject to rescission, ―the seller must refund all payments received in connection with the sale.‖ Hence, the award of damages to the Berensteins was reversed and the Sharabianlous were refunded their deposit. 213. Spotlight on Kansas City Chiefs—Consideration. On Brenda Sniezek‘s first day of work for the Kansas City Chiefs Football Club, she signed a document that purported to compel arbitration of any disputes that she might have with the Chiefs. In the document, Sniezek agreed to comply at all times with and be bound by the constitution and bylaws of the National Football League (NFL). She agreed to refer all disputes to the NFL commissioner for a binding decision and to release the Chiefs and others from any related claims. Nowhere in the document did the Chiefs agree to do anything. Was there consideration for the arbitration provision? Explain. [Sniezek v. Kansas City Chiefs Football Club, 402 S.W.3d 580 (Mo.App. W.D. 2013)] (See Consideration.) Solution No. There was no consideration for the arbitration provision. Consideration is required to create a bilateral contract. Consideration is something of legally sufficient value given in return for a promise. The ―something of legally sufficient value‖ may consist of either a promise to do or refrain from doing something or a transfer of something of value. In this problem, the arbitration ―agreement‖ contains promises made only by Sniezek. Only Sniezek agrees to comply at all times with and be bound by the constitution and bylaws of the National Football League (NFL). Only Sniezek agrees to refer all disputes to the NFL Commissioner for a binding decision. Only Sniezek agrees to release the Chiefs from any related claims on the Commissioner's decision. Nowhere in the document do the Chiefs agree to do anything. Thus, the document does not contain any promises by the Chiefs to constitute sufficient consideration for Sniezek's promise to forgo her right of access to the courts and arbitrate her claims against them. The Chiefs might argue that the ―agreement‖ was a condition of Sniezek's keeping her employment, which the Chiefs had already offered her, and she had already accepted. But the document did not alter the nature of her employment relationship—no employment contract was created; no additional compensation or other benefit was offered. Consequently, allowing Sniezek to stay on the job was not sufficient consideration to support a promise to arbitrate. In the actual case on which this problem is based, Sniezek filed a charge of age discrimination against the Chiefs in a Missouri state court, and the Chiefs filed a motion to compel arbitration. The court denied the motion, and a state intermediate appellate court affirmed the denial for the reasons stated above. 214. Consideration. Citynet, LLC, established an employee incentive plan ―to enable the Company to attract and retain experienced individuals.‖ The plan provided that a participant who left Citynet‘s employment was entitled to ―cash out‖ his or her entire vested balance. (When an employee‘s rights to a particular benefit become vested, they belong to that employee and cannot be taken away. The vested balance refers to the part of an account that goes with the employee if he or she leaves the company.)

141

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

When Citynet employee Ray Toney terminated his employment, he asked to redeem his $87,000.48 vested balance. Citynet refused, citing a provision of the plan that limited redemptions to no more than 20 percent annually. Toney filed a suit in a West Virginia state court against Citynet, alleging breach of contract. Citynet argued that the plan was not a contract but a discretionary bonus over which Citynet had sole discretion. Was the plan a contract? If so, was it bilateral or unilateral, and what was the consideration? [Citynet, LLC v. Toney, 235 W.Va.79, 772 S.E.2d 36 (2015)] (See Consideration.) Solution Citynet‘s employee incentive plan was an offer for a unilateral contract. A Citynet employee who stayed on the job while was under no obligation to do so could be considered to have accepted Citynet's offer and to have provided sufficient consideration to make the offer a binding and enforceable promise. Consideration has two elements—it must consist of something of legal value and must provide the basis for the bargain between the parties. A unilateral contract involves a promise in return for performance. The promisor becomes bound to the contract when the promisee performs, or in many cases begins to perform, the act. Both the promise and the performance have legal value. Here, Citynet set up an employee incentive plan ―to attract and retain experienced individuals.‖ The plan provided that participants who left Citynet‘s employ could ―cash out‖ their entire vested balances. When Ray Toney terminated his employment and asked to redeem his vested balance, however, Citynet refused. But Toney had long stayed on the job when he did not have to. This was sufficient consideration to make Citynet‘s offer under the incentive plan a binding and enforceable contract with Toney. In the actual case on which this problem is based, a West Virginia state court issued a judgment in Toney‘s favor. The West Virginia Supreme Court of Appeals affirmed, on the reasoning and principles stated above. 215. Business Case Problem with Sample Answer— Agreements That Lack Consideration. Arkansas-Missouri Forest Products, LLC (Ark-Mo), sells supplies to make wood pallets. Blue Chip Manufacturing (BCM) makes pallets. Mark Garnett, an owner of Ark-Mo, and Stuart Lerner, an owner of BCM, went into business together. Garnett and Lerner agreed that Ark-Mo would have a 30-percent ownership interest in their future projects. When Lerner formed Blue Chip Recycling, LLC (BCR), to manage a pallet repair facility in California, however, he allocated only a 5 percent interest to Ark-Mo. Garnett objected. In a ―Telephone Deal,‖ Lerner then promised Garnett that Ark-Mo would receive a 30 percent interest in their future projects in the Midwest, and Garnett agreed to forgo an ownership interest in BCR. But when Blue Chip III, LLC (BC III), was formed to operate a repair facility in the Midwest, Lerner told Garnett that he ―was not getting anything.‖ Ark-Mo filed a suit in a Missouri state court against Lerner, alleging breach of contract. Was there consideration to support the Telephone Deal? Explain. [Arkansas-Missouri Forest Products, LLC v. Lerner, 486 S.W.3d 438 (Mo.App. E.D. 2016)] (See Consideration.) —For a sample answer to Problem 12–6, go to Appendix E. Solution

142

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

Yes. There was consideration to support the Telephone Deal. Consideration can consist of a promise, a performance, or forbearance (refraining from an action that one has a legal right to undertake). In this problem, Mark Garnett, an owner of Arkansas–Missouri Forest Products, LLC (Ark-Mo), and Stuart Lerner, an owner of Blue Chip Manufacturing (BCM), agreed to go into wood-pallet enterprises together, with Ark-Mo to have a 30-percent ownership interest in their future projects. When Lerner formed Blue Chip Recycling, LLC (BCR) to manage a pallet repair facility in California, however, he allocated only a 5-percent interest to Ark-Mo. Garnett objected. In a ―Telephone Deal,‖ Lerner promised that Ark-Mo would receive a 30-percent interest in their future projects in the Midwest. Garnett then agreed to forego an ownership interest in BCR. Acting on Ark-Mo‘s behalf, Garnett could have accepted the 5-percent allocation in BCR, but he refrained from doing so. Instead, he accepted Lerner‘s promise of a 30-percent share in their future projects in the Midwest and made no more demand regarding BCR. In other words, Garnett forwent the opportunity to have an ownership interest in BCR in exchange for Lerner‘s agreement that Ark–Mo would have a 30-percent ownership interest in certain future projects. In the actual case on which this problem is based, Ark-Mo filed a suit in a Missouri state court against Lerner, alleging breach of contract. The court issued a judgment in Lerner‘s favor. A state intermediate appellate court reversed, in part on the reasoning stated here. ―Valid legal consideration supported the Telephone Deal.‖ 216. Elements of Consideration. Carmen White signed a lease with Sienna Ridge Apartments in San Antonio, Texas. The lease required White to reimburse Sienna Ridge for any damage to the apartment not caused by the landlord‘s negligence or fault. After moving in, White received a new washer and dryer from her parents. She did not read the instruction manual before overloading the dryer with bedding, including an unwashed pillow, which started a fire. Sienna Ridge filed a claim for the resulting damage with Philadelphia Indemnity Insurance Company. Philadelphia paid the claim and filed a suit in a Texas state court against White, alleging that she had breached the lease by failing to reimburse Sienna Ridge for the damage. White argued that the lease was unenforceable for lack of consideration. Is White correct? Discuss. [Philadelphia Indemnity Insurance Co. v. White, 2017 WL 32899 (Tex.App.— San Antonio 2017)] (See Consideration.) Solution White is not correct. Her lease with Sienna Ridge does not lack consideration and is therefore enforceable. Consideration is a requirement for every valid contract. Consideration consists of a bargained-for exchange of something of legal value, which can include promises and performance. In this problem, Carmen White signed a lease with Sienna Ridge Apartments. The lease presumably contained a number of obligations owed by each party to the other. These would include the tenant‘s payment of a deposit and rent and the landlord‘s permission to live on the premises. The landlord would owe a duty to keep the common areas free of hazards and to maintain the apartment‘s heating and water. The lease expressly required White to reimburse Sienna Ridge for damage not due to the landlord‘s negligence or fault. These obligations and duties constituted consideration.

143

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

White overloaded a dryer in her apartment, causing a fire. She failed to pay Sienna Ridge for the resulting damage. This is a clear breach of the lease. Arguably, even in the absence of a clause that required her to pay for the damage, White would have acted unethically by resisting payment. An ethical person would face the consequences of the conduct and act to resolve those that harm others. In the actual case on which this problem is based, a jury found in favor of Philadelphia but the court issued a judgment notwithstanding the verdict in favor of White. On appeal, the Texas Supreme Court reversed this judgment, and the case was remanded to the lower court for the entry of a judgment in accord with the jury‘s verdict. 217. A Question of Ethics—Promissory Estoppel. Claudia Aceves borrowed $845,000 from U.S. Bank to buy a home. Less than two years into the loan, she could no longer afford the monthly payments. The bank notified her that it planned to foreclose on her home. (Foreclosure is a process that allows a lender to repossess and sell the property that secures a loan.) The bank offered to modify Aceves’s mortgage if she would forgo bankruptcy. In reliance on the bank’s promise, she agreed. Once she withdrew the filing, however, the bank foreclosed and began eviction proceedings. Aceves filed a suit against the bank for promissory estoppel. [Aceves v. U.S. Bank, N.A., 192 Cal.App.4th 218, 120 Cal.Rptr.3d 507 (2011)] (See Promissory Estoppel.) 1. Could Aceves succeed in her claim of promissory estoppel? Why or why not? Solution The elements of promissory estoppel are (1) a promise, (2) the promisee‘s justifiable reliance on the promise, (3) reliance of a substantial and definite character, and (4) justice better served by the enforcement of the promise. In the facts of this problem, under a theory of promissory estoppel, Aceves‘s best strategy is to argue that the bank‘s promise to work with her in modifying the loan was enforceable, that she relied on the promise by forgoing bankruptcy protection, that the bank breached its promise by foreclosing on her home, and that justice would be better served by allowing her to stay in her home and work out a modified schedule of payments with the bank. In the actual case on which this problem is based, the court concluded that the bank promised to work on a loan modification if Aceves did not seek relief in bankruptcy, Aceves reasonably relied on this promise when she withdrew her filing, and this decision allowed the bank to foreclose on the property. 2. Did Aceves or U.S. Bank behave unethically? Discuss. Solution As for unethical behavior, U.S. Bank clearly misrepresented it was willing to forgo foreclosure while expediting foreclosure proceedings. The bank apparently never intended to work with Aceves to modify her loan. It promised to do this only to convince her to forgo bankruptcy proceedings so that the bank could foreclose on the property. The elements of fraud are similar to the elements of promissory estoppel, with the additional requirements that a false promise be made and that the promisor know of the falsity when making the promise. It is easy to view this conduct as unethical. Acts that support claims for promissory estoppel and fraud, as occurred in these facts, are patently unethical.

144

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 12: Consideration

A lapse of ethics in Aceves‘s conduct is less clear. She may have overextended herself in taking on this mortgage to buy this house. That the mortgage payments became unaffordable for her less than two years into the loan indicates that she may have fooled herself at the inception of the loan into thinking that she could afford it at all. If that was the circumstance, she may have been motivated by greed or she may have fallen victim to selfdeception, either of which are arguably unethical. She might have been better situated if she had bought a less expensive home under a more affordable loan.

Critical Thinking and Writing Assignments 218. Time-Limited Group Assignment—Preexisting Duty. Melissa Faraj owns a lot and wants to build a house according to a particular set of plans and specifications. She solicits bids from building contractors and receives three bids: one from Carlton for $160,000, one from Feldberg for $158,000, and one from Siegel for $153,000. She accepts Siegel‘s bid. One month after beginning construction of the house, Siegel contacts Faraj and tells her that because of inflation and a recent price hike for materials, his costs have gone up. He says he will not finish the house unless Faraj agrees to pay an extra $13,000. Faraj reluctantly agrees to pay the additional sum. (See Agreements That Lack Consideration.) 1.

One group will evaluate whether a contractor can ever raise the price of completing construction based on inflation and the rising cost of materials. Solution The legal issue deals with the preexisting duty rule, which basically states that a promise to do what one already has a legal or contractual duty to do does not constitute consideration, and thus a promise based on a preexisting duty is unenforceable. One of the purposes of this general rule is to prevent commercial blackmail. There are four basic exceptions to this rule. If any of these applied, a contractor might successfully raise the price of completing construction based on inflation and the rising cost of materials. i. If the duties of Siegel are modified, for example, by changes made by Faraj in the specifications, these changes can constitute consideration and bind Faraj to pay the additional $13,000. ii. Rescission and new contract theory could be applied, by which the old contract of $153,000 would mutually be canceled and a new contract for $166,000 would be made. Most courts would not apply this theory unless there was a clear intent to cancel the original contract. It appears here that the intent to cancel the $153,000 contract is lacking (there is merely an intent to modify), so this exception would not apply. iii. A few states have statutes that allow any modification to be enforceable if it is in writing. The facts stated give no evidence that Faraj‘s agreement to the additional $13,000 is in writing, but, if it is, Faraj is bound in those states. iv. The unforeseen difficulty or hardship rule could be argued. This rule, however, applies only to unknown risks not ordinarily assumed in business transactions. Because inflation and price rises are risks ordinarily assumed in business, this exception cannot be used by Siegel.

A second group will assume that after the house is finished, Faraj refuses to pay the extra $13,000. The group will decide whether Faraj is legally required to pay this additional amount. Solution

145

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

In this problem, Siegel was required contractually to build a house according to a specific set of plans for $153,000, and Faraj‘s later agreed to pay an additional $13,000 for exactly what Siegel was required to do for $153,000. Under the preexisting duty rule, this agreement is without consideration and unenforceable. Thus, Faraj is not legally required to pay this additional amount. 3.

A third group will determine what types of extraordinary difficulties could arise during construction that would justify a contractor‘s charging more than the original bid. Solution The preexisting duty rule states that a promise to do what one already has a legal or contractual duty to do does not constitute consideration, and thus a promise based on a preexisting duty is unenforceable. One of the purposes of this general rule is to prevent commercial blackmail. One of the exceptions to this rule concerns an unforeseen difficulty or hardship. This exception applies only to unknown risks not ordinarily assumed in business transactions. Because inflation and price rises are risks ordinarily assumed in business, this exception cannot be used by Siegel in this problem. The types of extraordinary difficulties that could arise during construction to justify a contractor charging more than an original bid include unexpected infrastructure and subsurface problems.

A fourth group will consider what would happen if Faraj and Siegel had rescinded the initial contract and entered a new construction contract that included the extra $13,000. Would a court be likely to find that there was no consideration because of a preexisting duty? Explain. Solution If Faraj and Siegel had rescinded the initial contract and entered into a new contract that included the extra $13,000, a court could be likely to find that there was no consideration for the new deal—i.e., that it could not be enforced for lack of consideration because of a preexisting duty. A promise to do what one has a legal duty to do is not legally sufficient consideration for a new contract. But two parties can mutually agree to rescind their contract, at least the extent that it is executory. By rescinding the deal, they return to the positions they were in before they made it. They are then free to enter into a new contract. If rescission and the new agreement occur at the same time, as was the circumstance indicated in the facts of this question, it may not be clear that there was consideration for the new contract. Thus, if Faraj were to refuse to comply with the new terms, a court might determine that there was no consideration for it because of a preexisting duty, and the new contract would be adjudged invalid.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 147

146

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

Managerial Strategy ........................................................................................................................... 147 Critical Thinking Questions in Cases ................................................................................................................... 148 Case 13.1 ............................................................................................................................................... 148 Case 13.2 ............................................................................................................................................... 148 Case 13.3 ............................................................................................................................................... 149 Chapter Review ........................................................................................................................................................... 150 Practice and Review .............................................................................................................................. 150 Practice and Review: Debate This ......................................................................................................... 151 Issue Spotters ........................................................................................................................................ 151 Business Scenarios and Case Problems ................................................................................................. 152 Critical Thinking and Writing Assignments ............................................................................................ 158

Critical Thinking Questions in Features Managerial Strategy 219. What would be your strategy regarding liability waivers if you were managing a business that relied on minors engaging in inherently dangerous activities? Solution Initially, a manager would need to become well-versed in the applicable state law. The majority of states, through case law or legislative action, will not enforce parental waivers signed on behalf of children. Managers of trampoline parks—or other businesses that place minors at risk such as paintball or laser tag courses or go-kart tracks—in these states need to take precautions such as purchasing sufficient insurance and training employees to diffuse particularly dangerous situations immediately. Managers should also avoid the situation discussed in this feature, where House of Boom relied on the parent‘s signature alone to relieve it of liability for her daughter‘s injury. Employees should verbally encourage parents to read and understand the implications of any liability waivers. Employees should also be made available to answer any questions parents might have about liability waivers. Furthermore, parents and the children should be explicitly warned of the risks of the activity in which they are about to engage. Generally speaking, the more information a business explicitly provides concerning a liability waiver, the more likely a court will be to find the waiver is enforceable. 220. Under what circumstances would you, as a business owner, choose to aggressively defend your business against a customer‘s liability lawsuit? Solution Business owners choose to aggressively defend liability lawsuits when they are certain that the customer was 100 percent negligent and that the lawsuit has nothing to do with the negligence of the business. Also, some large corporations choose to aggressively defend ―nuisance‖ lawsuits in order to deter the filing of such lawsuits in the future, or at least reduce the potential number.

147

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

Critical Thinking Questions in Cases Case 13.1 221. Could PAK Foods successfully contend that S.L.‘s minority does not bar enforcement of the arbitration agreement because medical expenses are necessaries? Discuss. Solution No. PAK Foods could not succeed in contending that S.L.'s minority does not bar enforcement of the arbitration agreement because medical expenses are necessaries. Of course, minors may be held liable on a contract to furnish necessaries. And necessaries are generally considered to be items like food, lodging, clothing, medicine, and medical attention, and may include attorney's fees in some circumstances. But the contract at issue in the PAK Foods case concerns a minor's employment and the resolution of disputes arising during that employment—the contact is not for the provision of necessaries.

Case 13.2 222.

What ―legitimate business interests‖ justify the enforcement of a non-compete provision?

Solution Legitimate business interests that justify the enforcement of a non-compete provision include, among other things, substantial relationships with specific prospective or existing customers, as well as client good will. In the Kennedy case, for example, The Shave intended the non-compete provision in Kennedy‘s employment contract to protect the resources the company had devoted to developing its name recognition and customer base. In the words of the appellate court, ―The Shave had a legitimate business interest in protecting itself from the risk that Kennedy might appropriate customers by taking advantage of the contacts developed while she worked at The Shave.‖ Similarly, an employer can have a substantial interest in maintaining its workforce. Thus, for example, Kennedy‘s attempt to influence employees to leave The Shave to work for the ―P.K. Does Hair‖ salon would contravene this legitimate business interest.

148

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

223. What sort of harm, particularly in Kennedy‘s situation, would support a court‘s refusal to enforce an employment contract‘s non-compete provision? Solution A court should refuse to enforce an employment contract‘s non-compete provision with an injunction if the threatened injury to the party being enjoined outweighs the threatened harm to the party seeking the injunction. In Kennedy‘s situation, for example, she might claim that she would face bankruptcy and financial ruin if the injunction were imposed. This harm is not insignificant, especially in terms of its effect on securing credit for any business or personal purpose. And it is very unlikely that The Shave would go out of business if Kennedy were allowed to continue to compete two miles from her exemployer‘s current location. Of course, as in this case, the court could consider the relative harms and might decide that on balance the equities weigh in favor of an employer not having competition by a former employee within a restricted area. Here, Kennedy had notice of the non-compete provision, which she violated. Without its enforcement, the court determined, The Shave would lose customers. With ―the equities‖ in mind, the court reformed the provision to be reasonable in its terms, and granted an injunction to enforce it.

Case 13.3 224. At the time Holmes signed the release, Multimedia had not yet become a sponsor of the event. Should this fact have rendered the clause unenforceable? Explain. Solution No. At the time that Holmes signed the release, Multimedia had not yet become a sponsor of the event, but that fact did not make the clause unenforceable. As the court stated in its opinion, the release of ―any Event sponsors‖ clearly released all sponsors without exclusion. The release is not ambiguous because it does not specifically indicate that it applies to sponsors who had not signed a sponsorship agreement at the time the release was executed. In this case, the exculpatory clause was a release of claims for any injury or accident ―that may occur during my participation in this Event or while on the premises of this Event.‖ Thus, the clause specifically governed liability for injuries or accidents arising out of a participant's participation in and presence at the event. The clause released ―any Event sponsors.‖ Multimedia was a sponsor of the event. The release of ―any Event sponsors‖ plainly released all sponsors without exclusion. This plain language cannot reasonably be interpreted to release only those sponsors who had signed a sponsorship agreement before a participant signed the release.

149

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

Chapter Review Practice and Review Renee Beaver started racing go-karts competitively in 2020, when she was fourteen. Many of the races required her to sign an exculpatory clause to participate. She or her parents regularly signed such clauses. In 2022, right before her birthday, Renee participated in the annual Elkhart Grand Prix, a series of races in Elkhart, Indiana. During the event in which she drove, a piece of foam padding used as a course barrier was torn from its base and ended up on the track. A portion of the padding struck Beaver in the head, and another portion was thrown into oncoming traffic, causing a multikart collision during which she sustained severe injuries. Beaver filed an action against the race organizers for negligence. The organizers could not locate the exculpatory clause that Beaver had supposedly signed. Race organizers argued that she must have signed one to enter the race, but even if she had not signed one, her actions showed her intent to be bound by its terms. Using the information presented in the chapter, answer the following questions. 225. Did Beaver have the contractual capacity to enter into a contract with an exculpatory clause? Why or why not? Solution Beaver did not have the capacity to enter into a contract whether or not it included an exculpatory clause because she was a minor, or, more accurately, she could enter into the contract but she could opt to disaffirm it. Her parents were not minors, however, and could be held to their contracts, including the contract at issue in this problem if it otherwise meets all of the legal requirements. 226. Assuming that Beaver did, in fact, sign the exculpatory clause, did she later disaffirm or ratify the contract? Explain. Solution To disaffirm a contract, a minor must express an intent by words or conduct not to be bound. Here, the filing of a suit would certainly indicate an intent not to be bound. If Beaver had reached the age of eighteen a reasonable time before attempting to disaffirm, however, she could be held to have impliedly ratified the contract. 227. Now assume that Beaver had stated that she was eighteen years old at the time she signed the exculpatory clause. How might this affect her ability to disaffirm or ratify the contract? Solution Beaver‘s misrepresentation of age would not usually affect her right to disaffirm the contract, but in some states, the opposite is true—she would be bound to the clause. 228. Suppose Beaver can prove that she did not actually sign an exculpatory clause and this fact convinces race organizers to pursue a settlement. They offer to pay Beaver one-half of the amount that she is claiming in damages if she now signs a release of all claims. Because Beaver is young and the full effect of her injuries may not yet be clear, what other type of settlement agreement might she prefer? What is the consideration to support any settlement agreement that Beaver enters into with the race organizers? Solution

150

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

The type of settlement agreement that Beaver might prefer to sign is a covenant not to sue because it would not bar the race organizers from further liability if Beaver‘s injuries manifest fuller effects later. Under a covenant not sue, Beaver could leave open the amount of damages and require the race organizers to pay a percentage of her medical bills now and in the future, and then sue them if they failed to pay. The consideration that supports a settlement agreement is the parties‘ giving up a legal right to contest the amount in dispute.

Practice and Review: Debate This 229. After agreeing to an exculpatory clause or purchasing some item, minors often seek to avoid the contracts. Today‘s minors are far from naïve and should not be allowed to avoid their contractual obligations. Solution Today, teenagers, and most certainly, those just under the age of majority, are exposed to what is happening in the business world on a constant basis because of the ubiquity of media outlets—at home, at school, and everywhere there is a Wi-Fi connection. When a minor avoids an otherwise valid contract, the seller of the good or service involved gets stuck ―holding the bag‖ while the minor had free (or at least cheap) use of the good in question. Few minors enter into contracts without understanding to what they are agreeing. As much as we wish to impute adult capacities to minors, they are still minors and are not so capable as adults in understanding the contracts into which they may voluntarily enter. Consequently, the courts are acting in a just manner when they allow minors to avoid contracts made for the purchase of goods or services. If all minors were held to their contractual obligations as if they were adults, adults would be more likely to take advantage of minors‘ inexperience.

Issue Spotters 230. Cedric, a minor, enters into a contract with Diane. How might Cedric effectively ratify this contract? Solution A minor may effectively ratify a contract after reaching the age of majority either expressly or impliedly. Failing to disaffirm an otherwise enforceable contract within a reasonable time after reaching the age of majority would also effectively ratify it. Nothing a minor does before attaining majority, however, will ratify a contract. 231. Sun Airlines, Inc., prints on its tickets that it is not liable for any injury to a passenger caused by the airline‘s negligence. If the cause of an accident is found to be the airline‘s negligence, can it use the clause as a defense to liability? Why or why not? Solution No. Generally, an exculpatory clause (a clause attempting to absolve parties of negligence or other wrongs) is not enforced if the party seeking its enforcement is involved in a business that is important to the public as a matter of practical necessity, such as an airline. Because of the essential nature of such services, the parties have an advantage in bargaining strength and could insist that anyone contracting for its services agree not to hold it liable.

151

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

Business Scenarios and Case Problems 232. Contracts by Minors. Kalen is a seventeen-year-old minor who has just graduated from high school. He is attending a university two hundred miles from home and has contracted to rent an apartment near the university for one year at $500 per month. He is working at a convenience store to earn enough income to be self-supporting. After living in the apartment and paying monthly rent for four months, he becomes involved in a dispute with his landlord. Kalen, still a minor, moves out and returns the key to the landlord. The landlord wants to hold Kalen liable for the balance of the payments due under the lease. Discuss fully Kalen‘s liability in this situation. (See Contractual Capacity.) Solution A contract for shelter for a minor can be classified as a necessary if the contract meets three criteria: (a) the item contracted for is absolutely necessary for the minor‘s existence, (b) the item contracted for is within the station (including financial) of life the minor is accustomed to, and (c) the minor is not under the care of a parent or guardian who is required to supply these necessaries. When these three criteria are met, minors can disaffirm their contractual liability, although they continue to be liable for the reasonable value of any contracted-for item based on use. In this case, Kalen made a contract for shelter, which appears to be of a type suitable for his station in life. He is self-supporting, having removed himself from the care of his parents. The lease is a contract for a necessity, and, although Kalen can disaffirm the lease contract, he is liable in quasi contract for the reasonable value based on use. Thus, the landlord can keep the four months‘ rent paid by Kalen (assuming that $450 per month is a fair market value), but the landlord cannot hold Kalen liable for the balance on the lease. 233. Intoxication. After Kira had had several drinks one night, she sold Charlotte a diamond necklace worth thousands of dollars for one hundred dollars. The next day, Kira offered the one hundred dollars to Charlotte and requested the return of her necklace. Charlotte refused to accept the money or return the necklace, claiming that she and Kira had a valid contract of sale. Kira explained that she had been intoxicated at the time the bargain was made and thus the contract was voidable at her option. Was Kira correct? Explain. (See Contractual Capacity.) Solution Kira is right and will prevail over Charlotte if Kira can prove that she was indeed intoxicated at the time she sold the necklace to Charlotte. Most likely, Kira will have little difficulty proving this because no reasonable person would sell a valuable necklace for only one hundred dollars. The fact that Kira did so strongly suggests that she was intoxicated at the time and not aware of the significance of her action. Because contracts made by an intoxicated person are voidable at the option of the intoxicated party, Kira has a good chance of recovering the necklace. 234. Disaffirmance. J.T., a minor, is a motocross competitor. At Monster Mountain MX Park, he signed a waiver of liability to ―hold harmless the park for any loss due to negligence.‖ Riding around the Monster Mountain track, J.T. rode over a blind jump, became airborne, and crashed into a tractor that he had not seen until he was in the air. To recover for his injuries, J.T. filed a suit against Monster Mountain, alleging negligence for its failure to remove the tractor from the track. Does the liability waiver bar this claim? Explain. [J.T. v. Monster Mountain, LLC, 754 F.Supp.2d 1323 (M.D.Ala. 2010)] (See Contractual Capacity.) Solution

152

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

No. Contracts entered into by a minor are voidable at the option of the minor. The minor has the choice of disaffirming the contract and setting aside all legal obligations arising from it. For minors to exercise the option to avoid a contract, they need only manifest an intention not to be bound by it. The minor avoids the contract by disaffirming it. Words or conduct may serve to express the intent. The contract may be disaffirmed at any time during minority or for a reasonable time after the minor comes of age. It is important that disaffirmance be timely. The waiver of liability in this set of facts is a contract between Monster Mountain and a minor— J.T. A contract with a minor is voidable. To disaffirm the contract, the minor only needs to show an intent not to be bound by it. J.T.‘s suit against Monster Mountain, seeking to hold the park liable for negligence, is conduct that serves to express that intent. Thus, the waiver does not bar J.T.‘s claim. In the actual case on which this problem is based, the court held that any contract made with J.T., including Monster Mountain‘s liability waiver, was voidable. 235. Business Case Problem with Sample Answer— Minors. D.V.G. (a minor) was injured in a one-car auto accident in Hoover, Alabama. The vehicle was covered by an insurance policy issued by Nationwide Mutual Insurance Co. Stan Brobston, D.V.G.‘s attorney, accepted Nationwide‘s offer of $50,000 on D.V.G.‘s behalf. Before the settlement could be submitted to an Alabama state court for approval, D.V.G. died from injuries received in a second, unrelated auto accident. Nationwide argued that it was not bound to the settlement because a minor lacks the capacity to contract and cannot enter into a binding settlement without court approval. Should Nationwide be bound to the settlement? Why or why not? [Nationwide Mutual Insurance Co. v. Wood, 121 So.3d 982 (Ala. 2013)] (See Contractual Capacity.) —For a sample answer to Problem 13–4, go to Appendix E. Solution No. Minors does not so lack the capacity to contract that they cannot enter into binding settlements without court approval. The general rule is that a minor can enter into any contract an adult can, unless the contract is prohibited by law for minors (for example, the sale of tobacco or alcoholic beverages). A contract entered into by a minor, however, is voidable at the option of that minor. An adult who enters into a contract with a minor cannot avoid contractual duties on the ground that the minor can. Unless the minor exercises the option to disaffirm the contract, the adult party normally is bound by it. In this problem, it is clear that a contract existed at the time of D.V.G.‘s death. As a minor, she did not lack the capacity to enter into a binding settlement of her potential claims. She would not have been liable on the contract, however, if she had chosen to avoid the deal. But she was the only party to the settlement that had this option. At the time that the settlement was agreed to, the contract was binding on Nationwide, notwithstanding that it was voidable at D.V.G.‘s option. In the actual case on which this problem is based, Nationwide asked a federal district court to declare that there was no settlement. The question was certified to the Alabama Supreme Court, which held that Nationwide was bound to the agreement. 236. Adhesion Contracts. David Desgro hired Paul Pack to inspect a house that Desgro wanted to buy. Pack had Desgro sign a standard-form contract that included a twelve-month limit for claims based on the agreement. Pack reported that the house had no major problems, but

153

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

after Desgro bought it, he discovered issues with the plumbing, insulation, heat pump, and floor support. Thirteen months after the inspection, Desgro filed a suit in a Tennessee state court against Pack. Was Desgro‘s complaint filed too late, or was the contract‘s twelve-month limit unenforceable? Discuss. [Desgro v. Pack, 2013 WL 84899 (Tenn. App. 2013)] (See Legality.) Solution Desgro‘s complaint was filed too late—the contract‘s twelve-month limit was enforceable. Standard-form contracts often contain fine-print provisions that shift a risk ordinarily borne by one party to the other or otherwise impose limitations on claims and disputes. Many businesses use such contracts. Life insurance policies, residential leases, loan agreements, and employment agency contracts are often standard-form contracts. To avoid enforcement of the contract or of a particular clause, a plaintiff normally must show that the contract or particular term is unconscionable. In this problem, Pack had Desgro sign a standard-form contract that included a twelve-month limit for claims based on the agreement. But this standard-form contract was not an unconscionable adhesion contract because Desgro did not have to take it or leave it, nor was he forced to agree to its terms to get the house inspected. He might have bargained with Pack over the terms. Or he might have simply contacted another inspection service to do the work. Thus, Desgro was bound to the terms of the contract with Pack, including the twelve-month limit on claims based on the agreement. In the actual case on which this problem is based, the court issued a judgment in Pack‘s favor, and a state intermediate appellate court affirmed, on the basis of the twelve-month limit. 237. Minors. Bonney McWilliam‘s father deeded a house in Norfolk County, Massachusetts, to Bonney and her daughter, Mechelle. Each owned a one-half interest. Described as ―an emotionally troubled teenager,‖ Mechelle had a history of substance abuse and a fractured relationship with her mother. At age sixteen, in the presence of her mother and her mother‘s attorney, Mechelle signed a deed transferring her interest in the house to Bonney. Later, still at odds with her mother, Mechelle learned that she did not have a right to enter the house to retrieve her belongings. Bonney claimed sole ownership. Mechelle filed a lawsuit in a Massachusetts state court against her mother to declare the deed void. Could the transfer of Mechelle‘s interest be disaffirmed? Explain. [McWilliam v. McWilliam, 46 N.E.3d 598 (Mass.App.Ct. 2016)] (See Contractual Capacity.) Solution Yes. The deed that Mechelle signed, transferring her interest in the house to her mother Bonney could be declared void. Minors—persons under eighteen—are not legally bound to most contracts that they enter. A contract is voidable at the option of the minor. That is, the minor may disaffirm the contract and set aside all legal obligations arising from it. For minors to exercise the option to disaffirm, they must show an intent not to be bound to it. In this problem, Bonney‘s father deeded a house to Bonney and Mechelle in equal parts. Mechelle was ―an emotionally troubled teenager,‖ with a history of substance abuse and a fractured relationship with Bonney. At age sixteen, Mechelle met with her mother and her mother‘s attorney, and signed a deed, transferring her interest in the house to Bonney. Later, still in a state of mutual disaffection with her mother, Mechelle learned that she did not have a right to enter the house to retrieve her belongings. Bonney claimed sole ownership. Mechelle objected. Mechelle‘s age at the time of the deed establishes her minority status. Her subsequent suit

154

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

against her mother to declare the deed void affirmatively indicates disaffirmance. In the actual case on which this problem is based, the court issued a judgment in Mechelle‘s favor. A state intermediate appellate court affirmed, in part on the basis of Mechelle‘s youth. 238. Legality. Sue Ann Apolinar hired a guide through Arkansas Valley Adventures, LLC, for a rafting excursion on the Arkansas River. At the outfitter‘s office, Apolinar signed a release that detailed potential hazards and risks, including ―overturning,‖ ―unpredictable currents,‖ ―obstacles‖ in the water, and ―drowning.‖ The release clearly stated that her signature discharged Arkansas Valley from liability for all claims arising in connection with the trip. On the river, while attempting to maneuver around a rapid, the raft capsized. The current swept Apolinar into a logjam where, despite efforts to save her, she drowned. Her son, Jesus Espinoza, Jr., filed a suit in a federal district court against the rafting company, alleging negligence. What are the arguments for and against enforcing the release that Apolinar signed? Discuss. [Espinoza v. Arkansas Valley Adventures, LLC, 809 F.3d 1150 (10th Cir. 2016)] (See Legality.) Solution An exculpatory clause releases a party from liability for injury or damage. A court may refuse to enforce an exculpatory clause when the parties are seen to possess unequal bargaining power—in a case involving an employment contract, for example. A business that offers non-essential services is not considered to be at a relative advantage in bargaining strength, so anyone contracting for its services is thought to do so voluntarily, making an exculpatory clause potentially enforceable as a part of the deal. This is especially likely if the clause is unambiguous and conspicuous. In this problem, Apolinar hired a guide through Arkansas Valley Adventures for a rafting trip on the Arkansas River. She signed a document that purported to release Arkansas Valley from liability for claims arising in connection with the trip. On a rapid on the river, the raft capsized. Apolinar was swept by the current into a logjam where she drowned. Her son filed a suit in a federal district court against the rafting company, alleging negligence. In support of enforcing the release in this set of circumstances, Arkansas Valley was engaged in non-essential services—recreational rafting on the Arkansas River. This indicated that the company had no relative advantage in bargaining over the exculpatory clause. The release set out some of the risks and hazards, and clearly stated a signature discharged the business from liability for all claims arising in connection with the trip. Against the enforcement of the release, it might be argued that the clause was not sufficiently clear or conspicuous, and that Apolinar had no choice but to agree to it or forego the trip. In the actual case on which this problem is based, the rafting company filed a motion for summary judgment, arguing that the release Apolinar signed shielded it from liability. The court granted the motion. The U.S. Court of Appeals for the Tenth Circuit affirmed. ―Colorado allows private parties to assume some of the risks associated with their recreational pursuits.‖ And the release ―was fairly entered into and clear in its terms.‖ 239. Contracts Contrary to Public Policy. P.M. and C.M. are married (the ―Ms‖) and live in Iowa. Unable to conceive their own child, they signed a contract with T.B., who, in exchange for $13,000 and medical expenses, agreed to be impregnated with embryos fertilized with P.M.‘s

155

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

sperm and the ova (eggs) of an anonymous donor. T.B. agreed to carry the pregnancy to term, and she and her spouse D.B. (the ―Bs‖) promised to deliver the baby at birth to the Ms. During the pregnancy, the relations between the parties deteriorated. When the baby was born, T.B. refused to honor the agreement to give up the child. Meanwhile, genetic testing excluded T.B. and D.B. as the biological parents, and established P.M. as the father. Iowa exempts ―surrogacy‖ from a state criminal statute that prohibits selling babies. There is no other state law on point. Is the contract between the Ms and the Bs enforceable? Discuss. [P.M. v. T.B., 907 N.W.2d 522 (Iowa 2018)] (See Legality.) Solution Yes. The contract between the two couples was enforceable. Some contracts between private parties are not enforceable because of a perceived negative impact on society. These contracts are considered contrary to public policy. One example would a contract to sell a child. In this problem, P.M. and C.M. were unable to conceive their own child. They signed a contract with T.B., who, in exchange for the payment of her medical expenses and an additional $13,000, agreed to carry embryos fertilized with P.M.‘s sperm and the ova of an anonymous donor to term. T.B. and her spouse D.B. promised to deliver the baby at birth to P.M. and C.M. After the baby was born, genetic testing excluded T.B. and D.B. as the biological parents, and established P.M. as the father, but T.B. refused to honor the agreement to give up the child. The facts note that there is no Iowa state statute or other law under which the contract is prohibited or could be considered against public policy. To the contrary, Iowa exempts surrogacy arrangements from potential criminal liability for selling children. This indicates that the state allows such agreements. Besides, the contract in the P.M. case was for gestational services, not for the sale of a child. And arguably, surrogacy contracts are favored by public policy—banning such contracts would deprive infertile couples of perhaps the only way to conceive and gestate their own biological children, and would limit the contractual rights of willing surrogates. In the actual case on which this problem is based, the Ms filed a suit in an Iowa state court against the Bs to enforce their agreement. The court ruled that the contract was enforceable, and awarded the Ms permanent legal and physical custody of the child. The Iowa Supreme Court affirmed. With respect to public policy, the court concluded, ―Gestational surrogacy agreements promote families by enabling infertile couples to raise their own children and help bring new life into this world through willing surrogate mothers.‖ 240. A Question of Ethics—The IDDR Approach and Minors. Sky High Sports Nashville Operations, LLC operated a trampoline park in Nashville, Tennessee. At the park, during a dodgeball tournament, Jacob Blackwell, a minor, suffered a torn tendon and a broken tibia. His mother Crystal filed a suit on his behalf in a Tennessee state court against Sky High, alleging negligence and seeking $500,000 to cover medical and other expenses. Sky High asserted that the claim was barred by a waiver of liability in a contract between the parties, which the defendant asked the court to enforce. The waiver released Sky High from liability for any ―negligent acts or omissions.‖ [ Blackwell v. Sky High Sports Nashville Operations, LLC, 523 S.W.3d 624 (Tenn.App. 2017)] ( See Contractual Capacity.) 1. Should Sky High offer a defense to the suit? What might Sky High argue as a reason for enforcing the waiver? Use the IDDR approach to answer these questions. Solution Sky High might argue that refusing to enforce the waiver in this and similar cases involving

156

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 13: Capacity and Legality

minors could lead to the loss of recreational activities and even school-sponsored programs for children. In other words, Sky High might depict itself as a victim if the waiver were struck down. In this problem, Sky High Sports operated a trampoline park. During a dodgeball tournament at the park, Jacob Blackwell, a minor, was injured. His mother, Crystal, filed a suit on his behalf against Sky High, alleging negligence and seeking to recover medical and other expenses. Sky High asserted that the claim was barred by a contractual waiver that released Sky High from liability for any ―negligent acts or omissions.‖ Under the IDDR approach, Sky High‘s ethical dilemma is how to preserve itself in the interests of its owners, customers, and others who benefit from its existence, including the operators of other recreational businesses. Not to offer a defense in the face of Blackwell‘s suit would be to default in this case and could lead to similar losses in other cases, which could end in the termination of Sky High. Of course, the firm might also opt to settle with the plaintiff, but that could likewise be interpreted as a precedent. The waiver would become for most purposes unenforceable. For all of these reasons, Sky High would most likely choose to defend against the suit. If the defendant argued the position stated at the beginning of this answer, however, it would be likely to fail—there is no evidence that recreational activities have in any way been curtailed by refusals to enforce liability waivers when minors were involved. This result would satisfy the stakeholders only if it effectively portrayed an obstacle to other potential plaintiffs—and that is not likely. In the actual case on which this problem is based, the court denied Sky High‘s request to enforce the release. A state intermediate appellate court found no error and affirmed. 2.

Would it be unethical to allow Jacob to recover? Apply the IDDR approach to explain. Solution Public policy permits minors to disaffirm, and thereby void, their contracts. It is also a wellsettled principle that a court should act to protect a minor‘s best interests. This includes financial interests. In a case involving a minor‘s medical expenses and damages encompassing other losses, the minor‘s financial interests are at the center of the dispute. It would not be unethical to decline to enforce the waiver against Jacob and allow him to recover his medical and other expenses. To the contrary, it would arguably be unethical to enforce it. Standards of ethics almost universally dictate the protection of the rights of those who are unable effectively to protect those rights themselves. This includes minors. Thus, the court—for whom such principles might be applied to resolve an ethical question about whether to enforce Sky High‘s waiver—would be likely to conclude that it should not enforce it. The stakeholders, including similarly situated plaintiffs and defendants, as well as other third parties affected by the court‘s decision and the public generally, would benefit from a striking of the waiver in many ways. These could include safer recreational activities, and public confidence in that safety, with a consequent increase in their use.

157

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Critical Thinking and Writing Assignments 241. Time-Limited Group Assignment. Assume that you are a group of executives at a large software corporation. The company is considering whether to add covenants not to compete to its employment contracts. You know that there are some issues with the enforceability of these covenants and want to make an informed decision. (See Legality.) 1. One group should make a list of interests that are served by enforcing covenants not to compete. Solution A covenant not to compete can be part of an employment contract. Such an agreement is legal so long as the specified period of time is not excessive in duration and the geographical restriction is reasonable—no greater than necessary to protect a legitimate business interest. Such interests include the protection of trade secrets (customer lists, marketing plans, and the like) and other intellectual property. 2.

A second group should create a list of interests that are served by refusing to enforce covenants not to compete. Solution A covenant not to compete that does not protect a legitimate business interest or is greater than necessary to protect that interest will not be enforced, because it unreasonably restrains trade and is contrary to public policy. Third group should discuss whether a court that determines that a covenant not to compete is illegal should reform (and then enforce) the covenant. The group should present arguments for and against reformation. Solution A covenant not to compete clause would be unreasonable if there are no limits to its duration and no restrictions on its geographical reach. These flaws would also make the clause unconscionable. Although a court may resort to contract reformation only when necessary to prevent undue burdens or hardships—because reformation implicitly makes the court a party to the contract—it would be reasonable for a court to either strike or reform such a clause.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

158

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Practice and Review .............................................................................................................................. 161 Practice and Review: Debate This ......................................................................................................... 163 Issue Spotters ........................................................................................................................................ 163 Business Scenarios and Case Problems ................................................................................................. 164 Critical Thinking and Writing Assignments ............................................................................................ 169

Critical Thinking Questions in Features Adapting the Law to the Online Environment 242. Josh pays AcademicShark.com $50 for an essay on the biblical references in Moby Dick. The website promises ―a top-notch grade‖ and includes a disclaimer as described above. Josh hands in the Moby Dick paper without making any changes and receives a C +. Does he have any recourse under contract law should he want a refund? Explain your answer. Solution Josh has little legal recourse against AcademicShark.com under contract law. Regardless of the language on the website offering ―a top-notch grade‖ or any other promises about the quality of the essay, the company will rely on the disclaimer to protect itself against being complicit in Josh‘s plagiarism. Josh cannot argue that the contract is void for illegality, because plagiarism is not illegal. Furthermore, he is not an innocent party, given that he certainly was aware of the true purpose of the transaction. Seventeen states have prohibited contract cheating. If Josh lives in one of those states, he might consider trying to void the contract for illegality. There has been little to no enforcement of such state laws, however, and Josh would still be complicit in the matter. Being truly committed to stop the practice, Josh could lobby for a federal law criminalizing the practice. Such a law is unlikely, however, as it might improperly penalize legitimate tutoring efforts.

Critical Thinking Questions in Cases Case 14.1 243. In most cases involving the interpretation and application of a contract, a party is not allowed to present evidence outside the document expressing the parties‘ agreement. Why not? Solution Generally, a court will determine the intent of contracting parties from the language used in their agreement and interpret that language to give effect to the intent as expressed. The court is bound to give effect to the contract according to this intent. A court will not normally interpret the language according to what a party claims was his or intent when the contract was made. A contracting party‘s memory may be faulty, especially if considerable time has passed since a contract was made. At the time, the parties may have had different, subjective, unstated notions of the terms. One of the parties might have changed their minds, or suffered a consequence that would make performance of the deal less appealing. None of these circumstances would seem to justify remaking what are otherwise clearly expressed terms.

159

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Thus, in interpreting and applying a contract, the prime reason for not allowing a party to present evidence outside its expression is fairness. If a court were to always give effect to what one or the other contracting party claimed later had been their intent at the time of the contract, there would be less stability and predictability to the making of a deal. Fraud might also thereby be encouraged.

Case 14.2 244.

Did Shivley‘s misrepresentations rise to the level of fraud? Explain.

Solution Yes. Shivley‘s misrepresentations to Cronkelton that he had taken the appropriate steps to winterize the property rose to the level of fraud. The elements of fraud are (1) the misrepresentation of a material fact, (2) an intent to deceive, (3) an innocent party‘s justifiable reliance on the misrepresentation, and (4) to collect damages, the innocent party must have been harmed as a result of the misrepresentation. In the Cronkelton case, Shivley‘s statements were (1) misrepresentations of material fact, (2) made (or concealed) with the intent to mislead, (4) justifiably relied on by Cronkelton, and (5) the cause of damage to Cronkelton. Shivley told Cronkelton that the property would be winterized. When this was not done sufficiently, Shivley did not inform Cronkelton. Cronkelton relied on Shivley‘s statements and did not further inspect the property until after the sale when he discovered the damage that freezing had done to the building and equipment.

160

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Case 14.3 245. The gold standard for due process in our judicial system is a jury trial. By undoing the jury‘s award of punitive damages in this case, did the court act contrary to due process? Explain. Solution No. Due process takes many forms. It provides procedural protections like notice and an opportunity to be heard. But it also protects defendants from bad results that might arise out of good procedures. After a jury hears evidence, listens to the parties‘ arguments, and receives the judge‘s instructions, the jury confers and renders a verdict. As in this case, the verdict can include how much a defendant like Silverstar should pay for its reprehensible conduct. If the judge finds the jury‘s punitive award to be grossly excessive, it can be reduced, as it was here, in the name of due process. The result may sometimes seem arbitrary. When it aligns with precedent, however—again, as in this case—it provides the defendant with notice of the potential penalty for certain conduct, and thereby coincides with the standard of due process. 246. Silverstar argued that the ratio between Adeli‘s actual harm and the amount of punitive damages should have been a single-digit ratio to comport with due process. How would the application of this principle affect the incidence of fraud in business deals? Discuss. Solution If SIlverstar‘s argument were a universal principle to be applied to awards of punitive damages, the incidence of fraud in business deals would likely increase. Punitive damages, Silverstar asserted, must strike a single-digit ratio. The court found precedent providing notice to the defendant, in a case involving the fraudulent sale of a used car, that such an award might in fact exceed that limit. This supported the court‘s dismissal of Silverstar‘s argument. To rigidly apply a single-digit ratio principle, as if it were a mathematical formula for due process, would turn fraudulent conduct into a calculable business decision, making the practice of fraud more likely.

Chapter Review Practice and Review Chelene had been a caregiver for Marta‘s elderly mother, Janis, for nine years. Shortly before Janis passed away, Chelene convinced her to buy Chelene‘s house for Marta. Janis died before the papers were signed, however. Four months later, Marta used her inheritance to buy Chelene‘s house without having it inspected. The house was built in the 1950s, and Chelene said it was in ―perfect condition.‖ Nevertheless, one year after the purchase, the basement started leaking. Marta had the paneling removed from the basement walls and discovered that the walls were bowed inward and cracked. Marta then had a civil engineer inspect the basement walls, and he found that the cracks had been caulked and painted over before the paneling was installed. He concluded that the ―wall failure‖ had existed ―for at least thirty years‖ and that the basement walls were ―structurally unsound.‖ Using the information presented in the chapter, answer the following questions.

161

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

247. Can Marta avoid the contract on the ground that both parties made a mistake about the condition of the house? Explain. Solution Yes, if both parties were ignorant of the fact of the structure, there may be grounds for rescinding the contract. If there is a bilateral (mutual) mistake of material fact, such as structural soundness, then the parties did not know what they were really bargaining for and the contract could be rescinded. 248. Can Marta sue Chelene for fraudulent misrepresentation? Why or why not? What element (or elements) might be lacking? Solution Anybody can file suit for anything; carrying the day in court is another matter. In the sale of an old house, the buyer has an obligation to have it inspected by a professional. A seller may very well not know of structural problems. Chelene is a caregiver, not a structural engineer. Unless Marta can show that Chelene put up the paneling to hide the wall problem, she is unlikely to have much of a case. 249. Now assume that Chelene knew that the basement walls were cracked and bowed and that she hired someone to install paneling before offering to sell the house. Did she have a duty to disclose this defect to Marta? Could a court find that Chelene‘s silence in this situation constituted misrepresentation? Explain. Solution Chelene appears to have lied because she said the house was in perfect condition and she covered up a known problem. Chelene knew of the problem, lied about it, and covered it up. That appears to be misrepresentation by deception. Chelene was not silent because she said the house was in ―perfect condition‖ when she knew the basement was a mess. 250. Can Marta obtain rescission of the contract based on undue influence? If the sale to Janis had been completed before her death, could Janis have obtained rescission based on undue influence? Explain. Solution Yes. Chelene was in a position of ―trust‖ for years, which allowed her to take advantage of Marta for personal gain. Marta made the deal on her own behalf. A buyer has some obligation to inspect property; Chelene‘s statements may reflect how she felt about the house, but any house more than 50 years old will have problems, so Marta was negligent. Had the sale been to Janis, it would be worthy of more inspection, as she was frail, did not need the house, and was in Chelene‘s care. Undue influence could arise there.

162

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Practice and Review: Debate This 251. The concept of caveat emptor (―let the buyer beware‖) should be applied to all sales, including those of real property. Solution Buyers of personal and real property should take responsibility for obtaining enough information about what they are buying so that they are not ―surprised‖ after the purchase. In the case of real property, buyers should pay for thorough inspections, rather than relying on the honesty of the real property seller. For consumer goods, there is sufficient competition in the marketplace to guarantee that only in exception situations will producers sell defective goods to their customers. Reputation and repeat business are valuable. Actions by supplier that lessen either of these factors will suffer. Not everyone can be a quality expert. Caveat emptor has no place in the modern consumer society. Products are just too complicated for the average consumer to know whether they are defective and perhaps dangerous. As for real property, if a seller willfully hides a costly-to-repair defect from the buyer, the latter should be able to sue for redress. Information is expensive to obtain, for both personal and real property. Buyers should be able to rely on statements made by sellers.

Issue Spotters 252. In selling a house, Matt tells Ann that the wiring, fixtures, and appliances are of a certain quality. Matt knows nothing about the quality, but it is not as specified. Ann buys the house. On learning the true quality, Ann confronts Matt. He says he wasn‘t trying to fool her; he was only trying to make a sale. Can she rescind the deal? Why or why not? Solution Yes. Rescission may be granted on the basis of fraudulent misrepresentation. The elements of fraudulent misrepresentation include intent to deceive, or scienter. Scienter exists if a party makes a statement recklessly, without regard to whether it is true or false, or if a party says or implies that a statement is made on some basis such as personal knowledge or personal investigation when it is not. 253. Brad, an accountant, files Dina‘s tax returns. When the Internal Revenue Service assesses a large tax against Dina, she retains Brad to contest the assessment. The day before the deadline for replying to the IRS, Brad tells Dina that unless she pays a higher fee, he will withdraw. If Dina agrees to pay, is the contract enforceable? Explain your answer. Solution No. Brad exerted economic duress on Dina. The threat to break a contract on the eve of the deadline in this problem was sufficiently coercive to constitute duress. Duress involves coercive conduct—forcing a party to enter into a contract by threatening the party with a wrongful act.

163

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Business Scenarios and Case Problems 254. Voluntary Consent. Jerome is an elderly man who lives with his nephew, Philip. Jerome is totally dependent on Philip‘s support. Philip tells Jerome that unless Jerome transfers a tract of land he owns to Philip for a price 30 percent below market value, Philip will no longer support and take care of him. Jerome enters into the contract. Discuss fully whether Jerome can set aside this contract. (See Undue Influence and Duress.) Solution Undue influence arises from a relationship in which one party can, through unfair persuasion, greatly influence or overcome the free will of another. Any contract entered into under excessive or undue influence lacks genuine assent and is therefore voidable. Here, the influence of Philip over his Uncle Jerome is greatly enhanced by Jerome‘s reliance on Philip for his support. Although Jerome cannot claim duress, the domination of Philip over Jerome‘s decisions results in undue influence. The contract is primarily for the benefit of Philip, and Philip used unfair persuasion in securing the contract from Jerome. Jerome can have the contract set aside. 255. Fraudulent Misrepresentation. Grano owns a fortyroom motel on Highway 100. Tanner is interested in purchasing the motel. During the course of negotiations, Grano tells Tanner that the motel netted $30,000 last year and that it will net at least $45,000 next year. The motel books, which Grano turns over to Tanner before the purchase, clearly show that Grano‘s motel netted only $15,000 last year. Also, Grano fails to tell Tanner that a bypass to Highway 100 is being planned that will redirect most traffic away from the front of the motel. Tanner purchases the motel. During the first year under Tanner‘s operation, the motel nets $18,000. At this time, Tanner learns of the previous low profitability of the motel and the planned bypass. Tanner wants his money back from Grano. Discuss fully Tanner‘s probable success in getting his money back. (See Fraudulent Misrepresentation.) Solution Four basic elements are necessary to prove fraud, thus rendering a contract voidable: (1) an intent to deceive, usually with knowledge of the falsity; (2) a misrepresentation of material facts; (3) a reliance by the innocent party on the misrepresentation; and (4) usually damage or injury caused by the misrepresentation. Statements of events to take place in the future or statements of opinions are generally not treated as representations of fact. Therefore, even though the prediction or opinion may turn out to be incorrect, a contract based on this type of statement would remain enforceable. Grano‘s statement that the motel would make at least $45,000 next year would probably be treated as a prediction or opinion; thus, one of the elements necessary to prove fraud—misrepresentation of facts—would be missing. The statement that the motel netted $30,000 last year is a deliberate falsehood (with intent and knowledge). Grano‘s defense will be that the books in Tanner‘s possession clearly indicated that the figure stated was untrue, and therefore Tanner cannot be said to have purchased the motel in reliance on the falsehood. If the innocent party, Tanner, knew the true facts, or should have known the true facts because they were available to him, Grano‘s argument will prevail. Lastly, the issue centers on Grano‘s duty to tell Tanner of the bypass. Ordinarily, neither party in a nonfiduciary relationship has a duty to disclose facts, even when the information might bear materially on the other‘s decision to enter into the contract. Exceptions are made, however, when the buyer cannot reasonably be expected to discover the information known by the seller, in which case fairness imposes a duty to speak on the seller. Here, the court can go either way. If the court decides there was no duty to disclose, deems the prediction of future profits to be opinion

164

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

rather than a statement of fact, and also decides there was no justifiable reliance by Tanner because the books available to Tanner clearly indicated Grano‘s profit statement for the last year to be false, then Tanner cannot get his money back on the basis of fraud. 256. Fraudulent Misrepresentation. Ricky Wilcox contracted with Fireside Log Homes to build a house. The logs were to be delivered precut and predrilled, but they arrived unfinished. Fireside told Wilcox that cutting and drilling the logs would take only two or three days. In fact, this process slowed the project by five months. To cover costs caused by the delay, Wilcox borrowed an additional $200,000. When the house was finally built, he filed a suit against Fireside. Did Fireside commit fraud? Explain. [Esprit Log and Timber Frame Homes, Inc. v. Wilcox, 302 Ga.App. 550, 691 S.E.2d 344 (2010)] (See Fraudulent Misrepresentation.) Solution Yes. The first element of proving fraud is to show that misrepresentation of a material fact has occurred. A promise made without a present intent to perform is a misrepresentation of a material fact and is sufficient to support a cause of action for fraud. The other elements are (1) an intent to deceive, (2) an innocent party‘s justifiable reliance on the misrepresentation, and (3) the innocent party‘s injury. Here, Fireside promised to deliver precut, predrilled logs. The company knew that the delivery of unfinished logs would cause a long delay. After the logs arrived, Fireside intentionally misrepresented to Wilcox that there would be only a two- or three-day delay while the logs where cut and drilled on site. Wilcox relied on this misrepresentation. When the delay proved much longer, he incurred considerable additional costs. Fireside‘s actions amounted to fraud. In the actual case on which this problem is based, a jury agreed with Wilcox and awarded $200,000 in damages, plus $250,000 in punitive damages and $20,000 in attorneys‘ fees. 257. Fraudulent Misrepresentation. Marguerite Eaton and Bobby Joe Waldrop moved into a mobile home on land owned by her son, James. Bobby Joe asked James to transfer that portion of the land to him and Marguerite, stating falsely that they had married. James agreed. Marguerite soon transferred her interest in the land to Bobby Joe. When James learned of this transfer and that his mother and Bobby Joe were not married, he filed a suit against Bobby Joe, alleging fraud. Bobby Joe asserted that James had not proved intent to deceive. Do these facts indicate intent to deceive? Explain. [Eaton v. Waldrop, 45 So.3d 371 (Ala. Civ.App. 2010)] (See Fraudulent Misrepresentation.) Solution Yes. The second element of fraud is knowledge on the part of the misrepresenting party that facts have been falsely represented. Normally called scienter, this usually signifies that there was an intent to deceive. Scienter clearly exists if a party knows that a fact is not as stated. The other elements are (1) a misrepresentation of a material fact, (2) an innocent party‘s justifiable reliance on the misrepresentation, and (3) the innocent party‘s injury. Here, Bobby Joe knew that he and Marguerite were not married. He falsely represented otherwise to James, while asking James to transfer that portion of James‘s land on which he and Marguerite lived to them. On the face of it, this would appear to show Bobby Joe‘s intent to deceive. James relied on this misrepresentation when he made the transfer to Bobby Joe and Marguerite. The injury was the loss of that portion of the land.

165

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

In the actual case on which this problem is based, the court ruled that James‘s ―evidence presented a prima facie case of misrepresentation without further proof of Waldrop‘s intent to deceive.‖ 258. Misrepresentation. Charter One Bank owned a fifteenstory commercial building. A fire inspector told Charter that the building‘s drinking-water and fire-suppression systems were linked, which violated building codes. Without disclosing this information, Charter sold the building to Northpoint Properties, Inc. Northpoint spent $280,000 to repair the water and firesuppression systems and filed a suit against Charter One. Is the seller liable for not disclosing the building‘s defects? Discuss. [Northpoint Properties, Inc. v. Charter One Bank, 2011-Ohio- 2512 (Ohio App. 8 Dist. 2011) (See Fraudulent Misrepresentation.) Solution Yes. Ordinarily, neither party to a contract has a duty to disclose facts about the object of their deal. If a seller knows of a serious problem that a buyer cannot reasonably be expected to discover, however, the seller has a duty to speak if the defect is latent and could not readily be ascertained. In this problem, Charter One was aware of the linked drinking-water and fire suppression lines. Despite Charter One‘s knowledge of this fact, it did not provide Northpoint as a potential buyer with this information. This constituted a material misrepresentation as to the actual condition of these systems. If the misrepresentation was made with the intent to induce reliance and Northpoint‘s reliance on this misrepresentation was justified—as appears to be the situation— then the seller is liable to the buyer. The appropriate measure of damages is the reasonable cost to repair. In the actual case on which this problem is based, the court found that all of the elements of fraud were present and that the ―cost of repair‖ was an appropriate measure of damages. 259. Business Case Problem with Sample Answer— Fraudulent Misrepresentation. Joy Pervis and Brenda Pauley worked together as talent agents in Georgia. When Pervis ―discovered‖ actress Dakota Fanning, Pervis sent Fanning‘s audition tape to Cindy Osbrink, a talent agent in California. Osbrink agreed to represent Fanning in California and to pay 3 percent of Osbrink‘s commissions to Pervis and Pauley, who agreed to split the payments equally. Six years later, Pervis told Pauley that their agreement with Osbrink had expired and there would be no more payments. Nevertheless, Pervis continued to receive payments from Osbrink. Each time Pauley asked about commissions, however, Pervis replied that she was not receiving any. Do these facts evidence fraud? Explain. [In re Pervis, 512 Bankr. 348 (N.D.Ga. 2014)] (See Fraudulent Misrepresentation.) —For a sample answer to Problem 14–6, go to Appendix E.

166

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Solution Yes. The facts in this problem evidence fraud. There are three elements to fraud: (1) the misrepresentation of a material fact, (2) an intent to deceive, and (3) an innocent party‘s justifiable reliance on the misrepresentation. To collect damages, the innocent party must suffer an injury. Here, Pervis represented to Pauley that no further commission would be paid by Osbrink. This representation was false—despite Pervis‘s statement to the contrary, Osbrink continued to send payments to Pervis. Pervis knew the representation was false, as shown by the fact that she made it more than once during the time that she was continuing to receive payments from Osbrink. Each time Pauley asked about commissions, Pervis replied that she was not receiving any. Pauley‘s reliance on her business associate‘s statements was justified and reasonable. And for the purpose of recovering damages, Pauley suffered an injury in the amount of her share of the commissions that Pervis received as a result of the fraud. In the actual case on which this problem is based, Pauley filed a suit in a Georgia state court against Pervis, who filed for bankruptcy in a federal bankruptcy court to stay the state action. The federal court held Pervis liable on the ground of fraud for the amount of the commissions that were not paid to Pauley, and denied Pervis a discharge of the debt. 260. A Question of Ethics—The IDDR Approach and Fraudulent Misrepresentation. Data Consulting Group contracted with Weston Medsurg Center, PLLC, a health-care facility in Charlotte, North Carolina, to install, maintain, and manage Weston‘s computers and software. At about the same time, Ginger Blackwood began to work for Weston as a medical billing and coding specialist. Soon, she was submitting false time reports and converting Weston documents and data to her own purposes. On her request, Data Consulting manager Nasko Dinev removed evidence of her actions from her work computer. [Weston Medsurg Center, PLLC v. Blackwood, 795 S.E.2d 829 (2017)] (See Fraudulent Misrepresentation.) 1.

What should Weston do when it learns of these activities? With respect to this situation, identify and consider the firm‘s primary ethical dilemma using the IDDR approach. Solution When Weston discovers the conduct identified in the facts, it might choose to fire Blackwood, stop paying Data Consulting, and file a suit against Blackwood, Data Consulting, and Dinev. Weston‘s primary ethical dilemma with respect to this situation is in deciding which legal steps to take. When an innocent party consents to a contract with fraudulent terms, the contract can be avoided because the innocent party did not voluntarily consent to the terms. Among the elements required to prove fraud, one party must intend to deceive the other by means of a misrepresentation of a material fact. The innocent party must justifiably rely on the misrepresentation and, to recover damages, suffer harm. In this problem, Weston contracted with Data Consulting to install, maintain, and manage Weston‘s computers and software. At the same time, Blackwood, a Weston medical billing and coding specialist, submitted false time reports and converted her employer‘s data for her own purposes. Dinev, a Data Consulting manager, helped her remove evidence of her transgressions from her work computer.

167

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Weston‘s discovery of these activities could prompt the company to terminate Blackwood, stop paying Data Consulting, and bring an action against Blackwood, Data Consulting, and Dinev for breach of contract and fraud. The first step of the IDDR approach requires a statement of the ethical issue and an identification of the stakeholders and the relevant ethical standards. From an ethical perspective, Weston‘s chief dilemma is to decide which of the actions to take. Stakeholders include Weston‘s owners and employees, including Blackwood, and its suppliers and others with whom it contracts, such as Data Consulting. But perhaps the most important stakeholders are Weston‘s patients, whose privacy and confidentiality might be at risk depending on what data has been converted or lost. Ethical standards to which Weston might adhere include its statements of policy to its owners, employees, and patients. The second step of the IDDR approach is a Discussion of actions that might resolve the issue. If Weston were to proceed with all of the possible actions stated above, from a legal perspective, the company is likely to prevail against any challenge to a decision to discharge Blackwood. She clearly breached her employment contract. Weston might not prevail against a claim by Data Consulting to recover any amount owed on its contract, however, absent proof that Data Consulting colluded with Blackwood and Dinev to commit fraud. Weston could succeed in a fraud claim against Blackwood and Dinev if the firm could prove an injury. Stakeholders include Weston‘s owners and employees, including Blackwood, and its suppliers and others with whom it contracts, such as Data Consulting. But perhaps the most important stakeholders are Weston‘s patients, whose privacy and confidentiality might be at risk depending on what data has been converted or lost. The disadvantages of the actions arise from their expense, such as the cost of litigation and any payment that might yet have to be made to Data Consulting. If Weston were not to take any of these actions, however, its loss of credibility among its owners, employees, and patients, with a consequent loss of investment, productive work, and business revenue, could more than exceed this expense. The third step of the IDDR approach is to state a Decision and its reasons. Here, Weston would seem to have only one clear decision—to discharge Blackwood and initiate legal action against her and the others. The reasons are set out in the paragraphs above. Withholding payment from Data Consulting might also be advisable under the circumstances—it could heighten the contractor‘s awareness of its manager‘s part in Blackwood‘s fraud and motivate that company to consider its own ethical practices. But Weston should be prepared to eventually pay what may be owed under its contract with Data Consulting—there is no indication that the contractor is liable for fraud or a contract breach. The last step of the approach is a Review of the success or failure of the proposed actions to resolve the issue, and satisfy the stakeholders. If Weston were to take the suggested legal actions, it could embolden its owners, employees, and patients to continue their investments, work efforts, and trust in the medical center. This would clearly be a success. 2.

Suppose that despite Dinev‘s efforts, Weston is later able to recover the data that was removed from Blackwood‘s work computer. How might this affect Weston‘s choices? Discuss. Solution If Weston were able to recover all of the deleted data—through the efforts of other Data Consulting employees, for example—it might thereby be able to recoup overpayments to

168

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 14: Voluntary Consent

Blackwood based on her false time reports. If she were to make restitution, this might mitigate what Weston could otherwise recover in a suit. Similarly, Data Consulting‘s undoing what its manager did might limit what Weston might otherwise recover against the contractor. In the actual case on which this problem is based, Weston learned of Blackwood and Dinev‘s activities and stopped paying Data Consulting. Data Consulting filed a claim in a North Carolina state court against Weston, and was awarded $5,441.60 for services rendered and unpaid. Weston filed claims of fraud against Blackwood and Dinev. At the same time, the firm was able to recover the data that had been removed from its computer. A jury ruled in the defendants‘ favor but denied them attorneys‘ fees. A state intermediate appellate court affirmed these results.

Critical Thinking and Writing Assignments 261. Time-Limited Group Assignment—Fraudulent Misrepresentation. Radiah Givens was involved romantically with Joseph Rosenzweig. She moved into an apartment on which he made the down payment. She signed the mortgage, but he made the payments and paid household expenses. They later married. She had their marriage annulled, however, when she learned that he was married to someone else. Rosenzweig then filed a suit against her to collect on the mortgage. (See The Fraudulent Misrepresentation.) 1.

The first group should decide whether Rosenzweig committed fraud. Solution Yes. Rosenzweig could have committed fraud against Givens. Fraud requires (1) a misrepresentation of a material fact, (2) an intent to deceive, (3) an innocent party‘s justifiable reliance on the misrepresentation, and (4) the innocent party‘s injury. Rosenzweig misrepresented to Givens, with whom he was romantically involved, that he was not married. Of course, he knew that the truth was otherwise. This meets the first two requirements for a finding of fraud. Agreements between spouses involve a fiduciary relationship that requires the utmost good faith. A similar fiduciary relationship may have existed between Givens and Rosenzweig. Givens justifiably relied on this relationship when she believed Rosenzweig‘s misrepresentation, signed the mortgage, and married him. As for injury, besides the mental and emotional anguish that these circumstances undoubtedly inflicted on Givens, she may have suffered other losses—giving up educational or employment opportunities, for example.

The second group should evaluate whether Rosenzweig‘s conduct was deceitful, and if so, whether his deceitfulness should affect the decision in this case. Solution Yes. Rosenzweig‘s conduct was deceitful. Rosenzweig certainly appears to have suffered from some deficiencies of character and he likely would be subject to sanctions by the state attorneys‘ professional responsibility organization. But a desire to see a scoundrel punished should not motivate the application of the legal principles in this, or any other, case. Here, Rosenzweig‘s deceit did not concern the mortgage contract, and thus it should not affect the outcome. But Rosenzweig is not the mortgagor and does not appear to be the mortgagee, so unless there is a different contract between Givens and Rosenzweig, there is no basis for a decision in his favor.

169

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

The third group should consider how fraud is related to ethics. Can a contracting party act ethically and still commit fraud? How? Solution It might be possible to act ethically and still commit fraud. For example, if fraud were committed in the service of an ethical duty or directed towards an ethical end—such as perpetrating fraud to subvert a greater evil by deceiving a party into foregoing a wrong—it could be interpreted as an ethical act.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 170 Case 15.1 ............................................................................................................................................... 170 Case 15.2 ............................................................................................................................................... 171 Case 15.3 ............................................................................................................................................... 172 Chapter Review ........................................................................................................................................................... 173 Practice and Review .............................................................................................................................. 173 Practice and Review: Debate This ......................................................................................................... 174 Issue Spotters ........................................................................................................................................ 174 Business Scenarios and Case Problems ................................................................................................. 175 Critical Thinking and Writing Assignments ............................................................................................ 180

Critical Thinking Questions in Cases Case 15.1 262. Why does the Statute of Frauds require that a contract for a sale of land contain a sufficient description of the property? Solution A contract for a sale of land is not enforceable unless it is in writing. Land is real property and includes all physical objects that are permanently attached to it, such as buildings. Generally, a contract for a sale of land is enforceable under the Statute of Frauds if the contract describes the property being transferred with sufficient definiteness for it to be identified. The purpose of the writing requirement is to prevent fraud in real estate deals. A party cannot normally obtain possession of real property by asserting that there was an oral agreement to affect its transfer. Because each parcel of land is unique, a sufficient description will uniquely identify it. For example, in the Sloop case, the court held that the contract‘s designation of the property by street

170

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

address met this requirement. The court also read the deed and the contract together as one instrument ―in the eyes of the law,‖ and the deed contained a more formal, legal description of the property by metes and bounds. 263. Suppose that the court in the Sloop case had not construed the deed and the contract as one instrument but as separate documents. How might that have affected the result? Explain. Solution In the Sloop case, the court construed the deed and the contract executed by Sloop and the Kikers as one instrument. The effect of this construction was an outcome in favor of the sellers. The court enforced the contract and its provision for the buyer‘s forfeit of the down payment. If the court had interpreted the deed and the contract differently, however, the result might have been a return to Sloop (the buyer) of her down payment. Of course, the Kikers (the sellers) would have retained their house and land. But Sloop would have been allowed to renege on the sale, as well as to have resided on the premises for an extended period of time without paying for the privilege. This result would seem to be unjust. Ultimately, the result in this case might have been the same even if the court had not construed the deed and the contract together, however. One of the contentions of Sloop (the buyer) on appeal was that the contract did not contain a sufficient description of the property, as required by the Statute of Frauds. But the court held that ―if a contract furnishes a means by which realty can be identified—a key to the property‘s location—the Statute of Frauds is satisfied.‖ In the Sloop case, the court ruled that the designation in the contract of the premises by its street address met this requirement.

Case 15.2 264. Could Moore have presented leases purportedly entered into as a result of his performance under the compensation agreement to provide a property description sufficient to satisfy the Statute of Frauds? Why or why not? Solution No. Moore could not have used subsequently executed leases to bring the compensation agreement into compliance with the Statute of Frauds. He could have shown the court leases that were allegedly entered into as a result of his performance under the agreement. But the documents could not have been used to supplement the terms of the contract and thereby provide a property description sufficient to meet the requirement of the Statute of Frauds. Parol evidence cannot be used to supply the essential elements of a contract. In the case of a property description, extrinsic evidence might be used for the purpose of identifying the property with reasonable certainty from the information contained in the contract, but not for the purpose of supplying the description of the property. Furthermore, documents that were not in existence at the time of the signing of a contract will not satisfy the Statute of Frauds.

171

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

265. What If the Facts Were Different? Suppose that Moore had filed his suit against Lane instead of Bearkat and that the court had held the compensation agreement to be enforceable. Would Lane have been liable on the agreement? Explain. Solution No. If Moore had filed his suit against Lane instead of Bearkat, Lane would not have been liable on the compensation agreement to pay Moore, even if the court had held the agreement to be enforceable. Under the Statute of Frauds, Lane was not a party to the agreement. In the facts of the question, he would have been the party against whom enforcement was sought, but he had not signed the agreement. Nor would Lane have been liable under other possible theories; for instance, Bearkat and Lane were not partners, Bearkat hired Moore without Lane‘s knowledge, and Lane did not ratify the agreement.

Case 15.3 266. Why is evidence of a prior negotiation or agreement that contradicts or varies the terms of a written agreement inadmissible in a court under the parol evidence rule? Solution Evidence of a prior negotiation or agreement that contradicts or varies the terms of a written agreement is inadmissible in a court under the parol evidence rule in order to provide finality to a claim. It can be argued, though, that because of the constantly changing nature of relationships between contracting parties, it is difficult to pinpoint precisely when there is a complete expression of an agreement. Under that view, parol evidence of negotiations that take place at any time between the parties to a deal should be admissible to modify, explain, or supplement the written terms. As indicated by the list of exceptions, most state courts do not apply the parol evidence rule strictly and generally permit the introduction of parol evidence at trial. 267. Suppose that the written terms of the deal between Habel and Capelli had referred to other documents, such as unpaid invoices for Capelli‘s purchases, to be included as part of their alleged agreement. Would the result have been different? Discuss. Solution Yes, it is possible that the result in the Habel case would have been different if the written terms of the deal between the parties had referred to other documents to be included as part of their alleged agreement. This possibility is especially likely if the documents included such items as unpaid invoices for Cappelli‘s purchases, which could support Habel‘s claim of forbearance. When a document makes clear that all mutual promises are recited within its terms, parol evidence cannot be used to vary or add to those terms. In this case, of course, the document declared that any mutual promises of ―consideration‖ were stated within it. Lacking from those statements was an expression of, or reference to, some detriment or obligation by Habel. Habel argued that forbearance was consideration, and offered to prove his forbearance with evidence extrinsic to the written terms. But the court concluded that it could not consider such evidence under the parol evidence rule. Thus, the alleged contract failed for a lack of

172

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

consideration. A reference to outside documents and an allusion to their inclusion in the written terms could have supported a different conclusion by the court to review those documents. This review might have contributed to an interpretation that consideration did in fact exist in the circumstance of forbearance on Habel‘s part. And the court might have held the contract to be enforceable.

Chapter Review Practice and Review Evelyn Vollmer orally agreed to loan Danny Lang $150,000 to make an investment in a local nightclub. The loan was to be repaid from the profits received from the investment. Their agreement was never memorialized in writing, however. Eighteen months later, Lang had paid only $15,000 on the loan from the profits from the business. Vollmer filed a lawsuit alleging breach of contract. Using the information presented in the chapter, answer the following questions. 268. Lang claimed that repayment of the loan would ―almost certainly‖ take over a year and that his agreement with Vollmer was therefore unenforceable because it was not in writing. Is he correct? Explain. Solution No, he is not correct. Even if it is unlikely that the nightclub would earn enough profits to pay the entire loan off within a year, it is possible. The test for determining whether an oral contract is enforceable under the one-year rule is whether performance is possible within that time, not whether it is likely. Only when performance is objectively impossible during the one-year period does the contract fall within the Statute of Frauds. 269. Suppose that a week after Vollmer gave Lang the funds, she sent him an e-mail containing the terms of their loan agreement with her named typed at the bottom. Lang did not respond to the e-mail. Is this sufficient as a writing under the Statute of Frauds? Solution No. Although an e-mail would constitute a writing, it still must be signed by the party against whom enforcement is sought (Lang). Because the e-mail was from Vollmer and not signed by Lang, it is not a sufficient writing. If, however, Lang had responded to the e-mail and typed his name at the bottom of his response, it would likely be sufficient. 270. Assume that at trial the court finds that the contract falls within the Statute of Frauds. Further assume that the state in which the court sits recognizes every exception to the Statute of Frauds discussed in the chapter. What exception provides Vollmer with the best chance of enforcing the oral contract in this situation?

173

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

Solution In this situation, Vollmer best argument to enforce the contract is partial performance. Lang had been making payments on the loan from the Nightclubs profits, which shows that there was an agreement to make payments on the loan from the profits. 271. Suppose that at trial, Lang never raises the argument that the parties‘ agreement violates the Statute of Frauds, and the court rules in favor of Vollmer. Then Lang appeals and raises the Statute of Frauds for the first time. What exception can Vollmer now argue? Solution Admission. She can argue that by not raising the defense of Statute of Frauds in the trial, Lang essentially admitted to the existence of the contract.

Practice and Review: Debate This 272. Many countries have eliminated the Statute of Frauds except for the sale of real estate. The United States should do the same. Solution Certainly, unfair situations arise concerning the enforceability of contracts or contract modifications because they were not evidenced by a writing or record. By eliminating the defense provided by the Statute of Frauds, there would be fewer unjust decisions that are based on the lack of a writing or record. In contrast, the requirement of a writing or record for certain contracts to be enforceable does avoid the ―she said, I said‖ arguments that could be used after the fact when a simple oral contract was made. In other words, unjust judicial decisions are avoided, too, if the Statute of Frauds is a requirement before certain contracts can be enforced.

Issue Spotters 273. GamesCo orders $800 worth of game pieces from Midstate Plastic, Inc. Midstate delivers, and GamesCo pays for, $450 worth. GamesCo then says it wants no more pieces from Midstate. GamesCo and Midstate have never dealt with each other before and have nothing in writing. Can Midstate enforce a deal for the full $800? Explain your answer. Solution No. Under the UCC, a contract for a sale of goods priced at $500 or more must be in writing to be enforceable. In this case, the contract is not enforceable beyond the quantity already delivered and paid for. 274. Paula orally agrees to work with Next Corporation in New York City for two years. Paula moves her family to the city and begins work. Three months later, Paula is fired for no stated cause. She sues for reinstatement and back pay. Next Corporation argues that there is no written contract between them. What will the court say? Solution The court might conclude that under the doctrine of promissory estoppel, the employer is estopped from claiming the lack of a written contract as a defense. The oral contract may be enforced because the employer made a promise on which the employee justifiably relied in moving to New York, the reliance was foreseeable, and injustice can be avoided only by enforcing

174

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

the promise. If the court strictly enforces the Statute of Frauds, however, the employee may be without a remedy.

Business Scenarios and Case Problems 275. The One-Year Rule. On May 1, by telephone, Yu offers to hire Benson to perform personal services. On May 5, Benson returns Yu‘s call and accepts the offer. Discuss fully whether this contract falls under the Statute of Frauds in the following circumstances: (See The Writing Requirement.) 1.

The contract calls for Benson to be employed for one year, with the right to begin performance immediately. Solution Under the Statute of Frauds, any contract that cannot be performed within one year from the date of entering into the contract (time of acceptance), without breaching the terms, needs a writing to be enforceable. Under this rule, the following decisions are made: The one-year period is measured from the day after the contract is made. Because Benson has the right to begin the one-year contract immediately, it is possible to perform the contract within one year. Therefore, the contract falls outside the Statute of Frauds and can be legally enforced without a writing.

The contract calls for Benson to be employed for nine months, with performance of services to begin on September 1. Solution The one-year period here begins with the formation of the contract, so it is measured from the day after the contract is made, May 6. Because performance is for nine months and cannot begin until September 1, however, the contract cannot be fully performed until midnight on May 31. Thus, the contract is impossible to perform within the one-year period and therefore comes under the Statute of Frauds. A writing is required for enforceability.

The contract calls for Benson to submit a written research report, with a deadline of two years for submission. Solution The likelihood or probability of a person performing according to the terms of a contract within a year is irrelevant to the question of whether such performance is possible. If it is possible for Benson to submit the written research report within one year, beginning May 6, the contract is outside the Statute of Frauds and legally enforceable without a writing— despite the fact that Benson is permitted two years to submit the report.

175

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

276. Statute of Frauds. Gemma promises a local hardware store that she will pay for a lawn mower that her brother is purchasing on credit if the brother fails to pay the debt. Must this promise be in writing to be enforceable? Why or why not? (See The Writing Requirement.) Solution In this situation, Gemma becomes what is known as a guarantor on the loan. That is, she guarantees the hardware store that she will pay for the mower if her brother fails to do so. This kind of collateral promise, in which the guarantor promises to become responsible only if the primary party does not perform, must be in writing to be enforceable. There is an exception, however. If the main purpose in accepting secondary liability is to secure a personal benefit—for example, if Gemma‘s brother bought the mower for her—the contract need not be in writing. The court will determine from the circumstances of the case whether the main purpose was to secure a personal benefit and thus, in effect, to answer for the guarantor‘s own debt. 277. Collateral Promises. Mallory promises a local hardware store that she will pay for a lawn mower that her brother is purchasing on credit if the brother fails to pay the debt. Must this promise be in writing to be enforceable? Why or why not? (See The Writing Requirement.) Solution In this situation, Mallory becomes what is known as a guarantor on the loan. That is, she guarantees the hardware store that she will pay for the mower if her brother fails to do so. This kind of collateral promise, in which the guarantor promises to become responsible only if the primary party does not perform, must be in writing to be enforceable. There is an exception, however. If the main purpose in accepting secondary liability is to secure a personal benefit—for example, if Mallory‘s brother bought the mower for her—the contract need not be in writing. The assumption is that a court can infer from the circumstances of the case whether the main purpose was to secure a personal benefit and thus, in effect, to answer for the guarantor‘s own debt. 278. Promises Made in Consideration of Marriage. After twenty-nine years of marriage, Robert and Mary Lou Tuttle were divorced. They admitted in court that before they were married, they had signed a prenuptial agreement. They both acknowledged that the agreement had stated that each would keep their own property and anything derived from that property. Robert came into the marriage owning farmland, while Mary Lou owned no real estate. During the marriage, ten different parcels of land, totaling about six hundred acres, were acquired, and two corporations, Tuttle Grain, Inc., and Tuttle Farms, Inc., were formed. A copy of the prenuptial agreement could not be found. Can the court enforce the agreement without a writing? Why or why not? [In re Marriage of Tuttle, 2015.WL 164035 (Ill.App. 5 Dist. 2015.] (See The Writing Requirement.) Solution No. The court cannot enforce the Tuttles‘ prenuptial agreement without a writing. A prenuptial agreement is an agreement made before marriage that defines each partner's ownership rights in the other partner's property. A prenuptial agreement must be in writing to be enforceable. In this problem, the Tuttles admitted in court that they had signed a prenuptial agreement before they were married, and they agreed on the general term. But a copy of the agreement could not be found. Thus, there was no way to confirm their testimony and no way to accurately determine

176

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

whether the alleged term was fair. In the actual case on which this problem is based, the court held that the Tuttles‘ prenuptial agreement was not enforceable, because no copy could be produced, and divided the marital assets ―in just proportions.‖ On Robert‘s appeal, a state intermediate appellate court affirmed the decision and the division of property. ―In order to accurately follow the terms of a prenuptial agreement, the writing is necessary.‖ 279. Business Case Problem with Sample Answer—The Parol Evidence Rule. Rimma Vaks and her husband, Steven Mangano, executed a written contract with Denise Ryan and Ryan Auction Co. to auction their furnishings. The six-page contract provided a detailed summary of the parties‘ agreement. It addressed the items to be auctioned, how reserve prices would be determined, and the amount of Ryan‘s commission. When a dispute arose between the parties, Vaks and Mangano sued Ryan for breach of contract. Vaks and Mangano asserted that, before they executed the contract, Ryan had made various oral representations that were inconsistent with the terms of their written agreement. Assuming that their written contract was valid, can Vaks and Mangano recover for breach of an oral contract? Why or why not? [Vaks v. Ryan, 2014 Mass.App.Div. 37 (2014)]. (See The Parol Evidence Rule.) —For a sample answer to Problem 15– 5, go to Appendix E. Solution Vaks and Mangano may not recover for breach of an oral contract. Under the parol evidence rule, if there is a written contract representing the complete and final statement of the parties‘ agreement, a party may not introduce any evidence of past agreements. Here, the written agreement was an integrated contract because the parties intended it to be a complete and final statement of the terms of their agreement. Vaks and Mangano therefore may not introduce evidence of any inconsistent oral representations made before the contract was executed. 280. Promises Made in Consideration of Marriage. Before their marriage, Linda and Gerald Heiden executed a prenuptial agreement. The agreement provided that ―no spouse shall have any right in the property of the other spouse, even in the event of the death of either party.‖ The description of Gerald‘s separate property included a settlement from a personal injury suit. Twenty-four years later, Linda filed for divorce. The court ruled that the prenuptial agreement applied only in the event of death, not divorce, and entered a judgment that included a property division and spousal support award. The ruling disparately favored Linda, whose monthly income with spousal support would be $4,467, leaving Gerald with only $1,116. Did the court interpret the Heidens‘ prenuptial agreement correctly? Discuss. [Heiden v. Heiden, 2015 WL 849006 (Mich.App. 2015)] (See The Writing Requirement.) Solution No. The court did not interpret the Heidens‘ prenuptial agreement correctly. A unilateral promise to make a monetary payment or to give property in consideration of marriage must be in writing. And this requirement applies to prenuptial agreements, which may define each partner‘s ownership rights in their separate and joint property. In interpreting these agreements, basic contract principles apply. The terms must be enforced as written, and unambiguous words and phrases should be construed according to their plain and ordinary meaning. The prenuptial agreement between Linda and Gerald Heiden provided that ―no spouse shall have any right in the property of the other spouse, even in the event of the death of either party.‖ The

177

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

description of Gerald's separate property included a settlement from a personal injury suit. On their divorce, the court interpreted the agreement to apply only in the event of death, not divorce, and entered a judgment that included a property division and spousal support award reflecting this interpretation. But the court was not correct. The use of the word ―even‖ indicated that the Heidens intended to keep their property separate in all events, including death and, in the circumstances here, divorce. Thus, the property division and spousal support award should not have taken into account Gerald's settlement from a personal injury suit. In the actual case on which this problem is based, on the Heidens‘ divorce, the court interpreted and applied the prenuptial agreement as stated in the facts. A state intermediate appellate court reversed, on the reasoning set out above. 281. The Statute of Frauds. Michael Brannon filed a suit in an Ohio state court against Derrick and Nancy Edman, claiming breach of an alleged oral contract for the sale of certain real property in Akron. Brannon asserted that he moved onto the property and made significant improvements to the house, investing time and money in anticipation of receiving ownership of the property after all of the payments had been made. Brannon asserted that he diligently made the payments, and the Edmans accepted them, crediting each against the remaining balance, until about half of the price had been paid. But when he attempted to make a payment in the third year of his occupancy, the Edmans refused it and threatened him with eviction. The Edmans argued that the Statute of Frauds barred Brannon‘s claim. Is this alleged contract enforceable? Explain. [Brannon v. Edman, 2018 -Ohio- 70, WL 357458 (9th Dist. 2018)] (See The Writing Requirement.) Solution Yes. If Brannon can prove his assertions, his alleged oral contract with the Edmans is enforceable. All states require certain types of contracts to be in writing and signed by the party against whom enforcement is sought, but there are exceptions. For example, in a case involving an oral contract for the transfer of an interest in land, a court may evaluate whether justice would be better served by enforcing the deal when partial performance has occurred. Thus, if the putative purchaser has taken possession, paid part of the price, and made significant improvements to the property, the court may grant specific performance. Here, Brannon filed a suit against the Edmans, alleging breach of an oral contract for the sale of a house and lot. Brannon claimed that he moved onto the property, resided there for three years, and made significant improvements to the house, investing time and money in reliance on receiving ownership of the property after all of the payments were made. Brannon asserted that he diligently made the payments, and the Edmans accepted them, until about half of the price was paid. When Brannon attempted to make a payment in the third year of his residency, however, the Edmans refused it and threatened eviction. If proved, these occurrences would clearly support the enforcement of an oral contract on the ground of partial performance. In the actual case on which this problem is based, the court dismissed Brannon‘s complaint. A state intermediate appellate court reversed. ―We conclude [Brannon‘s assertions] are sufficient to withstand a motion to dismiss based on the affirmative defense of the statute of frauds as there are allegations which if proven would support part performance.‖ 282. A Question of Ethics—Exceptions to the Writing Requirement. Madeline Castellotti was the sole shareholder of Whole Pies, Inc., which owns John‘s Pizzeria in New York City. Her other assets included a 51 percent interest in a real estate partnership, a residence on Staten

178

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

Island, and various bank accounts. When Madeline‘s son, Peter Castellotti, was going through a divorce, Madeline wanted to prevent Peter‘s then-wife Rea from benefiting from any of Madeline‘s assets. With this purpose in mind, she removed Peter from her will, leaving her daughter Lisa Free as the sole beneficiary. Lisa orally agreed to provide Peter with half of the income generated by the assets after their mother‘s death if his divorce was still pending and to transfer half of the assets after the divorce was final. In reliance on those promises, Peter agreed to pay the property taxes for the estate. Madeline died and Peter paid the taxes, but Lisa reneged on the deal. Peter filed a suit in a New York state court against his sister to recover. [Castellotti v. Free, 138 A.D.3d 198, 27 N.Y.S.3d 507 (1 Dept. 2016)] (See Exceptions to the Writing Requirement.) 1.

Should the court enforce the promise? On what legal theory? Solution Yes, the court should enforce Lisa’s promise to transfer half of the income generated by her mother’s assets before her death and half of those assets after her death to Lisa’s brother Peter. The facts in the circumstances described in this problem satisfy the requirements for a cause of action based on a theory of promissory estoppel. An oral contract that is otherwise unenforceable under the Statute of Frauds may be enforced on a theory of promissory estoppel. In that circumstance, a court will prevent a promisor from refusing to comply with the terms of a deal that, for example, is not evidenced in writing. The requirements for the application of this theory include the following: (a) A clear, definite promise. (b) The promisor‘s expectation that the promisee will rely on the promise. (c) The promisee‘s reasonable reliance on the promise, as shown by taking some action or refraining from acting. (d) Reliance on the part of the promise that is definite and results in substantial detriment. (e) Enforcement of the promise to avoid injustice. In this problem, Madeline Castellotti‘s son Peter was going through a divorce from his thenwife Rea. Madeline wanted to prevent Rea from benefiting from any of Madeline‘s assets, so she removed Peter from her will. This left her daughter Lisa Free as sole beneficiary. Lisa orally agreed to provide Peter with half of the income generated by the assets after their mother‘s death if his divorce was still pending, and to transfer half of the assets to him after the divorce was final. In reliance on those promises, Peter agreed to pay the property taxes for the estate. Madeline died and Peter paid the taxes, but Lisa backed out on the deal. These facts meet all the requirements for an action based on a theory of promissory estoppel. There was an unambiguous promise by Lisa to provide Peter with half of the income generated by the assets during the pendency of Peter‘s divorce, and to transfer half of the assets on the finality of the divorce. Peter reasonably and detrimentally relied on those promises by paying the property taxes for Madeline‘s estate, suffering damages. The only way to avoid injustice to Peter would be to enforce Lisa‘s promise—otherwise, Lisa would be allowed to keep all of the assets and Peter would suffer the loss of the funds that paid the estate‘s taxes. In the actual case on which this problem is based, in Peter‘s suit against his sister to recover half of the assets of their mother‘s estate, Lisa asserted that the Statute of Frauds barred his

179

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 15: The Statute of Frauds—Writing Requirement

claim. The court dismissed the complaint. A state intermediate appellate court reversed on the basis of the theory of promissory estoppel. 2.

If the court enforces the promise, should Rea get a share of what Peter and his mother and sister were ―hiding‖? Discuss. Solution Peter‘s failure to disclose his ultimate right to receive half of the assets of Madeline‘s estate in the future could have impacted the financial issues in his divorce from Rea. Rea would not have been entitled to a simple half of Peter‘s share—an inheritance is generally considered to be a spouse‘s separate property. But if Rea had known that Peter would later receive half of Madeline‘s estate, she might have sought, and might have been granted, more financial assets in the divorce proceeding. For example, any award by the court of spousal maintenance and child support might have been greater. It might be noted that there is nothing illegal about Madeline’s act of changing her will or the agreement between Peter and Lisa with respect to the distribution of Madeline’s assets. Madeline was free to leave her property to whomever she pleased, and the siblings were free to enter into an agreement to redistribute that inheritance. There is no statute, rule, or regulation violated by the siblings‘ agreement. There is also no indication that Peter fraudulently concealed or transferred any property owned by him or titled in his name, either before or during his divorce from Rea. The assets that might be alleged to have been ―hidden‖—half of the shares in Whole Pies, the real estate partnership, the house on Staten Island, and the bank accounts—were never in Peter‘s possession. At best, there is a claim that Peter attempted to delay the receipt of his half of the estate, which he was never legally entitled to in the first place, and did not disclose this potential revenue source to Rea.

Critical Thinking and Writing Assignments 283. Time-Limited Group Assignment—The Writing Requirement. Jason Novell, doing business as Novell Associates, hired Barbara Meade as an independent contractor. The parties orally agreed on the terms of employment, including payment of a share of the company‘s income to Meade, but they did not put anything in writing. Two years later, Meade quit. Novell then told Meade that she was entitled to $9,602—25 percent of the difference between the accounts receivable and the accounts payable as of Meade‘s last day of work. Meade disagreed and demanded more than $63,500—25 percent of the revenue from all invoices, less the cost of materials and outside processing, for each of the years that she had worked for Novell. Meade filed a lawsuit against Novell for breach of contract. (See The Writing Requirement.) 1.

The first group will evaluate whether the parties had an enforceable contract. Solution The parties had an enforceable contract. Meade would not have to prove the existence of a contract, despite its terms being part of an oral agreement, because—based on the facts stated in the problem—she would assert it in her complaint and Novell would admit to its existence in his answer and presumably at trial. They disagree only about its terms.

180

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

The second group will decide whether the parties‘ oral agreement falls within any exception to the Statute of Frauds. Solution The parties‘ oral agreement falls within the admissions exception to the Statute of Frauds. The pleadings—in which Meade would assert, and Novell would admit, the existence of a contract would establish that at the time the parties formed an oral contract.

The third group will discuss how the lawsuit would be affected if Novell admitted that the parties had an oral contract under which Meade was entitled to a share of the company‘s income, but claimed that they had agreed she would receive only 15 percent of the income from invoices, not 25 percent. Solution If a party against whom enforcement of an oral contract is sought admits under oath that a contract was made, it will be enforceable at least to the extent of the terms admitted. Thus, if Novell admitted that Meade was entitled to a share of the company‘s income, but claimed that they had agreed she would receive only 15 percent of the income from invoices, not 25 percent, as she alleged, the court would most likely enforce a contract for at least that amount. If Meade could additionally prove that she was entitled to a greater amount because that was the term to which Novell and she had agreed, the court would likely find a contract for that amount.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 182 Case 16.1 ............................................................................................................................................... 182 Case 16.2 ............................................................................................................................................... 182 Case 16.3 ............................................................................................................................................... 183 Chapter Review ........................................................................................................................................................... 184 Practice and Review .............................................................................................................................. 184 Practice and Review: Debate This ......................................................................................................... 186 Issue Spotters ........................................................................................................................................ 186 Business Scenarios and Case Problems ................................................................................................. 187 Critical Thinking and Writing Assignments ............................................................................................ 193

181

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

Critical Thinking Questions in Cases Case 16.1 284. The lease between RRE and Chalk Supply required a security deposit to cover any default on a month‘s rent by the tenant. Chalk Supply did not pay the deposit. Should the court have ruled that this breach prevented Chalk Supply from prevailing on its claim against RRE? Discuss. Solution No, the court should not have ruled that a tenant‘s failure to pay a security deposit required under a lease constituted a breach sufficient to prevent the tenant from prevailing on a claim against the landlord in the circumstances of the Chalk Supply case. Of course, a party who breaches a contract cannot base an action for breach against the other party on a subsequent breach or refusal to perform. But to prevent an action for a later breach, the first breach must be substantial. As a consequence, the non-breaching party must not have obtained the benefit reasonably expected under the contract. In the typical sequence of events under a lease, a tenant‘s failure to pay a security deposit is likely to precede the landlord‘s repudiation of a duty owed under the contract. In the Chalk Supply case, Chalk Supply failed to pay the security deposit before RRE balked at its duty to pay the initial cost for a fire suppression system. But the failure to pay the deposit was not a substantial breach. The purpose of the deposit was to cover a default on the payment of a month‘s rent by the tenant. Chalk Supply paid most of the rent in advance. With this advance, RRE clearly obtained the benefit it reasonably expected under the lease. 285. Suppose that RRE had received an estimate of the cost of the fire suppression system before the parties executed the lease and had then insisted on conditioning its payment on a longer term. Would the result in this case have been different? Explain. Solution Yes, the result in the Chalk Supply case would have been different if the landlord had received an estimate of the cost of the system before the parties signed the lease and had at that time insisted on negotiating a longer term. RRE‘s duty to pay for the initial cost of the fire suppression system was a provision in its contract to lease a warehouse to Chalk Supply. The landlord received an estimate of the cost after the parties executed their agreement and then notified the tenant that it was repudiating its duty to pay that price without a longer lease term. If, however, RRE had insisted on the condition of a longer term during the parties‘ original negotiations over the provisions of the lease, the proposal would not have been a repudiation of its duty. The landlord‘s refusal to otherwise pay for the fire suppression system would not have been a legitimate basis for the tenant to bring an action for material breach, and the result in the Chalk Supply case would have been different.

Case 16.2 286.

Did Brown and DWB breach the lease? If so, was the breach material? Discuss.

182

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

Solution Yes. Brown and DWB breached the lease, and the breach was material. The lease for the commercial premises owned by Boydston and D&T on which Brown and DWB operated Mayflower RV required the lessees to obtain insurance coverage in the amount of the replacement value of any structures and other improvements on the property. Despite this requirement, the lessees insured the property with cash-value insurance providing $450,000 worth of coverage. This was a clear breach of the lease. Did Boydston and D&T accept that there was only $450,000 of cash-value insurance on the property, and thereby waive their right to enforce the lease? A party to a contract, who, with knowledge of a breach by the other party, continues to accept the benefits of the deal, waives the right to file a claim for the breach. Here, there is no indication that Boydston or D&T agreed to the lower insured value. In fact, the amount and type of insurance that had previously covered the property was replacement-value. This would support a finding that the landlords would not have agreed to the lower amount of coverage, and that they did not waive their right to enforce this provision of the lease. A breach is the nonperformance of a contractual duty. A breach is material when performance is not at least substantial. Brown and DWB breached the lease by failing to obtain the required amount of insurance to cover any damage to the leased property. This failure deprived Boydston and D&T of a substantial benefit that they anticipated under the contract. 287. Suppose that Boydston and D&T had agreed to the cash-value policy in lieu of the lease‘s required replacement-value coverage, and that they had subsequently accepted the insurance check. Would the result have been different? Explain. Solution Yes. If the landlords had agreed to their tenants‘ procurement of cash-value insurance in place of the lease‘s required replacement-value coverage, and had later accepted the insurance proceeds, the result in the DWB case would have been different. In an accord and satisfaction, the parties to a contract agree to accept performance different from the performance originally promised. An accord is the agreement to perform and accept the different act, and its performance is a satisfaction. This arrangement discharges the original obligation. The sequence of facts stated in the question would have supported a finding of an accord and satisfaction. Any subsequent claim against Brown and DWB for the related property damage would have failed.

Case 16.3 288.

Did HRB violate any ethical duty by refusing to pay Harvard‘s golden parachute? Explain.

Solution No. Hampton Road Bankshares (HRB) did not violate any ethical duty by refusing to make the golden parachute payment that the employer had originally agreed to make to its employee, senior executive officer Scott Harvard. The payment was made illegal by the federal Emergency Economic Stabilization Act (EESA), which contained the Troubled Assets Relief Program that barred participating financial institutions from making golden parachute payments.

183

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

HRB was a participant in the program. Harvard agreed to an amendment to his employment agreement with HRB that provide that the agreement ―will be interpreted, administered and construed to, comply with EESA.‖ Harvard quit the firm and sued to obtain the golden parachute. Ultimately, the Virginia Supreme Court agreed with HRB. In the words of the court in the Hampton case, ―by its plain language, the amended Employment Agreement must be read to comply with EESA. Nothing therein exempts the agreement from . . . EESA . . . or places the risk of performance . . . on HRB.‖ Further, ―there is nothing in the record that would suggest HRB refused to make the golden parachute payment in bad faith.‖ HRB asked the U.S. Department of the Treasury for its advice—the agency advised that the payment would be in violation of the law, and that the law would be enforced. Arguably, HRB would have committed ethical misconduct if it had made the golden parachute payment in the face of these facts.

Chapter Review Practice and Review Val‘s Foods signs a contract to buy 1,500 pounds of basil from Sun Farms, a small organic herb grower, if an independent organization inspects the crop and certifies that it contains no pesticide or herbicide residue. Val‘s has a contract with several restaurant chains to supply pesto and intends to use Sun Farms‘ basil in the pesto to fulfill these contracts. When Sun Farms is preparing to harvest the basil, an unexpected hailstorm destroys half the crop. Sun Farms attempts to purchase additional basil from other farms, but it is late in the season, and the price is twice the normal market price. Sun Farms is too small to absorb this cost and immediately notifies Val‘s that it will not fulfill the contract. Using the information presented in the chapter, answer the following questions. 289. Suppose that Sun Farms supplies the basil that survived the storm but the basil does not pass the chemical-residue inspection. Which concept discussed in the chapter might allow Val‘s to refuse to perform the contract in this situation? Solution The appropriate concept might be failure of a condition. Under the terms of the contract, Val‘s does not have to perform (pay) unless the basil meets the stated condition (that it pass an independent inspection for chemical residue). Because the basil did not pass the inspection, Val‘s is not obligated to perform. 290. Under which legal theory or theories might Sun Farms claim that its obligation under the contract has been discharged by operation of law? Discuss fully. Solution Because a hailstorm destroyed half of Sun Farms‘ basil crop, it can claim that it is impossible for it to perform the entire contract. Also, Sun Farms attempted to procure the balance of the contracted amount from other sources, but discovered that the basil was extremely expensive. Therefore, Sun Farms can argue that its performance should be excused due to commercial impracticability.

184

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

291. Suppose that Sun Farms contacts every basil grower in the country and buys the last remaining chemical-free basil anywhere. Nevertheless, Sun Farms is able to ship only 1,475 pounds to Val‘s. Would this fulfill Sun Farms‘ obligations to Val‘s? Why or why not? Solution Substantial performance is good faith performance that does not vary greatly from the contract and confers the same benefits as promised in the contract. In this situation, Sun Farms acted in good faith and shipped as much chemical-free basic as it could obtain, which was only 25 pounds less than the contracted amount. Therefore, a court would likely find that it had substantially performed its obligation to Val‘s.

185

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

292. Now suppose that Sun Farms sells its operations to Happy Valley Farms. As part of the sale, all three parties agree that Happy Valley will provide the basil as stated under the original contract. What is this type of agreement called? Solution This is a novation—an agreement between the contracting parties to substitute a third party for one of the original parties. This is the type of agreement described here. Under a novation, the new contract extinguishes the old contract and discharges the obligations of the prior party to the contract.

Practice and Review: Debate This 293.

The doctrine of commercial impracticability should be abolished.

Solution Contracts are not made to be broken, even if that is a popular saying. Contracts are made to be respected. Those who seek to avoid their contractual obligations by using the excuse of commercial impracticability, if successful, reduce the certain of contractual obligations and end up hurting the commercial society in which we all live. Sometimes, a contract cannot be fulfilled through no fault of one of the parties. That is why the principle of commercial impracticability was created. If one party, usual a seller of goods or services, cannot perform because in so doing, that party would lose large sums and maybe go out of business, the courts should step in an allow that party to avoid the contract.

Issue Spotters 294. Ready Foods contracts to buy two hundred carloads of frozen pizzas from Speedy Distributors. Before Ready or Speedy starts performing, can the parties call off the deal? What if Speedy has already shipped the pizzas? Explain your answers. Solution Contracts that are executory on both sides—contracts on which neither party has performed—can be rescinded solely by agreement. Contracts that are executed on one side—contracts on which one party has performed—can be rescinded only if the party who has performed receives consideration for the promise to call off the deal. Thus, in this question, if neither party starts to perform, the deal can be rescinded solely by agreement. If Speedy already shipped the pizzas, however, the contract can be rescinded only if Speedy receives consideration to call off the deal. 295. C&D Services contracts with Ace Concessions, Inc., to service Ace‘s vending machines. Later, C&D wants Dean Vending Services to assume the duties under a new contract. Ace consents. What type of agreement is this? Are Ace‘s obligations discharged? Why or why not? Solution Novation substitutes a new party for an original party, by agreement of all the parties. The requirements are a previous valid obligation, an agreement of all the parties to a new contract, extinguishment of the old obligation, and a new, valid contract. Novation revokes and discharges the previous obligation. Here, C&D delegated its duties under its contract with Ace to Dean, with Ace‘s consent. Ace‘s obligation to pay C&D for the execution of those duties is discharged, but its

186

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

obligation under the new contract to pay Dean for those services will not be discharged until Dean is paid. The novation did, however, discharge C&D‘s obligation under the contract.

Business Scenarios and Case Problems 296. Conditions of Performance. The Caplans contract with Faithful Construction, Inc., to build a house for them for $360,000. The specifications state ―all plumbing bowls and fixtures . . . to be Crane brand.‖ The Caplans leave on vacation, and during their absence, Faithful is unable to buy and install Crane plumbing fixtures. Instead, Faithful installs Kohler brand fixtures, an equivalent in the industry. On completion of the building contract, the Caplans inspect the work, discover the substitution, and refuse to accept the house, claiming Faithful has breached the conditions set forth in the specifications. Discuss fully the Caplans‘ claim. (See Conditions of Performance.) Solution If the specifications are considered to be express conditions to the Caplans‘ acceptance and payment under the contract, Faithful must perform fully—that is, must install Crane brand plumbing fixtures—to recover the contract price. Until Faithful does so, the Caplans are not obligated to any performance. If, however, the specifications are merely promises (implied conditions), justice and fairness require only substantial, rather than full, performance for the Caplans‘ obligation to become absolute. This does not mean that Faithful has not committed a breach. Faithful is liable for any damages that can be proved to have resulted from its less than full performance. In this case, the specifications were stated not as express conditions but as mere promises (implied conditions). To avoid the harsh result of the Caplans having a house on their lot without having to pay Faithful, the courts would require only that Faithful prove substantial performance. Because Kohler brand is equivalent to Crane brand by industry standards, the substantial performance test has been met, and the Caplans are obligated to accept and pay. Whether they can deduct any damages from the contract price for the less than full performance will depend on proof that they suffered monetary damages. 297. Discharge by Agreement. Junior owes creditor Iba $1,000, which is due and payable on June 1. Junior has been in a car accident, has missed a great deal of work, and con-sequently will not have the funds on June 1. Junior‘s father, Fred, offers to pay Iba $1,100 in four equal installments if Iba will discharge Junior from any further liability on the debt. Iba accepts. Is this transaction a novation or an accord and satisfaction? Explain. (See Discharge by Agreement.) Solution A novation exists when a new, valid contract expressly or impliedly discharges a prior contract by the substitution of a party. Accord and satisfaction exists when the parties agree that the original obligation can be discharged by a substituted performance. In this case, Fred‘s agreement with Iba to pay off Junior‘s debt for $1,100 (as compared to the $1,000 owed) is definitely a valid contract. The terms of the contract substitute Fred as the debtor for Junior, and Junior is definitely discharged from further liability. This agreement is a novation. 298. Impossibility of Performance. In the follow-ing situations, certain events take place after the contracts are formed. Discuss which of these contracts are discharged because the events render the contracts impossible to perform. (See Discharge by Operation of Law.) Solution

187

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

Normally, events that take place after the formation of the contract and that make performance of the contract more difficult or burdensome do not render the contract impossible to perform and do not discharge a party‘s liability for failure to fully perform. If such events make performance so extremely difficult or burdensome that it is, in effect, impossible, impractical, or unreasonably expensive to perform, however, the contract is discharged. The basic problem is determining when this degree of difficulty or burdensomeness is reached. 1. Jimenez, a famous singer, contracts to perform in your nightclub. He dies prior to performance. Solution Jiminez‘s contract is personal, requiring his services for full performance of the contract. His death makes performance totally impossible, thereby discharging his estate from liability. 2.

Raglione contracts to sell you her land. Just before title is to be transferred, she dies. Solution The passage of title to this land can be by Raglione or any person so authorized. Therefore, the death of Raglione does not render the contract impossible to perform, because a representative of her estate can perform it in her place. The contract is not discharged.

Oppenheim contracts to sell you one thousand bushels of apples from her orchard in the state of Washington. Because of a severe frost, she is unable to deliver the apples. Solution The contract called for apples to come from a specific orchard. Through no fault of Oppenheim‘s, the specific subject matter of the contract is destroyed by the frost. Therefore, Oppenheim cannot deliver the apples called for in the contract, rendering the contract impossible to perform.

Maxwell contracts to lease a service station for ten years. His principal income is from the sale of gasoline. Because of an oil embargo by foreign oil-producing nations, gaso-line is rationed, cutting sharply into Maxwell‘s gasoline sales. He cannot make his lease payments. Solution Major discussion should center on the doctrine of commercial impracticability or frustration of commercial purpose. For the doctrine to be applied, most courts would need proof that either the rationing frustrated the very purpose both parties had in mind in making the contract, or that there was an implied condition that the premises were to be used for the sole purpose of selling products no longer available, or that the events rendered the anticipated performance extremely difficult or costly. In cases involving rationing during World War II, some courts held that the rationing merely created a hardship, not an absolute prohibition, and the lease contracts were enforced even though performance was more burdensome.

299. Conditions of Performance. Russ Wyant owned Humble Ranch in Perkins County, South Dakota. Edward Humble, whose parents had previously owned the ranch, was Wyant‘s uncle. Humble held a two-year option to buy the ranch. The option included specific conditions. Once it was exercised, the parties had thirty days to enter into a purchase agreement, and the seller could become the buyer‘s lender by matching the terms of the proposed financing. After the option was exercised, the parties engaged in lengthy negotiations, but Humble did not respond to Wyant‘s

188

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

proposed purchase agreement nor advise him of available financing terms before the option expired. Six months later, Humble filed a suit against Wyant to enforce the option. Is Humble entitled to specific performance? Explain. [Humble v. Wyant, 843 N.W.2d 334 (S.Dak. 2014)] (See Conditions of Performance.) Solution No. Humble is not entitled to specific performance. The equitable remedy of specific performance calls for the performance of an act promised in a contract. In a case involving an interest in real property, specific performance can be the appropriate remedy when money damages would be inadequate. In some situations, however, contractual promises are conditioned. A condition is a possible future event, the occurrence or nonoccurrence of which triggers the performance of a contractual obligation. If the condition is not satisfied, the obligations of the parties are discharged and cannot therefore be enforced. A condition that must be fulfilled before a party‘s promise becomes absolute is called a condition precedent. In this problem, Humble‘s option had conditions—once it was exercised the parties had thirty days to enter into a purchase agreement, and Wyant could become Humble‘s lender by matching the terms of the proposed financing. Humble exercised the option, tolling the two-year deadline. But the parties engaged in protracted negotiations. Humble did not respond to Wyant‘s proposed purchase agreement and did not advise him of available financing terms before the option expired. In other words, none of the option‘s conditions were satisfied before it expired. In the actual case on which this problem is based, the court issued a judgment in Wyant‘s favor. On Humble‘s appeal, the South Dakota Supreme Court affirmed. 300. Discharge by Operation of Law. Dr. Jake Lambert signed an employment agreement with Baptist Health Services, Inc., to provide cardiothoracic-surgery services to Baptist Memorial Hospital–North Mississippi, Inc., in Oxford, Mississippi. Complaints about Lambert‘s behavior arose almost immediately. He was evaluated by a team of doctors and psychologists, who diagnosed him as suffering from obsessivecompulsive personality disorder and concluded that he was unfit to practice medicine. Based on this conclusion, the hospital suspended his staff privileges. Citing the suspension, Baptist Health Services claimed that Lambert had breached his employment contract. What is Lambert‘s best defense to this claim? Explain. [Baptist Memorial Hospital–North Mississippi, Inc. v. Lambert, 157 So.3d 109 (Miss.App. 2015)] (See Discharge by Operation of Law.) Solution Lambert‘s best defense to Baptist‘s allegation of breach of contract is the doctrine of impossibility. Under this doctrine, if, after a contract has been made, a supervening event makes performance impossible in an objective sense, the contract is discharged. The doctrine applies only when the parties could not have reasonably foreseen the event that renders the performance impossible. One of the situations in which this doctrine applies occurs when a party whose personal performance is essential to the completion of the contract becomes incapacitated prior to performance.

189

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

In the facts of this problem, Baptist hired Lambert to provide certain surgical services to Baptist Memorial Hospital–North Mississippi. When complaints about his behavior arose, a team of doctors and psychologists conducted an evaluation, diagnosed him as suffering from obsessivecompulsive personality disorder, and concluded that he was unfit to practice medicine. The hospital suspended his staff privileges. Baptist terminated his employment and filed a suit against him for breach. The doctrine of impossibility discharges Lambert from the performance of his contract—his performance was made impossible through no fault of his own. In the actual case on which this problem is based, in Baptist‘s suit against Lambert, the court issued a judgment in the defendant‘s favor. A state intermediate appellate court applied the doctrine of impossibility to affirm this judgment. 301. Business Case Problem with Sample Answer— Conditions of Performance. H&J Ditching & Excavating, Inc., was hired by JRSF, LLC, to perform excavating and grading work on Terra Firma, a residential construction project in West Knox County, Tennessee. Cornerstone Community Bank financed the project with a loan to JRSF. As the work progressed, H&J received payments totaling 90 percent of the price on its contract. JRSF then defaulted on the loan from Cornerstone, and Cornerstone foreclosed and took possession of the property. H&J filed a suit in a Tennessee state court against the bank to recover the final payment on its contract. The bank responded that H&J had not received its payment because it had failed to obtain an engineer‘s certificate of final completion, a condition under its contract with JRSF. H&J responded that it had completed all the work it had contracted to do. What type of contract condition does obtaining the engineer‘s certificate represent? Is H&J entitled to the final payment? Discuss. [H&J Ditching & Excavating, Inc. v. Cornerstone Community Bank, 2016 WL 675554 (Tenn.App. 2016)] (See Conditions of Performance.) —For a sample answer to Problem 16–6, go to Appendix E. Solution

The requirement that the contractor obtain an engineer‘s certificate of final completion before the final payment will be made under the contract is a condition precedent. In most contracts, promises of performance are not expressly conditioned—they are absolute and must be performed to avoid a breach of the contract. In some situations, however, performance is contingent on the occurrence of a certain event. If the condition is not satisfied, the obligations of the parties are discharged. A condition that must be fulfilled before a party‘s performance can be required is a condition precedent. In this problem, H&J was hired to excavate and grade land for a residential construction project. Cornerstone Community Bank financed the project. As the work progressed, H&J received payments totaling 90 percent of the price on its contract. But the last payment was not forthcoming when H&J believed it was due. The contractor filed a suit in a Tennessee state court against the bank to recover the final payment. The bank responded that H&J did not receive the payment because it failed to obtain an engineer‘s certificate of final completion, a condition under its contract. H&J argued that it completed all the work it contracted to do. H&J is not entitled to the final payment on the contract because it did not comply with the condition to obtain the engineer‘s certificate. This condition preceded the obligation under the contract to make the final payment. Even assuming that H&J ―completed all the work it contracted to do,‖ the final payment is not subject to disbursal without the certificate.

190

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

In the actual case on which this problem is based, the court issued a judgment in the bank‘s favor. A state intermediate appellate court affirmed. ―No certificate of substantial completion was ever issued, a condition precedent to final payment.‖ 302. Substantial Performance. Melissa Gallegos bought a used 1996 Saturn automobile for $2,155 from Raul Quintero, doing business as JR‘s Motors. Their written contract focused primarily on the transfer of physical possession of the vehicle and did not mention who would pay the taxes on the sale. Gallegos paid Quintero $2,200, believing that this amount included the taxes. When she asked him for the title to the vehicle, he told her that only the state could provide the title and only after the taxes were paid. Quintero added that they had orally agreed Gallegos would pay the taxes. Without the title, Gallegos could not obtain license plates and legally operate the vehicle. More than six years later, she filed a suit in a Texas state court against Quintero, alleging breach of contract. Did Quintero substantially perform his obligation under the contract? Explain. [Gallegos v. Quintero, 2018 WL 655539 (Tex.App.—Corpus Christi-Edinburg 2018)] (See Discharge by Performance.) Solution Yes. Quintero substantially performed his part of the deal for the sale of the Saturn to Gallegos. The requirements for performance to qualify as substantial are: 1. Good faith. 2. Different or missing performance easily remedied by damages. 3. Performance that creates substantially the same benefits as promised. In this problem, Gallegos bought a used Saturn from Quintero. Their contract did not indicate who would pay the taxes on the vehicle. Gallegos believed that the sale price included the amount of the taxes. When she asked Quintero for the title, however, he told her that the state could provide it only after the taxes were paid. He also told her that they had orally agreed she would pay the taxes. Of course, without the title, she could not obtain license plates and legally operate the vehicle. Importantly, the contract did not state who would pay the taxes on the sale of the car. Instead, the contract primarily considered the transfer of physical possession of the vehicle from Quintero to Gallegos. By the time of the suit for breach, Gallegos had been in possession of the car for over six years. This supports a conclusion that Quintero fulfilled the essential terms of the contract or, in other words, that he substantially performed. The court might order him to pay Gallegos the costs of the taxes and title to make the performance complete. In the actual case on which this problem is based, the court found that Quintero substantially performed and ordered him to pay Gallegos the costs as stated. A state intermediate appellate court affirmed, on the reasoning set out above. 303. A Question of Ethics—The IDDR Approach and Discharge by Operation of Law. Lisa Goldstein reserved space for a marriage ceremony in a building owned by Orensanz Events, LLC, in New York City. The rental agreement provided that on cancellation of the event ―for any reason beyond Owner‘s control,‖ the client‘s sole remedy was another date for the event or a refund. Shortly before the wedding, the New York City Department of Buildings found Orensanz‘s building to be structurally unstable and ordered it vacated. The owner closed it and told Goldstein to find another venue. She filed a suit in a New York state court against Orensanz for breach of contract, arguing that the city‘s order had been for a cause within the defendant‘s control. [

191

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

Goldstein v. Orensanz Events, LLC, 146 A.D.3d 492, 44 N.Y.S.3d 437 (1 Dept. 2017)] (See Discharge by Operation of Law.) 1.

Is the owner of a commercial building ethically obligated to keep it structurally sound? Apply the IDDR approach in the context of the Goldstein case to answer this question. Solution Yes. The owner of a commercial building is under an ethical duty to keep it structurally sound—at least to the extent the owner is legally obligated to its occupants. That legal obligation, which may arise from a contract, is subject to a standard of foreseeability and hence something within the owner‘s control. In this case, Lisa Goldstein rented space for a wedding in a building owned by Orensanz Events. The rental agreement provided that if the event was canceled ―for any reason beyond Owner‘s control,‖ Goldstein‘s sole remedy was another date or a refund. Just before the wedding, the city found the building to be structurally unstable and ordered it vacated. Orensanz closed it and told Goldstein to find another venue. She filed a suit against Orensanz, arguing that the city‘s order had been for a cause within the defendant‘s control. The question poses an ethical issue that could arise from these facts— whether the owner of a commercial building is ethically obligated to keep it structurally sound. In this case, the immediate stakeholders include the parties to the contract. Others who could be affected by such a duty include persons who reserved or might reserve the venue, other property owners, those who enacted or enforce the city‘s building code, and parties who are expected to respond to an emergency in the building.

192

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

With respect to the circumstances of the Goldstein case, Orensanz was under an ethical duty to keep the building structurally sound, at least to the extent of its legal obligation under the parties‘ contract. That obligation was subject to a standard of foreseeability and hence something within the owner‘s control. Orensanz could have had the building inspected periodically and should have kept it in good repair. This would have benefited all of the stakeholders. The owner‘s choice not to pursue this course of action worked to their detriment. A party may sometimes be excused from performing a contract under the doctrine of commercial impracticability. Performance is commercially impracticable when it is significantly more difficult than anticipated. The difficulty must have been unforeseeable at the time the contract was made or due to forces the party could not control. Here, if the lack of structural integrity of Orensanz‘s building had been unforeseeable—such as structural damage from a catastrophic windstorm—it would have been beyond the owner‘s control. This would satisfy both the legal standard of excuse for contract performance and the ethical standard to benefit the stakeholders. In the actual case on which this problem is based, the court issued a summary judgment dismissing Goldstein‘s complaint. A state intermediate appellate court reversed the dismissal. The appellate court cited ―issues of fact whether the failure was foreseeable or within defendants‘ control.‖ 2.

Is a contracting party ethically obligated to ―relax‖ the terms of the deal if the other party encounters ―trouble‖ in performing them? Discuss. Solution A contracting party is not legally obligated to ―relax‖ the terms of a contract if the other party has difficulty performing its side of the bargain. From an ethical perspective, however, what that difficulty means for both parties should reasonably be taken into account. The difficulty of the performing party should reasonably be taken into account by the other party to the contract, for that party‘s own interest. There are costs associated with insisting on strict compliance—the time and effort to manage that goal, as well as litigation costs and negative publicity if it is not met. And the costs associated with the performing party‘s failure to strictly comply might be recouped in other ways, such as the other party‘s tailoring its own conduct to the same standard or renegotiating some of the terms. Of course, there is no ethical duty for contracting parties to act to their own detriment to benefit the other parties to the deal. This is an aspect of reasonably considering the performing party‘s difficulty. The strength or weakness of an excuse, its subjective or objective nature, and the credibility of the performing party are other factors to weigh in the balance. And contracting parties should expect good faith and legal and ethical behavior in all of their dealings. Illegal, unethical, or abusive conduct is not something that should be anticipated in any circumstance.

Critical Thinking and Writing Assignments 304. Critical Legal Thinking. The concept of substantial performance permits a party to be discharged from a contract even though the party has not fully performed all obligations

193

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 16: Performance and Discharge

according to the contract‘s terms. Is this fair? Why or why not? What policy interests are at issue here? (See Discharge by Performance.) Solution The fairness of the doctrine of substantial performance arises from human nature, which dictates that performance will not always fully satisfy all of the parties to a contract. Perfection is also impossible, given human nature, and thus, generally, something less than perfection is possible in the performance of a contract under the doctrine of substantial performance. The doctrine looks to the good faith of the parties in their efforts to perform. When disputes arise, a court may impose on the parties whatever is reasonable in the circumstances. In part, the policy behind the doctrine is to enforce the contract that the parties made—that is, to prevent one party from using a minor deviation from the contract to avoid performance. 305. Time-Limited Group Assignment—Anticipatory Repudiation. ABC Clothiers, Inc., has a contract with John Taylor, owner of Taylor & Sons, a retailer, to deliver one thousand summer suits to Taylor‘s place of business on or before May 1. On April 1, John receives a letter from ABC informing him that ABC will not be able to make the delivery as scheduled. John is very upset, as he had planned a big ad campaign. (See Discharge by Performance.) 1.

The first group will decide whether John Taylor can immediately sue ABC for breach of contract (on April 2). Solution When either party repudiates the contract with respect to a performance not yet due, the party‘s repudiation constitutes an anticipatory breach. An anticipatory breach legally permits the nonbreaching party to suspend performance without legal liability, and to treat the contract as in breach and immediately pursue a remedy.

Now suppose that John Taylor‘s son, Tom, tells his father that they cannot file a lawsuit until ABC actually fails to deliver the suits on May 1. The second group will determine who is correct, John or Tom. Solution Taylor senior is correct. He can immediately file suit for breach of contract, even though actual performance is not due until May 1. He does not have to wait until May 1, as Tom insists. An anticipatory breach legally permits the nonbreaching party to suspend performance without legal liability, and to take a choice of either waiting until the performance date to treat the contract as in breach or immediately pursuing a remedy.

194

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Assume that Taylor & Sons can either file immediately or wait until ABC fails to deliver the goods. The third group will evaluate which course of action is better, given the circumstances. Solution From Taylor & Sons‘s perspective, the chief consideration is the effect that their choice of action will have on their business. Should they cut their losses by immediately finding another party to suit their needs and suing ABC for breach? Could they obtain damages? Should they instead attempt to obtain their order more quickly from ABC by working with the supplier? Generally, until a nonbreaching party does actually pursue a remedy, the repudiating party can, with notice, retract the repudiation, reinstating that party‘s rights under the contract.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 195 Cybersecurity and the Law—Critical Thinking ....................................................................................... 195 Critical Thinking Questions in Cases ................................................................................................................... 196 Case 17.1—Legal Environment.............................................................................................................. 196 Economic ............................................................................................................................................... 196 Case 17.2—Cultural ............................................................................................................................... 197 Case 17.3— Legal Environment............................................................................................................. 197 Economic ............................................................................................................................................... 198 Chapter Review ........................................................................................................................................................... 198 Practice and Review .............................................................................................................................. 198 Practice and Review: Debate This ......................................................................................................... 199 Issue Spotters ........................................................................................................................................ 200 Business Scenarios and Case Problems ................................................................................................. 200 Critical Thinking and Writing Assignments ............................................................................................ 206

Critical Thinking Questions in Features Cybersecurity and the Law—Critical Thinking 306. Suppose a court rules that Arby‘s weak point-of-sale security system does constitute a breach of its contract. What might be some of the compensatory damages due to Arby‘s customers who had their credit card information stolen by hackers? Solution The goal of compensatory damages is to ―make whole‖ the party who has suffered a breach of contract. Therefore, in this case, the plaintiffs would attempt to be compensated for any economic

195

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

hardship they suffered because of the breach. Such hardships could include (1) unauthorized charges to the hacked credit card that were not reimbursed by the credit card company; (2) losses arising from the theft of financial and personal information; (3) losses arising from the inability to use a suspended credit card account; (4) the loss of productivity and enjoyment caused by the time spent reporting and rectifying the data breach; and (5) the dollar amount of any Arby‘s products that would not have been purchased using a credit card had the customer known about the unreasonably high possibility of a data breach.

Critical Thinking Questions in Cases Case 17.1—Legal Environment 307. What might explain the difference between Razack‘s estimate and the district court‘s award of Red Square‘s lost profits for the delay in the delivery of the truck? Discuss. Solution The difference between Razack‘s estimate of Red Square‘s lost profits for the delay in the delivery of the truck and the district court‘s award could be explained by a number of factors. These might include the court‘s estimation of the witness‘s credibility, for example, or the reasonableness, in the court‘s view, of the amount of the claim compared to the past profits of the company. Credibility or reasonableness could be based on the witness‘s position within the company and personal knowledge of its business, as well as whatever documents, such as company invoices, are available under the circumstances. Evidence of unfulfilled ad contracts or service agreements for the period of the delay could also affect the amount of the award. In this case, during the trial, Razack, Red Square‘s sales manager, testified that the company lost $12,000 per month in profits from ad contracts that it was unable to execute because of HDAV‘s ―untimely‖ work. The court awarded Red Square $10,000 damages per month for lost profits (a total of $45,000 for the four and a half months between the promised and actual delivery dates). On appeal, the state court of appeals affirmed the award of lost profits. As to the amount, the court acknowledged that the trial court reduced the amount of the plaintiff‘s claim, but added that a court can ―adjust past profits where appropriate in determining lost profits.‖ The appellate concluded, therefore, ―The district court‘s award of lost-profit damages in the amount of $45,000, or $10,000 per month for four and one-half months, was not an abuse of discretion.‖

Economic 308. Instead of being awarded as consequential damages, should ―lost profits‖ be considered a risk in the change of value to the object of a contract assumed by the non-breaching party? Why or why not? Solution No, instead of being awarded as consequential damages, ―lost profits‖ should not be viewed as a risk in the change of value to the object of a contract assumed by the non-breaching party. Of course, a change in the value of the object of a contract is a risk that any contracting party takes on entering into an agreement. An unfavorable drop in value, even to the point of affecting a loss of profit on the transaction, will not support a suit for breach by the disappointed, or ―mistaken,‖ party.

196

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

That one of the parties to a contract will not perform their part of the deal is not a risk for which the non-breaching party should be held to account. On the contrary, the party that caused the breach should pay for the other party‘s resulting damages. Profits lost as a consequence of the breach can be part of an award of the damages if the consequence was reasonably foreseeable at the time of the contract. To hold otherwise would be to support a breach of contract whenever a party could switch to a more profitable deal with the same subject matter, without regard to the effect on the non-breaching party. This would encourage breaking promises, not fulfilling them.

Case 17.2—Cultural 309. How does a college basketball team‘s record of wins and losses, and its ranking in its conference, support the court‘s decision in this case? Solution In this case, the court enforced a liquidated damages clause, determining that when the contract was entered into, ascertaining the damages resulting from the defendant‘s breach was difficult, if not impossible. And the clause was not a penalty—the plaintiff was justified in seeking liquidated damages to compensate for its losses. Among the factors that the court relied on to make its determination was the effect that the resignation of a head coach from a university‘s basketball team can have on ticket sales and community and alumni support for the team. The coach‘s resignation can also affect the team‘s record of wins and losses, and consequent ranking in its conference. This effect lends support to the court‘s reasoning and decision in this case.

Case 17.3— Legal Environment 310. Cipriano designated Nicholas Vassello to testify on its behalf. Vassello was unable to explain how the Munawars‘ share of the property taxes was calculated. What effect might this testimony have had on the trial court‘s decision? Solution The inability of Vassello to explain how the Munawars‘ share of the property taxes was calculated would add to a perception that Cipriano had no interest in adjusting or remedying the excessive charges imposed on the Munawars. There would have been no basis to conclude that Cipriano would cure its breach. In the case, the Munawars leased space in a shopping center owned by Cipriano. The lease obligated the Munawars to pay a pro rata share of the property taxes. They were assessed with the charges shortly after occupying the space. Asserting that the amount was excessive, they asked Cipriano to explain, as required by the lease. After repeated requests, the Munawars received a partial reduction but no explanation. In their suit, alleging breach, the court rescinded the deal. A state intermediate appellate court affirmed. Cipriano breached its duties to the Munawars regarding payment of their pro rata share of the property taxes, the breach was material, and rescission restored the parties to their positions before the lease was signed.

197

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Economic 311. The lease provided that any monetary judgment in favor of the tenant could be recovered only on the landlord‘s sale of the shopping center. As a practical matter, how might this provision have affected the result in the Cipriano case? Solution The effect of the provision in the lease, and stated in the question, supported the result in the Cipriano case. Under that provision, the Munawars were essentially left without an adequate remedy at law. They would be unable to recover a money judgment in their favor until the landlord sold the shopping center. Such a judgment would not be enforceable as a practical matter. This situation would clearly support the court‘s judgment in the Munawars‘ favor to rescind the lease rather than to award damages, which would be virtually uncollectible.

Chapter Review Practice and Review Kyle Bruno enters into a contract with X Entertainment to be a stuntman in a movie. Bruno is widely known as the best motorcycle stuntman in the business, and the movie, Xtreme Riders, has numerous scenes involving high-speed freestyle street-bike stunts. Filming is set to begin August 1 and end by December 1 so that the film can be released the following summer. Both parties to the contract have stipulated that the filming must end on time in order to capture the profits from the summer movie market. The contract states that Bruno will be paid 10 percent of the net proceeds from the movie for his stunts. The contract also includes a liquidated damages provision, which specifies that if Bruno breaches the contract, he will owe X Entertainment $1 million. In addition, the contract includes a limitation-of-liability clause stating that if Bruno is injured during filming, X Entertainment‘s liability is limited to nominal damages. Using the information presented in the chapter, answer the following questions. 312. One day, while Bruno is preparing for a difficult stunt, he gets into an argument with the director and refuses to perform any stunts. Can X Entertainment seek specific performance of the contract? Why or why not? Solution No. This is a personal-service contract, and courts are reluctant to grant specific performance of contracts for personal services. To order parties to perform personal services against their will amounts to a type of involuntary servitude, which is contrary to the public policy (expressed in the Thirteenth Amendment). Also, the courts do not want to monitor such contracts. 313. Suppose that while performing a high-speed wheelie on a motorcycle, Bruno is injured by an intentionally reckless act of an X Entertainment employee. Will a court be likely to enforce the limitation-of-liability clause? Why or why not? Solution In light of the status of Bruno in the stunt industry, the clause may be enforced. When an exculpatory clause for negligence is contained in a contract made between parties who have roughly equal bargaining positions, the clause usually will be enforced. Besides, his presumed experience and knowledge indicates that he likely carries his own insurance.

198

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

314. What factors would a court consider to determine if the $1 million liquidated damages clause is valid or is a penalty? Solution To determine whether a provision is for liquidated damages or for a penalty, a court asks (1) at the time the contract was formed, was it apparent that damages would be difficult to estimate in the event of a breach, and (2) was the amount set as damages a reasonable estimate of the potential damages and not excessive. If the answers to both questions are yes, the provision normally will be enforced. If either answer is no, the provision will normally not be enforced. 315. Suppose that there was no liquidated damages clause (or the court refused to enforce it) and X Entertainment breached the contract. The breach caused the release of the film to be delayed by many months. Could Bruno seek consequential (special) damages for lost profits from the summer movie market in that situation? Explain. Solution When damages are awarded, compensation is given only for those injuries that a defendant could reasonably have foreseen as a probable result of the usual course of events following a breach. If the injury complained of is outside the usual and foreseeable course of events, the plaintiff must show specifically that the defendant had reason to know the facts and foresee the injury. In other words, to recover consequential damages, a breaching party must know (or have reason to know) before the breach that special circumstances will cause the nonbreaching party to suffer an additional loss. Thus, if X Entertainment breached the contract with Bruno, knowing that it would delay the release of the film, Bruno may collect consequential damages.

Practice and Review: Debate This 316. Courts should always uphold limitation-of-liability clauses, whether or not the two parties to the contract had equal bargaining power. Solution One of the reasons that imitation-of-liability clauses are included in contracts is to allow sellers to predict the extent of their liabilities should something go wrong. Without such clauses, sellers would have a difficult time obtaining liability insurance and when such insurance could be obtained, it would be at higher prices. All consumers would suffer as a result. Moreover, certainly buyers and sellers with equal bargaining powers should be obligated to accept all clauses written into contracts. Nevertheless, even if one of the parties has less bargaining power than the other, the courts should still uphold limitation-of-liability clauses because there is enough competition in the marketplace so that contracts between buyers and sellers are the result of the interactions of supply and demand and are therefore efficient. How can a judge or jury uphold all limitation-of-liability clauses when in so doing they often would be perpetuating gross injustices? After all, such clauses are usually contained in long contracts when printed out or presented on a website in small type. Most of the time, consumers do not read contracts because they are so long and so complicated. To enforce a limitation-ofliability clause when the consumer was not even aware of its existence would be unfair. Even if a consumer understands such a clause, that does not mean the consumer really has a choice. Most contracts are presented in an all-or-nothing manner. Take it or leave it, with nothing in the middle. Consumers with little or no bargaining power must sign or not obtain the good or service they need.

199

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Issue Spotters 317. Greg contracts to build a storage shed for Haney. Haney pays Greg in advance, but Greg completes only half the work. Haney pays Ipswich $500 to finish the shed. If Haney sues Greg, what would be the measure of recovery? Solution Nonbreaching parties are entitled to their benefit of the bargain under the contract. Here, the innocent party is entitled to be put in the position she would have been in if the contract had been fully performed. The measure of the benefit is the cost to complete the work ($500). These are compensatory damages. 318. Lyle contracts to sell his ranch to Marley, who is to take possession on June 1. Lyle delays the transfer until August 1. Marley incurs expenses in providing for cattle that he bought for the ranch. When they made the contract, Lyle had no reason to know of the cattle. Is Lyle liable for Marley‘s expenses in providing for the cattle? Why or why not? Solution No. To recover damages that flow from the consequences of a breach but that are caused by circumstances beyond the contract (consequential damages), the breaching party must know, or have reason to know, that special circumstances will cause the nonbreaching party to suffer the additional loss. That was not the circumstance in this problem.

Business Scenarios and Case Problems 319. Liquidated Damages. Carnack contracts to sell his house and lot to Willard for $100,000. The terms of the contract call for Willard to make a deposit of 10 percent of the purchase price as a down payment. The terms further stipulate that if the buyer breaches the contract, Carnack will retain the deposit as liquidated damages. Willard makes the deposit, but because her expected financing of the $90,000 balance falls through, she breaches the contract. Two weeks later, Carnack sells the house and lot to Balkova for $105,000. Willard demands her $10,000 back, but Carnack refuses, claiming that Willard‘s breach and the contract terms entitle him to keep the deposit. Discuss who is correct. (See Damages.) Solution The entire issue rests on whether the provision is an enforceable liquidated damages clause or a penalty. Generally, the courts will enforce liquidated damages clauses under the principle of freedom of contract if damages resulting from breach would have been difficult to estimate at the time the contract was entered into and, more importantly, if the amount set is a reasonable estimate of what such damages would be. If the amount is excessive, the court will declare the clause to be a penalty and unenforceable, and only the amount of actual damages proved will be allowed. If, however, the amount in the clause is a reasonable estimate, the court will enforce the clause, even if the actual damages proved to be less. A good discussion of this problem would go into the hindsight effect of the court in comparing actual damages proved to result from breach against those estimated at the time the contract was entered into. Should this influence the court‘s decision? (Here, Carnack actually suffered no damage and instead profited from the breach.) If one believes that $10,000 (10 percent) is excessive, what about $1,000, given the same facts? These clauses are commonly placed in real estate purchase contracts, and the answer in either case depends on whether the clause is treated as a penalty.

200

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

320. Measure of Damages. Before buying a house, Dean and Donna Testa hired Ground Systems, Inc. (GSI), to inspect the sewage and water disposal system. GSI reported a split system with a watertight septic tank, a wastewater tank, a distribution box, and a leach field. The Testas bought the house. Later, Dean saw that the system was not as GSI described—there was no distribution box or leach field, and there was only one tank, which was not watertight. The Testas arranged for the installation of a new system and sold the house. Assuming that GSI is liable for breach of contract, what is the measure of damages? [Testa v. Ground Systems, Inc., 206 N.J. 330, 20 A.3d 435 (App. Div. 2011)] (See Damages.) Solution The Testas may recover compensatory damages and consequential damages for the breach of their contract with GSI. Damages that compensate a nonbreaching party for the loss of the bargain are compensatory damages. These damages compensate the injured party for the damages actually sustained and proved to have arisen directly from the loss of the bargain caused by the breach. The standard measure of compensatory damages is the difference between the value of the breaching party‘s performance under the contract and the value of the breaching party‘s actual performance. A measure of the compensatory damages in this case could be the difference in the value of the property with and without a septic system. Consequential damages are foreseeable damages that result from a party‘s breach of contract. These damages are caused by special circumstances beyond the contract—they flow from the consequences of a breach. To recover consequential damages, the breaching party must know or have reason to know that special circumstances will cause an additional loss. For example, when a party fails to perform a service, knowing that the buyer is depending on that service to determine a further course of action, a court may award consequential damages for the loss of profits from or added costs to fulfill the planned action. In this problem, as consequential damages, the Testas might recover the costs to install the new septic system and the costs to maintain the house between the discovery of the erroneous report and the date that the house was finally sold. In the actual case on which this problem is based, the court issued a judgment in the Testas‘ favor on their claim. 321. Consequential Damages. After submitting the high bid at a foreclosure sale, David Simard entered into a contract to purchase real property in Maryland for $192,000. Simard defaulted (failed to pay) on the contract, so a state court ordered the property to be resold at Simard‘s expense, as required by state law. The property was then resold for $163,000, but the second purchaser also defaulted on his contract. The court then ordered a second resale, resulting in a final price of $130,000. Assuming that Simard is liable for consequential damages, what is the extent of his liability? Is he liable for losses and expenses related to the first resale? If so, is he also liable for losses and expenses related to the second resale? Why or why not? [Burson v. Simard, 35 A.3d 1154 (Md. 2012)] (See Damages.) Solution Simard is liable only for the losses and expenses related to the first resale. Simard could reasonably anticipate that his breach would require another sale and that the sales price might be less than what he agreed to pay. Therefore, he should be liable for the difference between his sales price and the first resale price ($29,000), plus any expenses arising from the first resale. Simard is not liable, however, for any expenses and losses related to the second resale. After all,

201

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Simard did not cause the second purchaser‘s default, and he could not reasonably foresee that default as a probable result of his breach. 322. Liquidated Damages. Cuesport Properties, LLC, sold a condominium in Anne Arundel County, Maryland, to Critical Developments, LLC. As part of the sale, Cuesport agreed to build a wall between Critical Developments‘ unit and an adjacent unit within thirty days of closing. If Cuesport failed to do so, it was to pay $126 per day until completion. This was an estimate of the amount of rent that Critical Developments would lose until the wall was finished and the unit could be rented. Actual damages were otherwise difficult to estimate at the time of the contract. The wall was built on time, but without a county permit, and it did not comply with the county building code. Critical Developments did not modify the wall to comply with the code until 260 days after the date of the contract deadline for completion of the wall. Does Cuesport have to pay Critical Developments $126 for each of the 260 days? Explain. [Cuesport Properties, LLC v. Critical Developments, LLC, 209 Md.App. 607, 61 A.3d 91 (2013)] (See Damages.) Solution Yes. Cuesport has to pay Critical Developments $126 for each of the 260 days that elapsed between the contract deadline and the date of the completion of the wall. A liquidated damages provision in a contract specifies a certain dollar amount to be paid in the event of a future default or breach of contract. A penalty provision also specifies a certain amount to be paid in the event of a default or breach of contract but is designed to penalize the breaching party. Liquidated damages provisions are usually enforceable. A provision that calls for a penalty, however, will not be enforced—recovery will be limited to actual damages. To determine if a provision is for liquidated damages or a penalty, a court asks when the contract was agreed to (1) was it apparent that damages would be difficult to estimate in the event of a breach and (2) was the amount set as damages a reasonable estimate and not excessive? If the answers to both questions are yes, the provision normally will be enforced. If either answer is no, the provision usually will not be enforced. In this problem, the contract that required the construction of the wall provided a $126 per-day payment for Cuesport‘s failure to complete the wall within thirty days. This was a valid liquidated damages clause, rather than an invalid penalty. It was an estimate of the amount of rent that Critical Developments would lose until the wall was finished and the unit could be rented. Actual damages were otherwise difficult to estimate at the time of the contract. In other words, in these circumstances, the answers to both of the questions above are yes. In the actual case on which this problem is based, Critical Developments filed a suit in a Maryland state court against Cuesport for breach. The court awarded the liquidated damages stipulated in the parties‘ contract. On Cuesport‘s appeal, a state intermediate appellate court affirmed. 323. Business Case Problem with Sample Answer— Limitation-of-Liability Clauses. Mia Eriksson was a seventeen-year-old competitor in horseback- riding events. Her riding coach was Kristi Nunnink. Eriksson signed an agreement that released Nunnink from all liability except for damages caused by Nunnink‘s ―direct, willful and wanton negligence.‖ During an event at Galway Downs in Temecula, California, Eriksson‘s horse struck a hurdle. She fell from the horse and the horse fell on her, causing her death. Her parents, Karan and Stan Eriksson, filed a suit in a California state court against Nunnink for wrongful death. Is the limitation-of-liability agreement that Eriksson signed likely to be enforced in her parents‘ case? If so, how would it affect their claim? Explain. [Eriksson v. Nunnink, 233 Cal.App.4th 708, 183 Cal. Rptr.3d 234 (4 Dist. 2015)] (See Contract Provisions Limiting Remedies.)

202

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Solution Yes, the limitation-of-liability agreement that Eriksson signed is likely to be enforced in her parents‘ suit against Nunnink, their daughter‘s riding coach. And this would likely result in a judgment against them unless they can establish Nunnink's ―direct, willful and wanton negligence.‖ A limitation-of-liability clause affects the availability of certain remedies. Under basic contract principles, to be enforceable, these clauses must be clear and unambiguous. In this problem, Eriksson, a young equestrian event competitor, signed an agreement that released Nunnink from all liability except for damages caused by Nunnink's ―direct, willful and wanton negligence.‖ During an event, Eriksson‘s horse struck a hurdle, causing her to fall from the horse. The horse fell on her, resulting in her death. Her parents filed a suit against Nunnink for wrongful death. The limitation-of-liability clause expressly released Nunnink from liability for all of Eriksson‘s equestrian activities related to Nunnink's services except for those caused by Nunnink's ―direct, willful and wanton negligence.‖ The clause is straightforward, clear, and unambiguous, and therefore enforceable. Nunnink would be liable only if Eriksson‘s death was caused by Nunnink's gross negligence. The facts do not state that Eriksson‘s parents proved Nunnink was grossly negligent. In the actual case on which this problem is based, the court issued a judgment in Nunnink‘s favor. A state intermediate appellate court affirmed the judgment, on the basis expressed here. 324. Damages. Robert Morris was a licensed insurance agent working for his father‘s independent insurance agency when he contacted Farmers Insurance Exchange in Alabama about becoming a Farmers agent. According to Farmers‘ company policy, Morris was an unsuitable candidate due to his relationship with his father‘s agency. But no Farmers representative told Morris of this policy, and none of the documents that he signed expressed it. Farmers trained Morris and appointed him its agent. About three years later, however, Farmers terminated the appointment for ―a conflict of interest because his father was in the insurance business.‖ Morris filed a suit in an Alabama state court against Farmers, claiming that he had been fraudulently induced to leave his father‘s agency to work for Farmers. If Morris was successful, what type of damages was he most likely awarded? What was the measure of damages? Discuss. [Farmers Insurance Exchange v. Morris, 228 So.3d 971 (Ala. 2016)] (See Damages.) Solution

If Morris succeeds in the action against his former employer for fraudulently inducement, he is most likely to be awarded compensatory damages. Plaintiffs are awarded compensatory damages to compensate for actual losses. The goal is to make the plaintiffs whole and place them in the same positions that they would have been in if the damage had not occurred. In this problem, Morris was working for his father‘s insurance agency when he contacted Farmers Insurance Exchange about becoming its agent. Farmers trained Morris and gave him an appointment as an agent. But three years later, Farmers terminated the appointment for ―a conflict of interest because his father was in the insurance business.‖ Farmers had never informed Morris that according to its company policy he was unsuitable to serve as its agent due to his relationship with his father‘s agency. These circumstances constitute a case of fraud—the company‘s silence on its policy was an intentional misrepresentation of a material fact on which Morris reasonably relied to his detriment.

203

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

Morris‘s injury consisted of the ―opportunities‖ that he had lost by becoming an agent for Farmers—selling insurance policies out of his father‘s agency—and this would be the measure of the damages to which he is entitled. He might prove the amount of the lost commissions on those sales by showing what he sold during that same period for Farmers. In the actual case on which this problem is based, a jury awarded Morris $600,000 in compensatory damages, and the court entered a judgment on the verdict. The Alabama Supreme Court affirmed. Morris‘s measure of damages was based on ―the opportunities he had lost by becoming a Farmers agent.‖ 325. Reformation. Dr. John Holm signed a two-year employment agreement with Gateway Anesthesia Associates PLLC. During negotiations for the agreement, Gateway‘s president, Dr. Jon Nottingham, told Holm that on completion of the contract he would become a partner in the firm, and during the term he would be paid ―like a partner.‖ The written agreement did not reflect this promise—the contract read that Holm would be paid based on ―net collections‖ for his services and did not state that at the end of the term he would become a partner. Later, Gateway told Holm that it did not intend to make him a partner. Holm filed a complaint in an Arizona state court against Gateway, alleging breach. Before the trial, Holm filed a motion to reform the contract to express what he had been told. Nottingham did not dispute Holm‘s account. What is the basis for the reformation of a contract? Is it appropriate in this case? Why or why not? [Holm v. Gateway Anesthesia Associates PLLC, 2018 WL 770503 (Ariz. Div. 1 2018)] (See Equitable Remedies.) Solution Yes, reformation is appropriate in the circumstances of this case. Reformation is an equitable remedy used when the parties to an agreement have imperfectly expressed it in writing. A court applies this remedy to rewrite the contract to reflect the parties‘ true intentions. Courts often order reformation when a mutual mistake exists. In this problem, during negotiations for an employment agreement, the employer‘s president Nottingham told the potential employee Holm that at the end of the contract‘s term Holm would become a partner in the firm. Nottingham also told Holm that during the term he would be paid ―like a partner.‖ The written expression did not reflect this exchange—it explained that Holm‘s compensation would be based on ―net collections‖ for his services and did not state that he would become a partner. When the firm refused to offer Holm a partnership, he filed a suit for breach and sought to reform the contract. Nottingham‘s telling Holm that during the term of the deal Holm would be paid ―like a partner‖ supports a conclusion that he would be compensated as he was told. And Nottingham did not dispute that this is what he told Holm. Thus, there does not appear to be a genuine issue of material fact regarding a mistake in the written expression of the parties‘ agreement. The purpose of reformation is to correct a mistake that occurs when, as here, the parties‘ intent does not accord with its written expression. In the actual case on which this problem is based, the court granted Holm‘s motion for reformation. A state intermediate appellate court affirmed. Holm did ―not seek to alter the agreement in the sense of changing what the parties agreed to, but rather to bring it in conformity with what the parties actually agreed.‖

204

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

326. A Question of Ethics—The IDDR Approach and Damages. Dr. John Braun conceived a cutting- edge device to treat adolescent scoliosis, a severe deformity of the spine. As consideration for the assignment of his intellectual property in the invention, Medtronic Sofamor Danek, Inc., a medical device manufacturer, offered Braun a higher-than-typical royalty and upfront payment. Medtronic also promised to fund expensive human trials for the device to obtain Food and Drug Administration (FDA) approval. But Medtronic never applied for permission to conduct human clinical studies. Finally, frustrated with the lack of performance on the contract, Braun filed a suit in a federal district court against Medtronic, seeking damages for breach. [Braun v. Medtronic Sofamor Danek, Inc. 2017 WL 6388810 (10th Cir. 2017)] (See Damages.) 327. Why would Medtronic make expensive promises and fail to perform? Is this ethical? Discuss, using the IDDR approach. Solution In answering this question, it should be assumed that Medtronic did not enter into the contract with Braun recklessly. Medtronic must have felt confident that Braun‘s device would obtain the approval of the Food and Drug Administration and be successfully marketed. Perhaps the company‘s actions were chiefly motivated by a desire to keep the device out of the hands of its competitors. The first step of the IDDR approach is an Inquiry—a statement of the ethical issue, its stakeholders, and the applicable standards. Here, the question was whether Medtronic would perform its contract with Braun. The stakeholders would include the parties to the contract, Medtronic‘s personnel, the company‘s owners, its competitors, scoliosis patients and the medical personnel who treat them, and others with a stake in the healthcare field—insurers, consumers, the federal and state governments, and taxpayers. The standards would include the legal prescription that a contract must be performed, and the legal and ethical principle to act truthfully and in good faith. The next steps of the IDDR approach, a Discussion and a Decision, focus on actions to resolve the issue, their strengths and weaknesses, their consequences and effects, and a choice among the options. With respect to its deal with Braun, Medtronic could fully perform, perform substantially, comply in part, or breach the contract. Complete performance would satisfy the company‘s duties to Braun and all stakeholders. This may have been a costly deal, but this sophisticated, business-wise, medical-device maker must calculate the expense into its offer to Braun. Substantial performance might also have met most of the company‘s legal and ethical duties. Part performance would have been less satisfactory and would not have likely prevented Braun‘s suit. But it might have represented a defensible good faith effort. Instead, Medtronic committed to developing Braun‘s invention and then chose not to. The last step of the IDDR approach is a Review of the success or failure of the chosen action to resolve the issue and satisfy the stakeholders. Medtronic‘s choice was clearly a legal breach of the contract and an ethical transgression. This exposed the company to the ensuing litigation, making the deal more expensive than the terms of the original agreement. None of the stakeholders would have been satisfied by this consequence. If Braun were to win the suit, he could attain at least partial gratification from an award of damages. If his invention were then to be developed and marketed, many of the other stakeholders might ultimately benefit.

205

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

In the actual case on which this problem is based, a jury found Medtronic liable and awarded Braun $37 million in damages, including $16 million for breach of contract. The U.S. Court of Appeals for the Tenth Circuit affirmed the award. 328. What would be the measure of damages that Braun seeks? Do the circumstances warrant an award of punitive damages? Explain. Solution The measure of damages that Braun seeks is lost profits. And yes, an award of punitive damages could be appropriate. Damages are designed to compensate a nonbreaching party for the loss of a bargain. In other words, an innocent party is to be placed in the position that party would have been in if the contract had been performed. These damages compensate the injured party only for damages actually sustained and proved to have arisen directly from the loss of the bargain caused by the breach. The standard measure is the difference between the breaching party‘s promised performance and the value of the actual performance. In the deal between Braun and Medtronic, the company promised the doctor a high initial payment and a higher than typical royalty for the assignment of his medical device. The company also promised to pay for human trials so the device could obtain government approval. But Medtronic never applied for permission to conduct human clinical studies, effectively breaching the contract and prompting Braun‘s suit. To obtain damages representing the present value of the profits that Braun lost on the breach, he would have to show that his device was likely to gain government approval. This likelihood was evidenced by Medtronic‘s confidence in the commercial value of the device as underscored by its promises of higher than normal royalties. Braun could have also testified as to the readiness of the device. Other experts might have opined on specific figures for the lost profits. A reasonable jury could base an award of damages on all of this evidence. Punitive damages may be available when a party‘s actions cause both a breach of contract and a tort. In the Braun case, Medtronic‘s conduct could be interpreted as a basis for the tort of fraud. The company chose to induce Braun to enter into a contract for his device and not to perform its part of the deal. As a ground for an award of punitive damages, this misrepresentation could be perceived as having been undertaken in knowing and reckless disregard for any harm to Braun‘s rights. A reasonable jury could infer that Medtronic chose to make this deal only to keep Braun‘s invention out of the hands of the company‘s competitors. The firm may have had no intention of keeping its promise to develop the device for the market. Clearly, this would deprive Braun of royalties and other benefits.

Critical Thinking and Writing Assignments 329. Critical Legal Thinking. Review the discussion of the doctrine of mitigation of damages in this chapter. What are some of the advantages and disadvantages of this doctrine? (See Damages.) Solution One advantage of the mitigation of damages doctrine is that it encourages the productive use of resources, whether they consist of vacant premises, idle employable workers, stored goods, or

206

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 17: Breach and Remedies

some other asset. One disadvantage of the doctrine is that it can reduce the amount a party who breached a contract can be required to pay a nonbreaching party, in effect rewarding the wrongdoer for the breach. 330. Time-Limited Group Assignment—Remedies. Frances Morelli agreed to sell Judith Bucklin a house in Rhode Island for $177,000. The sale was supposed to be closed by September 1. The contract included a provision that ―if Seller is unable to convey good, clear, insurable, and marketable title, Buyer shall have the option to (a) accept such title as Seller is able to convey without reduction of the Purchase Price, or (b) cancel this Agreement and receive a return of all Deposits.‖ An examination of the public records revealed that the house did not have marketable title. Bucklin offered Morelli additional time to resolve the problem, and the closing did not occur as scheduled. Morelli decided that ―the deal was over‖ and offered to return the deposit. Bucklin refused and, in mid-October, decided to exercise her option to accept the house without marketable title. She notified Morelli, who did not respond. She then filed a lawsuit against Morelli in a state court. (See Equitable Remedies.) 331. One group will discuss whether Morelli has breached the contract and will decide in whose favor the court should rule.

207

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Solution The court should rule in Bucklin‘s favor—Morelli was to convey the house with whatever title she had. In this problem, a valid agreement existed and Bucklin was ready to pay the price and obtain the property with its less than marketable title. Morelli‘s effort to return Bucklin‘s deposit should have no effect on the outcome. The option of a return of all deposits belonged to Bucklin, not Morelli. 332. A second group will assume that Morelli did breach the contract and will determine what the appropriate remedy is in this situation. Solution The court should order the remedy of specific performance. Specific performance is an available remedy when purchasers of real estate under written contracts demonstrate that they were at all times ready and willing to perform the contract or when a party unjustifiably refuses or fails to perform under the agreement. In this case, a valid agreement existed and Bucklin was ready, willing, and able to pay the price and accept the property with its title as is. 333. A third group will list some possible reasons why Bucklin wanted to go through with the transaction even when faced with not receiving marketable title. Solution Bucklin could have determined that the current market value of the property greatly exceeded the contract price of $177,000. Thus, even with the additional legal costs associated with converting the title into a marketable title, she would be better off than if she didn't buy the property.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 209 Case 18.1 ............................................................................................................................................... 209 Case 18.2 ............................................................................................................................................... 210 Case 18.3 ............................................................................................................................................... 211 Chapter Review ........................................................................................................................................................... 212 Practice and Review .............................................................................................................................. 212 Practice and Review: Debate This ......................................................................................................... 213 Issue Spotters ........................................................................................................................................ 213 Business Scenarios and Case Problems ................................................................................................. 214 Critical Thinking and Writing Assignments ............................................................................................ 220

208

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Critical Thinking Questions in Cases Case 18.1 334. The contract between McNeill and Rodeo Ford provided that ―any change to [it] must be in writing and we must sign it.‖ Based on this provision, should the court have ruled in favor of McNeill? Explain. Solution No, the court should not have ruled in McNeill‘s favor based on the provision in his contract that ―any change to [it] must be in writing and we must sign it.‖ Rights under a contract cannot be assigned without the obligor‘s consent if the assignment will significantly alter the obligor‘s risks or duties. The contract between Rodeo Ford and McNeill expressly recognized this principle by stating that ―any change to this contract must be in writing and we must sign it.‖ But the assignment of the contract from Rodeo Ford to JP Morgan Chase Bank did not alter the terms of the deal or materially increase the burden on McNeill. And, in fact, as the appellate court pointed out, ―To the contrary, the terms and conditions of the sale remained unchanged after the assignment.‖

209

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

335. Suppose that as part of the assignment of McNeill‘s contract to Chase, instead of decreasing the annual interest rate, the bank had increased it. Would the result have been the same? Discuss. Solution No, the result in this case would not have been the same if, as part of the assignment of McNeill‘s contract to JP Morgan Chase Bank, the bank had increased the annual interest rate instead of decreasing it. Generally, contract rights cannot be assigned without the obligor‘s consent if the assignment will materially alter the obligor‘s risks or duties. In McNeill‘s case, a potentially applicable state statute recognized that assignments are enforceable ―unless otherwise agreed‖ and ―except where the assignment would * * * increase materially the burden or risk imposed on the other party.‖ And the contract between Rodeo Ford and McNeill expressly stated that ―any change to this contract must be in writing and we must sign it.‖ The assignment of the contract from Rodeo Ford to Chase neither altered the terms of the contract nor materially increased the burden on McNeill. The appellate court pointed out that ―the terms and conditions of the sale remained unchanged or favored McNeill,‖ except for Chase‘s lowering of the annual interest rate, which ―favored McNeill.‖ If, however, the bank had increased the annual interest rate instead of decreasing it, McNeill‘s obligation under the contract would have been significantly altered. In that circumstance, without his consent, the court would most likely have considered the assignment to be invalid, rendering the contract void, as McNeill claimed.

Case 18.2 336. The MPN stated that ―applicable state law . . . may provide for certain borrower rights.‖ The Nelnet companies are based in Nebraska. Nebraska‘s commercial code provides that the delivery of a check marks the date of payment. How might this provision affect the decision of the lower court on remand? Solution If the lower court applies the Nebraska provision in the question to the facts in the Mirandette case, the decision of the court will favor the plaintiff. Further, the court‘s reasoning will likely reflect the plaintiff‘s payment-on-receipt theory. The remedy should include at least a refund of ―the wrongful accrual of interest and late fees,‖ with any applicable penalties and interest. In the case, Mirandette borrowed funds to pay for his daughter‘s education. The accompanying note did not specify when payments on the loan were to be credited. Nelnet, Inc. and Nelnet Servicing, LLC credited Mirandette‘s payments ten to thirty days after he mailed the checks. Alleging that this was a manipulation to accrue interest and late fees, Mirandette filed a suit in a federal district court against the Nelnet companies, claiming breach of contract. The defendants filed a motion to dismiss, which the court granted. The U.S. Court of Appeals for the Sixth Circuit reversed. The defendants argued that Mirandette‘s contract was with a third-party lender, not with them— they had been delegated the duty to service the loan. This argument ―failed‖ because the Nelnets did not show that they had ―no obligation to the debtor arising from their acceptance of the

210

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

asserted delegation.‖ They also argued that the note did not state when payments were to be credited, so they could credit them any time. The court concluded that this was an ―absurdity‖ and could not have been intended by the contracting parties. Mirandette theorized that his payments should be credited on receipt. Because the lower court had not addressed this theory, the appellate court remanded the case for consideration of this theory. 337. According to the defendants‘ reasoning, borrowers would have no contract remedies if loan servicers overcharged them. What effect might this circumstance have in the market for credit? Discuss. Solution If borrowers had no contract remedies against loan servicers‘ overcharges, the market for credit could be either non-existent for lack of borrowers or chaotic with an abundance of bad deals from the borrowers‘ perspective. Without possible remedies, there would be considerably less incentive to contract. Of course, honest lenders with integrity might be willing to include remedies in their loan contracts. Potential borrowers would likely seek out such lenders. And sophisticated borrowers might require the inclusion of remedies in their loan contracts (or they might at least insist on sufficient specific details in the deals to avoid an onerous result.)

Case 18.3 338. Capitol Records will, of course, contend that Bozzio‘s agreement to look solely to MPI for payment of all royalties and not to bring any claims against Capitol Records bars her suit in this case. What is Bozzio‘s best response to this contention? Discuss. Solution Bozzio‘s best response to Capitol‘s contention about the interpretation and effect of the band member‘s agreement not to pursue claims against the recording company might be that the agreement bars only claims arising after royalties have been paid to the band‘s loan-out corporation. Her complaint in this case concerns royalties that have allegedly not yet been paid. Thus, her agreement not to file claims against Capitol does not apply. In this case, the plaintiff was Dale Bozzio, a former frontwoman for a Los Angeles, new wave band. She asserted that she was a third-party beneficiary of a contract between Capitol Records, the band‘s recording company and distributor, and Missing Persons, Inc. (MPI), a loan-out corporation formed by the band members to receive the band‘s royalties. The contract at the center of the case concerned the payment of those royalties. MPI had been suspended for its failure to pay state taxes and thus lacked the capacity to sue. The lower court ruled that Bozzio could not maintain this suit due to MPI‘s suspended status and dismissed the complaint. The appellate court reversed the dismissal. The appellate court found no controlling case law to support the lower court‘s ruling and concluded that the corporation‘s suspended status was irrelevant with respect to Bozzio‘s right to bring her third-party claim. 339. What effect might an ultimate decision in the plaintiff‘s favor in this case have on the licensing and sale of digital music? Explain. Solution

211

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

The effect that an ultimate decision in the plaintiff‘s favor in this case might have on the licensing and sale of digital music would seem to be mostly positive. The artists who create the music licensed and sold in digital format would realize a fair share of the profits from their efforts. They would thus be more likely to promote licenses and sales in these formats and be motivated to create more compositions for those markets. The recording and distributing companies that record, produce, license and sell the music would certainly profit from their transactions in digital markets. And they would likewise realize benefits from the artists who tout their products and have an incentive to create more.

Chapter Review Practice and Review Myrtle Jackson owns several commercial buildings that she leases to businesses, one of which is a restaurant. The lease states that tenants are responsible for securing all necessary insurance policies but the landlord is obligated to keep the buildings in good repair. The owner of the restaurant, Joe McCall, tells his restaurant manager to purchase insurance, but the manager never does so. Jackson tells her son-in-law, Rob Dunn, to perform any necessary maintenance for the buildings. Dunn knows that the ceiling in the restaurant needs repair but fails to do anything about it. One day a customer, Ian Faught, is dining in the restaurant when a chunk of the ceiling falls on his head and fractures his skull. Faught files suit against the restaurant and discovers that there is no insurance policy in effect. Faught then files a suit against Jackson. He argues that he is an intended third-party beneficiary of the lease provision requiring the restaurant to carry insurance and thus can sue Jackson for failing to enforce that provision. Using the information presented in the chapter, answer the following questions. 340.

Can Jackson delegate her duty to maintain the buildings to Dunn? Why or why not?

Solution Jackson can delegate the duty to Dunn because she cannot perform all tasks related to her property, but that does not necessarily relieve her of liability. 341.

Who can be held liable for Dunn‘s failure to fix the ceiling, Jackson or Dunn? Why?

Solution Jackson had an obligation to McCall, and thereby his customers, to maintain the building. Her delegation to Dunn will not relieve her of possible liability. If Dunn is in the business of providing such maintenance, by contract, for Jackson, then Dunn could be liable; if Dunn is just an employee of Jackson, then Jackson retains primary liability. 342. Was Faught an intended third-party beneficiary of the lease between Jackson and McCall? Why or why not? Solution The purpose of the contract was to have business premises that would be frequented by clients such as Faught. Hence, he is a third-party beneficiary of the relationship and is due protection from such hazards.

212

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

343. Suppose that Jackson tells Dan Stryker, a local builder to whom she owes $50,000, that he can collect the rents from the buildings‘ tenants until the debt is satisfied. Is this a valid assignment? Why or why not? Solution The assignment of income that is owed from other parties to help satisfy a debt is a normal assignment. However, it could not interfere with the rights in the relationship between Jackson and her tenants.

Practice and Review: Debate This 344. As a matter of public policy, personal injury tort claims cannot be assigned. This public policy is wrong and should be changed. Solution If it‘s not against public policy to allow attorneys to take cases in which, if won, the attorneys obtain contingency fees of, say, one third of the awards, then it should not be against public policy to allow the assignment of personal injury tort claims. Sometimes, individuals do not have the knowledge or the mental state to pursue their own personal injury tort claims. Third parties should be able to undertake the effort necessary, and that is what an assignment of the claims can do. The public policy against the assignment of personal injury tort claims is based on the notion that others should not be the beneficiaries of someone‘s unfortunate situation. If such assignments were legal, unscrupulous individuals and companies would offer money up front—at steep discounts—to pursue individuals‘ personal injury tort claims, thereby depriving the injured parties of their full compensation.

Issue Spotters 345. Eagle Company contracts to build a house for Frank. The contract states that ―any assignment of this contract renders the contract void.‖ After Eagle builds the house, but before Frank pays, Eagle assigns its right to payment to Good Credit Company. Can Good Credit enforce the contract against Frank? Why or why not? Solution Yes. Generally, if a contract clearly states that a right is not assignable, no assignment will be effective, but there are exceptions. Assignment of the right to receive monetary payment cannot be prohibited. 346. Brian owes Jeff $1,000. Ed tells Brian to give him the $1,000 and he will pay Jeff. Brian gives Ed the $1,000, but Ed never pays Jeff. Can Jeff successfully sue Ed for the $1,000? Why or why not? Solution Yes. When one person makes a promise with the intention of benefiting a third person, the third person can sue to enforce it. This is a third-party beneficiary contract. The third party in this problem is an intended beneficiary.

213

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Business Scenarios and Case Problems 347. Third Party Beneficiaries. Wilken owes Rivera $2,000. Howie promises Wilken that he will pay Rivera the $2,000 in return for Wilken‘s promise to give Howie‘s children guitar lessons. Is Rivera an intended beneficiary of the Howie-Wilken contract? Explain. (See Third Party Beneficiaries.) Solution An intended beneficiary is one who can sue the promisor directly for breach of a contract made for the beneficiary‘s benefit. It must be clear from the contract that the parties intended the third party to benefit, the benefit in the agreement must be direct to the third party, and the liability of the promisor must arise from the language of the agreement. In this problem, Rivera is an intended beneficiary: it is clear from the contract that Howie and Wilken intended Rivera to benefit and that the benefit in the agreement is direct to Rivera (Howie is to pay Rivera directly). In this case, Rivera is a creditor beneficiary (one who benefits from a contract in which one party promises another party to pay a third party a debt owed by the promisee to the third party). 348. Assignment. Aron, a college student, signs a one-year lease agreement that runs from September 1 to August 31. The lease agreement specifies that the lease cannot be assigned without the landlord‘s consent. In late May, Aron decides not to go to summer school and assigns the balance of the lease (three months) to a close friend, Erica. The landlord objects to the assignment and denies Erica access to the apartment. Aron claims that Erica is financially sound and should be allowed the full rights and privileges of an assignee. Discuss fully whether the landlord or Aron is correct. (See Assignments.) Solution As a general rule, any rights flowing from a contract can be assigned. There are, however, exceptions, such as when the contract expressly prohibits or limits assignment. Under the principle of freedom of contract, such prohibitions are enforced—unless they are deemed contrary to public policy. For example, courts have held that a clause prohibiting assignment that restrains the alienation of property is invalid by virtue of being against public policy. Authorities differ on how a case like Aron‘s should be decided. Some courts would enforce the prohibition and hold that Aron‘s assignment to Erica is ineffective without the landlord‘s consent. Others would permit the assignment to be effective and would limit the landlord‘s remedies to the normal contract remedies ensuing from Aron‘s breach.

214

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

349. Delegation. Inez has a specific set of plans to build a sailboat. The plans are detailed, and any boatbuilder can construct the boat. Inez secures bids, and the low bid is made by the Whale of a Boat Corp. Inez contracts with Whale to build the boat for $4,000. Whale then receives unexpected business from elsewhere. To meet the delivery date in the contract with Inez, Whale delegates its obligation to build the boat, without Inez‘s consent, to Quick Brothers, a reputable boatbuilder. When the boat is ready for delivery, Inez learns of the delegation and refuses to accept delivery, even though the boat is built to her specifications. Discuss fully whether Inez is obligated to accept and pay for the boat. Would your answer be any different if Inez had not had a specific set of plans but had instead contracted with Whale to design and build a sailboat for $4,000? Explain. (See Delegations.) Solution The contract to build the boat created a set of duties. Whether these duties can be assigned or delegated without Inez‘s consent depends on whether the contractual duties are personal in nature to the performance of the obligor, Whale of a Boat Corp. If the duties are routine (standardized or nonpersonal) and capable of being performed by any firm in the same field, the delegation is permitted and Inez, the obligee, must accept the performance of Quick Brothers. The facts in this case indicate that the building of the boat requires a routine, nonpersonal performance such that any builder could provide. Consequently, the delegation is permitted without Inez‘s consent, and she is obligated to accept and pay for the boat as per her contract. If the contract called for Whale to both design and build the boat, however, a strong argument could be made that the contract is personal to Whale, that delegation is therefore not permitted, and that Inez therefore does not have to accept the boat built by Quick Brothers. 350. Business Case Problem with Sample Answer— Third Party Beneficiary. David and Sandra Dess contracted with Sirva Relocation, LLC, to assist in selling their home. In their contract, the Desses agreed to disclose all information about the property on which Sirva ―and other prospective buyers may rely in deciding whether and on what terms to purchase the Property.‖ The Kincaids contracted with Sirva to buy the house. After the closing, they discovered dampness in the walls, defective and rotten windows, mold, and other undisclosed problems. Can the Kincaids bring an action against the Desses for breach of their contract with Sirva? Why or why not? [Kincaid v. Dess, 48 Kan. App.2d 640, 298 P.3d 358 (2013)] (See Third Party Beneficiaries.) — For a sample answer to Problem 18–4, go to Appendix E. Solution Yes. The Kincaids can bring an action against the Desses for breach of their contract with Sirva. A third person becomes an intended third-party beneficiary of a contract when the original parties to the contract expressly agree that the performance should be rendered to or directly benefit a third person. As the intended beneficiary of a contract, a third party has legal rights and can sue the promisor directly for breach of the contract. Here, the Desses agreed in their contract with Sirva to disclose all information about their property. They further agreed that Sirva and ―other prospective buyers‖ could rely on the Desses' disclosure in deciding ―whether and on what terms to purchase the Property.‖ The Kincaids were not direct parties to the contract between Sirva and the Desses, but the Kincaids were ―other prospective buyers.‖ Thus, the language of the contract indicated that the Kincaids were intended by Sirva and the Desses to be third party beneficiaries of it. As intended beneficiaries of the contract, the Kincaids could sue the Desses directly for its breach.

215

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

In the actual case on which this problem is based, the Kincaids filed a suit in a Kansas state court against the Desses. From a judgment in the Desses‘ favor (for lack of privity), the Kincaids appealed. A state intermediate appellate court reversed on the basis of the reasoning stated above and remanded the case for trial. 351. Third Party Beneficiaries. Randy Jones is an agent for Farmers Insurance Co. of Arizona. Through Jones, Robert and Marcia Murray obtained auto insurance with Farmers. On Jones‘s advice, the Murrays increased the policy‘s limits over the minimums required by the state of Arizona, except for uninsured/ underinsured motorist coverage, for which Jones made no recommendation. Later, the Murrays‘ seventeen-year-old daughter, Jessyka, was in an accident that involved both an uninsured motorist and an underinsured motorist. She sustained a traumatic brain injury that permanently incapacitated her. Does Jessyka have standing to bring a claim against Jones and Farmers as a third party to her parents‘ contract for auto insurance? Explain. [Lucas Contracting, Inc. v. Altisource Portfolio Solutions, Inc., 2016 -Ohio- 474 (Ohio App. 2016)] (See Third Party Beneficiaries.) Solution Yes. Jessyka has standing to bring a claim against Jones and Farmers as a third party to her parents‘ contract for auto insurance. The original parties to a contract can agree that its performance will be rendered to or directly benefit a third person. In that circumstance, the third person is an intended third-party beneficiary of the contract. As an intended beneficiary, the third party has legal rights and can sue the promisor directly for breach of the contract. In this problem, Jessyka‘s parents, Robert and Marcia Murray, obtained auto insurance with Farmers Insurance Co. of Arizona through its agent, Randy Jones. On Jones‘s advice, the Murrays increased the policy‘s limits over the minimums required by the state of Arizona, except for uninsured/underinsured motorist coverage, for which Jones made no recommendation. Later, the Murrays‘ seventeen-year-old daughter Jessyka was in an accident that involved both an uninsured motorist and an underinsured motorist. She sustained a traumatic brain injury that permanently incapacitated her. As a direct beneficiary of the auto policy, Jessyka was clearly a third party intended beneficiary to the insurance transaction between her parents and Farmers, and therefore had standing to file a claim against Farmers based on that contract. In the actual case on which this problem is based, Jessyka, through her parents, filed a claim in an Arizona state court against Farmers and Jones under the state‘s Consumer Fraud Act (CFA). The defendants argued that only the parties to the transaction could bring a claim under the CFA. The court agreed and ruled that Jessyka lacked standing. A state intermediate appellate court reversed, ―in view of the broad language and remedial purpose of the CFA, Jessyka‘s status as a third-party beneficiary to the transaction, and the persuasive reasoning of other courts that have addressed this or similar issues.‖ 352. Third Party Beneficiaries. The Health Care Providers Self Insurance Trust (the trust) provided workers‘ compensation coverage to the employees of its members, including Accredited Aides Plus, Inc. The trust contracted with Program Risk Management, Inc. (PRM), to serve as the program administrator. The contract obligated PRM to reimburse the trust for ―claims, losses, and liabilities . . . arising out of‖ PRM‘s acts or omissions. When the trust became insolvent, the state of New York assessed the trust‘s employer-members for some of its debts. These employermembers filed a suit against PRM for breach of contract. Were the trust‘s employer-members third party beneficiaries of the trust‘s contract with PRM? If so, could the employer-members

216

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

maintain this action against PRM? Explain. [Accredited Aides Plus, Inc. v. Program Risk Management, Inc., 147 A.D.3d 122, 46 N.Y.S.3d 246 (N.Y.A.D. 3 Dept. 2017)] (See Third Party Beneficiaries.) Solution Yes. The members of the trust were third party beneficiaries of the contract with PRM. To establish third-party beneficiary status, there must be a valid contract between two parties and the contract must benefit a third party. To establish intended third party beneficiary status, which would enable the third party to bring an action to enforce the contract, the agreement must have been intended to benefit that third party. In this problem, the Health Care Providers Self Insurance Trust provided workers‘ compensation coverage for the employees of its members. The trust contracted with Program Risk Management, Inc. (PRM) to serve as program administrator. The contract obligated PRM to reimburse the trust for ―claims, losses, and liabilities . . . arising out of‖ PRM‘s acts or omissions. The employermembers of the trust clearly benefitted from the contract with PRM. And these employer-members were necessarily intended to benefit from the contract, considering that the purpose of the trust was to provide its employer-members‘ employees with workers‘ compensation insurance. If PRM breached its duties under the contract, as alleged, it deprived the employer-members of their benefit. The employer-members were thus entitled to maintain their action against PRM. The members of the trust have an ethical duty to pursue this claim on behalf of their stakeholders. These stakeholders include the member corporations, and their owners and employees. The stakeholders also include those who filed claims for workers‘ compensation that were unpaid due to the trust‘s insolvency. The amount of the trust‘s debts and the unpaid claims constitute at least part of the damages that PRM could be ordered to pay. In the actual case on which this problem is based, the court dismissed the employer-members‘ claim for breach on the ground that they were not intended third party beneficiaries of the trust‘s contract with PRM. A state intermediate appellate court reversed the dismissal of the claim for breach, holding that the members sufficiently ―stated‖ their status as intended third-party beneficiaries.

217

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

353. Assignments. State Farm Insurance Co. issued a policy to David Stulberger to insure a Nissan Rogue for collision damage. The policy provided, ―No assignment . . . is binding upon us unless approved by us.‖ When the Nissan was involved in an accident, State Farm agreed that the vehicle should be repaired. M.V.B. Collision, Inc., performed the repairs at a cost of $14,101.80. State Farm offered to pay $9,960.36. Stulberger assigned to M.V.B. the right to pursue State Farm for the difference, or $4,141.44. The assignee filed a suit in a New York state court against the insurer to recoup this amount. The defendant responded with a motion to dismiss, arguing that the plaintiff lacked the capacity to sue because the defendant had not consented to the transfer by Stulberger. Is the assignment valid? Why or why not? [M.V.B. Collision, Inc. v. State Farm Insurance Co., 59 Misc.3d 406, 72 N.Y.S.3d 407 (2018)] (See Assignments.) Solution Yes. The assignment from Stulberger to M.V.B. of the right to pursue State Farm for the difference between the cost of the repair to the insured vehicle and the insurer‘s reimbursement offer is valid. The general rule is of course that parties can freely limit the assignment of their contract rights. But there is an exception to this rule based on the public policy against restraints on alienation—a contract cannot prohibit an assignment of the right to receive funds. Thus, for example, a provision that prohibits the assignment of an insurance policy, or that requires the insurer‘s consent to the assignment, is valid until a loss occurs. An added reason for the prohibition of an assignment of an insurance policy is that the transfer would materially increase the risk to the insurer. Once a loss occurs, however, the anti-assignment provision is void. A subsequent assignment is no longer a transfer of risk under the policy, but a transfer of the right to receive payment for the loss. To prohibit a transfer of this right would be to enforce a restraint on alienation. In this problem, State Farm issued a policy to David Stulberger to cover his auto. The policy barred its assignment without State Farm‘s approval. When Stulberger‘s car was damaged in an accident, State Farm consented to its repair. M.V.B. Collision did the work for $14,101.80. The insurer offered to reimburse $9,960.36. Stulberger assigned to M.V.B. the right to sue State Farm for the difference. In response to M.V.B.‘s suit, State Farm filed a motion to dismiss, arguing that the assignment was invalid. Under the principles stated above, State Farm‘s motion should be denied. In the actual case on which this problem is based, the court denied the motion. ―If we permitted an insurer to avoid its contractual obligations by prohibiting all post-loss assignments, we could be granting the insurer a windfall.‖ 354. A Question of Ethics—Intended Third Party Beneficiaries. The Health Care Providers Self Insurance Trust (the trust) provided workers‘ compensation coverage to the employees of its members, including Accredited Aides Plus, Inc. The trust contracted with Program Risk Management, Inc. (PRM), to serve as the program administrator. The contract obligated PRM to reimburse the trust for ―claims, losses, and liabilities . . . arising out of‖ PRM‘s acts or omissions. When the trust became insolvent, the state of New York assessed the trust‘s employer-members for some of its debts. These employer-members filed a suit against PRM for breach of contract. [Accredited Aides Plus, Inc. v. Program Risk Management, Inc., 147 A.D.3d 122, 46 N.Y.S.3d 246 (3 Dept. 2017)] (See Third Party Beneficiaries.)

218

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Were the trust‘s employer-members third party beneficiaries of the trust‘s contract with PRM? If so, could the employer-members maintain this action against PRM? Solution Yes. The members of the trust were third party beneficiaries of the contract with PRM. To establish third-party beneficiary status, there must be a valid contract between two parties and the contract must benefit a third party. To establish intended third party beneficiary status, which would enable the third party to bring an action to enforce the contract, the agreement must have been intended to benefit that third party. In this problem, the Health Care Providers Self Insurance Trust provided workers‘ compensation coverage for the employees of its members. The trust contracted with Program Risk Management, Inc. (PRM) to serve as program administrator. The contract obligated PRM to reimburse the trust for ―claims, losses, and liabilities . . . arising out of‖ PRM‘s acts or omissions. The employer-members of the trust clearly benefitted from the contract with PRM. And these employer-members were necessarily intended to benefit from the contract, considering that the purpose of the trust was to provide its employer-members‘ employees with workers‘ compensation insurance. If PRM breached its duties under the contract, as alleged, it deprived the employer-members of their benefit. The employer-members were thus entitled to maintain their action against PRM.

Did the members have an ethical duty to pursue this claim? Explain. Solution Yes. The members of the trust have an ethical duty to pursue this claim on behalf of their stakeholders. These stakeholders include the member corporations, and their owners and employees. The stakeholders also include those who filed claims for workers‘ compensation that were unpaid due to the trust‘s insolvency. The amount of the trust‘s debts and the unpaid claims constitute at least part of the damages that PRM could be ordered to pay. In the actual case on which this problem is based, the court dismissed the employermembers‘ claim for breach on the ground that they were not intended third party beneficiaries of the trust‘s contract with PRM. A state intermediate appellate court reversed the dismissal of the claim for breach, holding that the members sufficiently ―stated‖ their status as intended third-party beneficiaries.

219

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 18: Third Party Rights

Critical Thinking and Writing Assignments 355. Critical Legal Thinking. If intended third party beneficiaries could not sue the promisor directly to enforce a contract, what would their legal remedy be? (See Third Party Beneficiaries.) Solution Allowing a third-party beneficiary to sue a promisor directly in effect circumvents the ―middle person‖ (the promisee) and thus reduces the burden on the courts. If a third-party beneficiary could not sue the promisor directly for a breach of the contract, the third party could most likely sue the promisee, who would then sue the promisor. 356. Time-Limited Group Assignment—Assignment. The Smiths buy a house. They borrow 80 percent of the purchase price from the local ABC Savings and Loan. Before they make their first payment, ABC transfers the right to receive mortgage payments to Citibank. (See Assignments.) 1.

The first group will outline what would happen if the Smiths continued to make all their payments to ABC Savings and Loan because ABC never notified them of the assignment. Solution Until the obligor has notice of an assignment, the obligor can discharge the obligation by performance to the assignor (the obligee). Performance by the obligor to the assignor (obligee) constitutes a discharge to the assignee. In this problem, the Smiths are not notified of ABC‘s assignment of their mortgage payments to Citibank, and they continue to make the payments to ABC. Although the assignment was presumably valid, the Smiths‘ payments to ABC can discharge the debt. The failure to notify the Smiths of the assignment causes Citibank to lose its right to collect the payments from the Smiths. (Citibank still has a claim against ABC for the amount, however.)

The second group will describe what would happen if the Smiths were notified by ABC of the assignment but continued to make payments to ABC. Solution A borrower who obtains a loan may later receive a notice from the lender stating that it has transferred (assigned) its rights to receive payments on the loan to another firm. When it is time to repay the loan, the borrower must make the payments to that other firm. This is common among financial institutions that make mortgage loans. Giving notice of the assignment is not legally necessary to establish its validity—an assignment is effective immediately, whether or not notice is given. But once the obligor receives proper notice, only performance to the assignee can discharge the obligor's obligations. Thus, in this problem, if ABC notified the Smiths of the assignment, but the Smiths continued to make payments on the loan to ABC, their payments to ABC would not discharge the debt, which is of course owed to Citibank.

220

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

A third group will determine what would happen if the Smiths failed to make any payments on the loan. Which financial institution would have the right to repossess their house? Solution A borrower who obtains a loan must make the payments on the loan to discharge it. And once the obligor receives notice of an assignment of those payments, only performance to the assignee can discharge the obligor's obligations. In this problem, assuming that the Smiths were notified of ABC‘s assignment of the payments on their loan to Citibank, the assignee would be entitled to enforce the payments in court. The Smiths‘ failure to make payments on the loan would give the assignee the right to repossess their house.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 221 Adapting the Law to the Online Environment ................................................................................ 221 Critical Thinking Questions in Cases ................................................................................................................... 222 Case 19.1 ............................................................................................................................................... 222 Case 19.2 ............................................................................................................................................... 222 Case 19.3 ............................................................................................................................................... 224 Chapter Review ........................................................................................................................................................... 224 Practice and Review .............................................................................................................................. 224 Practice and Review: Debate This ......................................................................................................... 226 Issue Spotters ........................................................................................................................................ 226 Business Scenarios and Case Problems ................................................................................................. 227 Critical Thinking and Writing Assignments ............................................................................................ 233

Critical Thinking Questions in Features Adapting the Law to the Online Environment 357. Does the Supreme Court‘s decision in South Dakota v. Wayfair, Inc., make it more or less likely that Congress will enact legislation that requires out-of-state corporations to collect and pay taxes to states for online sales? Solution Congress is probably more likely to pass legislation aimed at taxing online sales in the aftermath of the Supreme Court‘s holding to clarify the states‘ power to impose taxes on Internet sales. Although legislation had been proposed before this case was decided, it is has been difficult for Congress to come to a consensus because there are so many taxing jurisdictions involved (by one estimate, nearly twelve thousand, including states, cities, and counties).

221

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

Critical Thinking Questions in Cases Case 19.1 358. Suppose that the parties admitted that they had agreed Kastalon would store the rolls for up to one year. How would this have affected the court‘s decision on breach of contract? Solution If the parties had admitted to an agreement for Kastalon to store the rolls for up to one year, then a court would likely have held that there was an enforceable contract. The terms would have been sufficiently definite for the court to enforce the agreement and determine a remedy for breach. The end result may not have been much different for Toll Processing, however, since the facts of this case indicate that Kastalon stored the rolls for more than two years. Thus, even if the storage agreement for one year were enforceable, a court would likely have decided that Kastalon did not breach the contract by getting rid of the rolls two years later. Kastalon did not promise to store the rolls indefinitely, and it would be unreasonable for a court to require it to store the rolls an entire year past the time specified in the contract. 359. Was it unethical for Kastalon to scrap the rolls without attempting to contact Toll Processing? Explain. Solution Probably not. Kastalon had agreed to move and store the rolls for Toll Processing at no cost because it anticipated getting a contract to refurbish the rolls for Toll Processing. It took Kastalon three months to move the rolls to its own facility, and the company incurred costs for labor and transportation, as well as the burden of storing fifty-seven pickle rolls. It was Toll Processing‘s responsibility to contact Kastalon about the rolls that were in its possession, more than it was Kastalon‘s duty to contact Toll Processing. If Toll Processing had informed Kastalon what was happening with the pickle rolls and that it still intended to use them, the whole dispute could have been avoided. Nevertheless, even if it were not an ethical breach, it would have been a prudent business practice for Kastalon to contact Toll Processing before scraping the rolls.

Case 19.2 360. In a requirements contract, a buyer agrees to buy, and a seller agrees to sell, all or up to a stated amount of what the buyer needs or requires. Was the contract between Avon and Tubular a requirements contract? Explain. Solution Yes, the contract between Avon and Tubular was a requirements contract. In a requirements contract, a buyer agrees to buy, and a seller agrees to sell, all or up to a stated amount of what the buyer needs or requires. Tubular issued a purchase order that provided the buyer would issue weekly lists of the quantity of parts needed and a reasonable forecast of future requirements. The order obligated Tubular to buy from Avon a quantity between one part and 100 percent of the parts that the buyer needed. In this case, the purchase order, considered together with the parties‘ six-year compliance with its terms, established a requirements contract. A requirements contract does not have to be exclusive. Thus, the fact that Tubular was not required by the terms of the purchase order to buy all of its requirements for parts from Avon did not disqualify the deal from meeting the definition of a requirements contract.

222

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

223

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

361. Suppose that the purchase order had not provided for the payment of consideration. Would the result have been the same? Discuss. Solution No, the result in this case would not have been the same if Tubular‘s purchase order had not provided for the payment of consideration. The purchase order stated, ―In consideration for ten US dollars (US$10.00) * * * Seller grants to Buyer an irrevocable option during the term of this Order to purchase Supplies in such quantities as determined by Buyer.‖ The appellate court interpreted this term as a merchant‘s firm offer under MCL Section 440.2205, the state‘s version of UCC 2–205. Under that statute, the offer does not require consideration, but it remains irrevocable for only three months (or less, subject to a stated contingency), unless it is renewed. The court found that this provision applies only to offers that are not supported by consideration. Because Tubular‘s order provided for the payment of consideration, the court concluded that the statute did not apply. If, however, the order had not provided for the payment of consideration, UCC 2–205 could have been applied to limit the term of the offer to three months. The parties had been doing business for six years, well beyond an initial three-month period. And, arguably, because the statute requires a signed writing, it might not have applied at all, since Avon did not sign it. Under those circumstances, Avon would have been successful in its request for the court‘s declaration that the ―irrevocable option‖ was invalid. The seller could then have chosen to fulfill only some of the buyer‘s lists for parts, which is what Avon sought.

Case 19.3 362. Why would the seller‘s knowledge of the buyers‘ limited resources support a finding of unconscionability? Solution It may be that the court viewed the sellers‘ knowledge of the buyers‘ limited resources as evidence that the defendant‘s approach to the transaction was knowingly exploitative and overreaching.

Chapter Review Practice and Review Guy Holcomb owns and operates Oasis Goodtime Emporium, an adult entertainment establishment. Holcomb wanted to create an adult Internet system for Oasis that would offer customers adult theme videos and live chat room programs using performers at the club. On May 10, Holcomb signed a work order authorizing Thomas Consulting Group (TCG) ―to deliver a working prototype of a customer chat system, demonstrating the integration of live video and chatting in a Web browser.‖ In exchange for creating the prototype, Holcomb agreed to pay TCG $64,697. On May 20, Holcomb signed an additional work order in the amount of $12,943 for TCG to install a customized firewall system. The work orders stated that Holcomb would make monthly installment payments to TCG, and both parties expected the work would be finished by September. Due to unforeseen problems largely attributable to system configuration and software incompatibility, the project required more time than anticipated. By the end of the summer, the website was still not ready, and Holcomb had fallen behind in the payments to TCG. TCG was threatening to cease work and file suit for breach of contract unless the

224

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

bill was paid. Rather than make further payments, Holcomb wanted to abandon the website project. Using the information presented in the chapter, answer the following questions. 363. Would a court be likely to decide that the transaction between Holcomb and TCG was covered by the Uniform Commercial Code (UCC)? Why or why not? Solution The issue in this question is whether the predominant feature of the contract in the problem is goods or services. Most goods require some related service—their design, assembly, installation, or manufacture— but the effort and expertise to make a good does not mean that the buyer is buying the service instead of the good. The focus is on the buyer‘s objective. Does the buyer want a good or a service? To fall under the UCC, the service must be incidental to the buyer‘s purpose. In this problem, a court would most likely conclude that the service TCG is providing (customizing software) is incidental to Holcomb‘s goal (acquiring an operational website). 364. not?

Would a court be likely to consider Holcomb a merchant under the UCC? Why or why

Solution Under the UCC, a merchant is a person who deals in goods of the kind involved in the sales contract. A merchant for one type of goods is not necessarily a merchant for another type. Here, the goods in the contract between Holcomb and TCG consist of a website, for which Holcomb might not be considered a merchant because his business is adult entertainment (arguably a service), not technology. 365.

Did the parties have a valid contract under the UCC? Explain.

Solution It appears that the parties in this problem have a valid contract under the UCC. The essential terms—price, payment, delivery, duration, and quantity—are not left open, but are set out in a signed writing. 366. Suppose that Holcomb and TCG meet in October in an attempt to resolve their problems. At that time, the parties reach an oral agreement that TCG will continue to work without demanding full payment of the past-due amounts and Holcomb will pay TCG $5,000 per week. Assuming that the contract falls under the UCC, is the oral agreement enforceable? Why or why not? Solution This oral agreement would not be enforceable, because its amount would bring it within the Statute of Frauds, which requires that to be enforceable, a contract for a sale of goods priced at $500 or more must be in writing and signed by the party against whom enforcement is sought.

225

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

Practice and Review: Debate This 367. The UCC should require the same degree of definiteness of terms, especially with respect to price and quantity, as general contract law does. Solution Contract law requires definiteness sufficient for the parties to ascertain the contract‘s essential terms when it is accepted. The UCC, in its quest to encourage more commerce, went overboard by removing this definiteness requirement. In so doing, the UCC opened up too many possibilities for fraud and unethical behavior on the part of one of the parties to a sales contract. Simply requiring that the parties‘ actions show an intent to enter into a contract seems like an awfully weak standard. The UCC was created to make sure that parties to sales agreements carried out those agreements. The UCC creates a sales contracting environment that promotes exchange rather than one that encourages parties to find ways to back out of sales agreements. Sometimes, parties to a sales contract truly wish to reach an agreement but do not specify certain elements to the sales contract. That does not necessarily mean that they weren‘t serious about entering into the agreement.

Issue Spotters 368. E-Design, Inc., orders 150 computer desks. Fav-O-Rite Supplies, Inc., ships 150 printer stands. Is this an acceptance of the offer or a counteroffer? If it is an acceptance, is it a breach of the contract? What if Fav-O-Rite told E-Design it was sending the printer stands as ―an accommodation‖? Solution A shipment of nonconforming goods constitutes an acceptance and a breach, unless the seller seasonably notifies the buyer that the nonconforming shipment does not constitute an acceptance and is offered only as an accommodation. Thus, since there was no notification in this problem, the shipment was both an acceptance and a breach. 369. Truck Parts, Inc. (TPI), often sells supplies to United Fix-It Company (UFC), which services trucks. Over the phone, they negotiate for the sale of eighty-four sets of tires. TPI sends a letter to UFC detailing the terms and two weeks later ships the tires. Is there an enforceable contract between them? Why or why not? Solution Yes. In a transaction between merchants, the requirement of a writing is satisfied if one of them sends to the other a signed written confirmation that indicates the terms of the agreement, and the merchant receiving it has reason to know of its contents. If the merchant who receives the confirmation does not object in writing within ten days after receipt, the writing will be enforceable against that merchant even though no document had been signed.

226

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

Business Scenarios and Case Problems 370. Additional Terms. Strike offers to sell Bailey one thousand shirts for a stated price. The offer declares that shipment will be made by Dependable Truck Line. Bailey replies, ―I accept your offer for one thousand shirts at the price quoted. Delivery to be by Yellow Express Truck Line.‖ Both Strike and Bailey are merchants. Three weeks later, Strike ships the shirts by Dependable Truck Line, and Bailey refuses to accept delivery. Strike sues for breach of contract. Bailey claims that there never was a contract because his reply, which included a modification of carriers, did not constitute an acceptance. Bailey further claims that even if there had been a contract, Strike would have been in breach because Strike shipped the shirts by Dependable, contrary to the contract terms. Discuss fully Bailey‘s claims. (See The Formation of Sales and Lease Contracts.) Solution The answer falls under UCC 2–207. Bailey is incorrect in claiming that the modification of carriers is sufficient reason to claim an acceptance was not made. The law states that if the offeree (Bailey) makes a definite expression of acceptance, a contract is formed even if the terms of acceptance modify the terms of the offer. Therefore, when Bailey replied, ―I accept your offer,‖ an acceptance was made even though the acceptance carried with it a modification. Bailey‘s second contention is probably correct. Between merchants, the additional or modified terms become a part of the contract unless they materially alter the contract or one party objects to the modifications within a reasonable time after receiving notice of them. Three weeks after Strike received the acceptance with the modification, she had still not notified Bailey of her objection to the modification. Therefore, unless the change of truck lines is a material alteration (involving cost or availability, for example), the terms of shipment by Yellow Express have become a part of the contract, and Strike is in breach in using Dependable. The concept of good faith, however, permeates the entire UCC. Thus, it should not make a difference if the shirts come by an unauthorized means of transportation as long as (a) they arrive within a reasonable time, (b) they strictly conform to the contract terms, and (c) it is obvious that both parties intended the contract. 371. Merchant’s Firm Offer. On May 1, Jennings, a car dealer, e-mails Wheeler and says, ―I have a 1955 Thunderbird convertible in mint condition that I will sell you for $13,500 at any time before June 9. [Signed] Peter Jennings.‖ By May 15, having heard nothing from Wheeler, Jennings sells the car to another. On May 29, Wheeler accepts Jennings‘s offer and tenders $13,500. When told Jennings has sold the car to another, Wheeler claims Jennings has breached their contract. Is Jennings in breach? Explain. (See The Formation of Sales and Lease Contracts.) Solution Yes. Under UCC 2–205, a merchant offeror, who in a signed writing gives assurance that an offer will remain open, creates an irrevocable offer (without payment of consideration) for the time period stated in the assurance up to a three-month period. Jennings, as a merchant, was obliged to hold the offer (which had been made in a signed writing—the e-mail) open until June 9. Wheeler‘s acceptance of the offer prior to June 9 created a valid contract, which Jennings breached when he sold the Thunderbird to a third party.

227

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

372. Spotlight on Goods and Services—The Statute of Frauds. Fallsview Glatt Kosher Caterers ran a business that provided travel packages, including food, entertainment, and lectures on religious subjects, to customers during the Passover holiday at a New York resort. Willie Rosenfeld verbally agreed to pay Fallsview $24,050 for the Passover package for himself and his family. Rosenfeld did not appear at the resort and never paid the money owed. Fallsview sued Rosenfeld for breach of contract. Rosenfeld claimed that the contract was unenforceable because it was not in writing and violated the UCC‘s Statute of Frauds. Is the contract valid? Explain. [Fallsview Glatt Kosher Caterers, Inc. v. Rosenfeld, 7 Misc.3d 557, 794 N.Y.S.2d 790 (2005)] (See The Formation of Sales and Lease Contracts.) Solution Yes. The contract was valid because the UCC‘s Statute of Frauds did not apply. Although the contract involved the provision of goods (food) and services (entertainment and accommodations), the holiday resort package was an overall experience, with the predominant part of the contract delivering services. Therefore, under the predominant-factor test, the contract was primarily for the sale of services and was not governed by the UCC. The food was merely secondary to the holiday event, and the Statute of Frauds did not apply. 373. Partial Performance and the Statute of Frauds. After a series of e-mails, Jorge Bonilla, the sole proprietor of a printing company in Uruguay, agreed to buy a used printer from Crystal Graphics Equipment, Inc., in New York. Crystal Graphics, through its agent, told Bonilla that the printing press was fully operational, contained all of its parts, and was in excellent condition except for some damage to one of the printing towers. Bonilla paid $95,000. Crystal Graphics sent him a signed, stamped invoice reflecting this payment. The invoice was dated six days after Bonilla‘s conversation with the agent. When the printing press arrived, Bonilla discovered that it was missing parts and was damaged. Crystal Graphics sent replacement parts, but they did not work. Crystal Graphics was never able to make the printer operational. Bonilla sued, alleging breach of contract, breach of the implied covenant of good faith and fair dealing, breach of express warranty, and breach of implied warranty. Crystal Graphics claimed that the contract was not enforceable because it did not satisfy the Statute of Frauds. Can Crystal Graphics prevail on this basis? Why or why not? [Bonilla v. Crystal Graphics Equipment, Inc., 2012 WL 360145 (S.D.Fla. 2012)] (See The Formation of Sales and Lease Contracts.) Solution Florida Statutes Section 672.103(3)(c) states that a contract that does not satisfy the Statute of Frauds may nonetheless be enforceable ―with respect to goods for which payment has been made and accepted or which have been received and accepted.‖ Given that Bonilla had proof that he had paid in full and received the used printing press, that was ―sufficient to take the contract out of the Statute of Frauds.‖ Both the defendant and the plaintiff are merchants. Because the invoice from Crystal Graphics contained a stamp and signature, specified the quantity (one used printing press), and was dated approximately six days after the parties allegedly entered into an oral agreement, the trier of fact found sufficient evidence ―to establish the existence of an oral contract for the sale of goods over $500, outside the Statute of Frauds.‖ 374. The Statute of Frauds. Kendall Gardner agreed to buy from B&C Shavings a specially built shaving mill to produce wood shavings for poultry processors. B&C faxed an invoice to Gardner reflecting a purchase price of $86,200, with a 30 percent down payment and the ―balance due before shipment.‖ Gardner paid the down payment. B&C finished the mill and wrote Gardner

228

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

a letter telling him to ―pay the balance due or you will lose the down payment.‖ By then, Gardner had lost his customers for the wood shavings, could not pay the balance due, and asked for the return of his down payment. Did these parties have an enforceable contract under the Statute of Frauds? Explain. [Bowen v. Gardner, 2013 Ark.App. 52, 425 S.W.3d 875 (2013)] (See The Formation of Sales and Lease Contracts.) Solution Yes. Gardner and B&C Shavings had a contract enforceable under the Statute of Frauds. The Statute of Frauds applies to contracts for the sales of goods for more than $500. Those contracts must be in writing to be enforceable. A writing satisfies the Statute of Frauds as long as it indicates that the parties intended to form a contract and is signed by the party against whom enforcement is sought. An oral contract for the sale of goods priced at $500 or more will be enforceable despite the absence of a writing if goods are specially manufactured for a particular buyer, are not suitable for resale to others in the ordinary course of the seller's business, and the seller has substantially started to manufacture the goods. In this problem, Gardner agreed to buy a special-order shaving mill from B&C for $86,200, which is clearly more than $500. Thus, the Statute of Frauds applied. B&C agreed to make and deliver the product according to Gardner‘s specifications, and faxed an invoice to Gardner reflecting the purchase price, with a 30-percent down payment and the ―balance due before shipment.‖ The faxed invoice did not contain all of the provisions of the deal—for example, and important to the circumstances in this case, after finishing the mill B&C wrote Gardner a letter telling him to ―pay the balance due or you will lose the down payment.‖ But the order could be enforceable as a contract under the specially-made-goods exception (B&C specially made the mill for Gardner according to his specifications) provided it is not suitable for resale to others without further modifications. In the actual case on which this problem is based, B&C filed a suit in an Arkansas state court against Gardner to recover the rest of the price. On Gardner‘s appeal from a judgment in B&C‘s favor, a state intermediate appellate court affirmed. 375. Business Case Problem with Sample Answer— Goods and Services Combined. Allied Shelving and Equipment, Inc., sells and installs shelving systems. National Deli, LLC, contracted with Allied to provide and install a parallel rack system (a series of large shelves) in National‘s warehouse. Both parties were dissatisfied with the result. National filed a suit in a Florida state court against Allied, which filed a counterclaim. Each contended that the other had materially breached the contract. The court applied common law contract principles to rule in National‘s favor on both claims. Allied appealed, arguing that the court should have applied the UCC. When does a court apply common law principles to a contract that involves both goods and services? In this case, why might an appellate court rule that the UCC should be applied instead? Explain. [Allied Shelving and Equipment, Inc. v. National Deli, LLC, 40 Fla.L.Weekly D145, 154 So.3d 482 (Dist.App. 2015)] (See The Scope of Articles 2 and 2A.) —For a sample answer to Problem 19–6, go to Appendix E. Solution A court applies common law principles to a dispute over contract that involves both goods and services when the court finds the services to be the dominant feature of the agreement. An appellate court, or any court, would rule that the UCC should be applied instead of the common

229

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

law when the court finds the goods to be the dominant aspect of the deal. In either situation, the applicable law covers both the goods and services parts of the contract. In this problem, because the court applied common law contract principles to rule in National‘s favor on both parties‘ claims, the court must have concluded that the services part of the contract was the dominant aspect. In the actual case on which this problem is based, a state intermediate appellate court affirmed the lower court‘s ruling in National‘s favor. The appellate court recognized that the contract was a hybrid involving goods ands services and reasoned that the lower court must have determined the services portion of the agreement to be the dominant factor. But the parties did not provide a trial transcript or a copy of the contract, so the appellate court could only affirm the lower court‘s order. 376. Acceptance. New England Precision Grinding, Inc. (NEPG), sells precision medical parts in Massachusetts. NEPG agreed to supply Kyphon, Inc., with certain medical parts. NEPG contracted with Simply Surgical, LLC, to obtain the parts from Iscon Surgicals, Ltd. The contract did not mention Kyphon or require Kyphon‘s acceptance of the parts. Before shipping, Iscon would certify that the parts conformed to NEPG‘s specifications. On receiving the parts, NEPG would certify that they conformed to Kyphon‘s specifications. On delivery, Kyphon would also inspect the parts. After about half a dozen transactions, NEPG‘s payments to Simply Surgical lagged, and the seller refused to make further deliveries. NEPG filed a suit in a Massachusetts state court against Simply Surgical, alleging breach of contract. NEPG claimed that Kyphon had rejected some of the parts, which gave NEPG the right not to pay for them. Do the UCC‘s rules with respect to acceptance support or undercut the parties‘ actions? Discuss. [New England Precision Grinding, Inc. v. Simply Surgical, LLC, 89 Mass.App.Ct.176, 46 N.E.3d 590 (2016)] (See The Formation of Sales and Lease Contracts.) Solution The UCC‘s rules with respect to acceptance support the decision of Simply Surgical to refuse deliveries, and those principles undercut the decision of NEPG to withhold payment. Under the UCC, acceptance of an offer to buy or sell goods may be made in any reasonable manner and by any reasonable means. The UCC permits acceptance of an offer to buy goods ―either by a prompt promise to ship or by the prompt or current shipment of conforming or nonconforming goods‖ Conforming goods, of course, are in accord with the terms of the parties‘ contract, and nonconforming goods are not. The prompt shipment of nonconforming goods constitutes both an acceptance, which creates a contract, and a breach of a contract for their sale. In this problem, the facts indicate that the goods provided by Simply Surgical were conforming and that NEPG accepted them within the meaning of the UCC. NEPG ordered parts from Simply Surgical that Iscon manufactured according to NEPG‘s specifications, and each party in the chain of distribution certified that the parts conformed to those specifications. NEPG did its own inspection before accepting the parts, and sent the parts to Kyphon with a certification that they conformed to Kyphon‘s specifications. Kyphon also inspected the parts, but this was not a requirement of the contract between NEPG and Simply Surgical. In fact, there is no indication that NEPG even mentioned Kyphon‘s acceptance or rejection of the parts to Simply Surgical.

230

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

In the actual case on which this problem is based, the court issued a judgment in favor of Simply Surgical. A state intermediate appellate court affirmed, in part, on the facts and reasoning stated above. 377. Requirements Contracts. Medalist Golf, Inc., a high-end golf course builder, was working on a new golf course project in Missouri. Chris Williams, doing business as Cane Creek Sod, submitted a bid with Medalist to provide Meyer Zoysia grass sod for the project. Williams and Medalist executed a ―grass supplier agreement‖ that specified the type and quality of grass to be used, stated the price, and gave Medalist a right to inspect and reject the sod. The parties estimated the quantity of sod needed for the project to be twenty-one acres. Williams had approximately sixty-five acres of Meyer Zoysia growing at the time. The agreement did not specify the amount of sod that Medalist would purchase from Williams, nor did it say that Medalist would buy Williams‘s sod exclusively. Later, when Medalist had an expert inspect William‘s sod (before it was harvested), the expert concluded that it did not meet the quality standards required for the project. Medalist therefore rejected the sod. Williams sued for breach of contract. Was the ―grass supplier agreement‖ enforceable as a requirements contract? Why or why not? [Williams v. Medalist Golf, Inc., 2018 WL 1046889 (E.D.Mo. 2018)] (See The Formation of Sales and Lease Contracts.) Solution No. The grass supplier agreement does not qualify as a requirements contract because Medalist did not give up the right to buy sod from someone other than Williams. In a requirements contract, the buyer agrees to purchase, and the seller agrees to sell all or up to a stated amount of what the buyer needs or requires. There is implicit consideration because the buyer gives up the right to buy goods from any other seller. An enforceable ―requirements contract‖ thus requires exclusivity. In this problem, Medalist did not give up the right to buy sod from any other seller, so its promise (in the grass supplier agreement) was unenforceable as a requirements contract. Without a definite and certain quantity term, there is no mutuality of obligation. If the quantity term is left open in a contract, the courts do not have a basis for determining a remedy. In the actual case on which this problem is based, the court held that no requirements contract was formed and granted Medalist a summary judgment. The court reasoned that Williams admitted that he understood the agreement to mean that he was guaranteeing that the sod would be of a quality that satisfied the customer. In addition, Williams understood that the quantity in the agreement was an estimate, and that Medalist could use less Meyer Zoysia sod on the Project. The court further noted that even if the agreement was an enforceable contract, Williams did not tender conforming goods and Medalist promptly rejected the nonconforming goods (even before the sod had been harvested). Therefore, Williams could not prove any damages. 378. A Question of Ethics—The IDDR Approach and Sales and Lease Contracts. Camal Terry signed a ―Sales Contract‖ to buy a 1995 BMW 3 Series from Robin Drive Auto, a car dealership in Delaware. Terry agreed to pay $4,995, and Robin Drive agreed to hold the BMW on layaway for him in contemplation of a sale within twenty-one days. Also specified were a down payment of $1,200 and the timing of other payments. But under the payment schedule, Terry was to pay $100 a week for six weeks (forty-two days) even though the sale was to take place twentyone days later. In addition, the contract provided that the payments were fees for storage and

231

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

―prep‖ and were not deductible from the price of the car. Terry paid more than $1,000 before asking Robin Drive to refund the money. When the dealership refused, Terry filed a suit in a Delaware state court against Robin Drive. Testimony about the mismatched contract terms was conflicting. [Terry v. Robin Drive Auto, 2017 WL 65842 (Del.Com.Pl. 2017)] (See The Formation of Sales and Lease Contracts.) 1.

Ethically, what is wrong with this deal? Explain. Solution From an ethical (and legal) perspective, what is wrong with this deal for a BMW is the lack of clarity in the written ―Sales Contract,‖ the discrepancy among its terms, and the parties‘ conflicting testimony about their agreement. The situation could have been fixed by an expression of definite terms or by terms of sufficient clarity that a court could supply whatever was missing and fashion a remedy. This fix would have protected the rights of the deal‘s stakeholders—Robin Drive Auto and Camal Terry. From a legal (and ethical) perspective, the Uniform Commercial Code (UCC) governs the creation, interpretation, and enforcement of this sales contract—it involves a merchant selling goods to a consumer. The UCC imposes an obligation of good faith into every sales contract. In the case of a merchant, good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. The UCC provides open-term provisions that can be used to fill the gaps in a contract. All that is necessary to prove the existence of a contract is an indication that there is a contract. Missing terms can be proved by evidence, or it will be presumed that what the parties intended was whatever is reasonable. In this problem, however, the agreement contained ambiguities and contradictions in its terms for the price of the goods and the date for full payment. With regard to the merchant seller, this likely violated the UCC‘s requirement of good faith. In Terry‘s suit, the court would have been unable to determine the parties‘ intent from their ―Sales Contract‖ and conflicting testimony. The court may have had no choice but to hold the contract void from the outset. If the contract were held to be void, Terry could not use it as a basis to recover from Robin Drive. But this would have the effect of unjustly enriching the auto dealer by the amount of Terry‘s payments. In the actual case on which this problem is based, the court rendered a decision from which Terry appealed. A state intermediate appellate court awarded Terry damages, on the basis of unjust enrichment, in the amount of the payments that he could prove had been made.

Using the IDDR approach, consider whether Robin Drive has an ethical obligation to use a different contract in its sales to consumers. Solution To be more successful, Robin Drive has an ethical obligation to redraft its contract to use with its sales to consumers. In the Terry case, the contract could have been fixed by an expression of definite terms or by terms of sufficient clarity that a court could supply whatever was missing and fashion a remedy. This draft would have satisfied the auto dealer‘s ethical duty in subsequent deals.

232

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 19: The Formation of Sales and Lease Contracts

The IDDR approach has four steps, starting with an Inquiry to set out the issue, list the stakeholders, and identify applicable ethical standards. The issue here is whether Robin Drive has an ethical obligation to use, in its sales to consumers, a contract that is different from the one at the center of the Terry case. Stakeholders include the dealer‘s owners and employees, including its salespersons, its customers, other auto dealers, and the general public. The IDDR approach‘s next step is a Discussion that considers actions to address the issue. The strengths and weaknesses of the actions, and the consequences and the effects on the stakeholders, are factors to consider. Why should Robin Drive redraft its contract? Making changes could avoid future litigation and, perhaps more importantly, effectively thwart bad reviews related to the current contract. What should such changes consist of? As recognized in the answer to the previous question, the problems with the auto dealer‘s contract include its lack of clarity and the discrepancy among its terms. Those terms could be made consistent and clear, with phrasing in ―plain language.‖ The weaknesses might include the expense of having the contract rewritten and the loss of business from any consumers who would balk at the terms once they are clear. The cost of a redraft could be small compared to an increase in sales to consumers who understand their deals. And some terms could be negotiated with buyers who would otherwise ―walk.‖ The approach‘s third step is to arrive at a Decision and state the reasons. The decision here would seem to be to rewrite the contract. To do nothing would have the obvious effect of changing nothing—no potential increase in business, for example, among consumers who want their deals to be clear. Reasons in support of this decision are stated above—avoiding litigation, thwarting bad reviews, and enhancing the dealer‘s reputation among the general public. Other results might be more confident salespersons and trusting customers, which could affect competition in the local market among other auto dealers. The approach‘s final step is a Review of the success or failure of the action to resolve the issue, and satisfy the stakeholders. If the issue were phrased as a question about the ethical obligation of the dealer to redraft its contract, then doing so would resolve the issue. Such a fix could have the added value of meeting a merchant‘s good faith obligation under the law, and could lead to more business. This would seem to be a win-win-win situation for Robin Drive.

Critical Thinking and Writing Assignments 379. Time-Limited Group Assignment—Parol Evidence. Mountain Stream Trout Co. agreed to buy ―market size‖ trout from trout grower Lake Farms, LLC. Their five-year contract did not define market size. At the time, in the trade, market size referred to fish of one-pound live weight. After three years, Mountain Stream began taking fewer, smaller deliveries of larger fish, claiming that market size varied according to whatever its customers demanded and that its customers now demanded larger fish. Lake Farms filed a suit for breach of contract. (See The Formation and of Sales and Lease Contracts.) 1.

The first group will decide whether parol evidence is admissible to explain the terms of this contract. Are there any exceptions that could apply? Solution

233

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Parol evidence is admissible to explain the terms of this contract. The exceptions that could apply to allow for the admission of outside evidence are those for usage of trade, course of dealing, and course of performance. Under the UCC, the meaning of an agreement is interpreted in light of commercial practices and other surrounding circumstances. Thus, in interpreting a commercial agreement, a court will assume that the usage of trade and course of dealing between the parties was considered when the contract was formed. Also, the conduct that occurs under an agreement—the course of performance—is the best indication of what the parties meant. 2.

A second group will determine the impact of course of dealing and usage of trade on the interpretation of contract terms. Solution In the facts of this problem, the trade usage at the time of the contract indicated that ―market size‖ referred to fish of one-pound live weight. This was the standard for the course of performance between the parties over the first three years of the contract.

A third group will discuss how parties to a commercial contract can avoid the possibility that a court will interpret the contract terms in accordance with trade usage. Solution To avoid the possibility that a court will interpret contract terms in accordance with trade usage or custom, the parties to a commercial contract can include in the writing all of the terms to which they agreed. And the terms of the written contract should be as clear and unambiguous as possible.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 235 Managerial Strategy ........................................................................................................................... 235 Critical Thinking Questions in Cases ................................................................................................................... 235 Case 20.1 ............................................................................................................................................... 235 Case 20.2 ............................................................................................................................................... 236 Case 20.3 ............................................................................................................................................... 237 Chapter Review ........................................................................................................................................................... 237 Practice and Review .............................................................................................................................. 237 Practice and Review: Debate This ......................................................................................................... 238 Issue Spotters ........................................................................................................................................ 239 Business Scenarios and Case Problems ................................................................................................. 239 Critical Thinking and Writing Assignments ............................................................................................ 245

234

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Critical Thinking Questions in Features Managerial Strategy 380. What benefits can delivery by commercial drone provide to consumers? Solution One benefit is the speed of delivery. Amazon Prime Air promises the delivery of small parcels (under five pounds) in thirty minutes. Another benefit is less harm to the environment. At present, most packages are shipped via trucks, which use a lot of fuel, polluting the environment and contributing to global warming, often while stuck in traffic. Delivery by drones may eventually be more efficient and commonplace. 381. Why might the United States be slow to adopt commercial drone delivery in comparison with some other nations? Solution One reason why the United States has taken longer to adopt this technology may be national security. Because of the infamous terrorist attacks of September 11, 2001, in New York, Pennsylvania, and at the Pentagon, the United States is perhaps more concerned than Australia or China about the safety of its airspace (air traffic). Another reason is that the U.S. military uses drones as weapons. Therefore, the government may legitimately be concerned about the potential for commercial drones being hacked by terrorist organizations and used as weapons. In addition, invasion of privacy—by drones flying over residential neighborhoods—is also likely a bigger concern for U.S. citizens than citizens of communist China.

Critical Thinking Questions in Cases Case 20.1 382. State and federal law allows and encourages the use of certain forms of used oil for fuel in high-temperature industrial settings and other situations. Should the court in the BMW case have considered these policies in its opinion? Explain. Solution No. The court in the BMW case did not need to take into account in its opinion state and federal law or policy that allows or encourages the use of certain forms of used oil for fuel in hightemperature industrial settings and other circumstances. The issue at center of the case at bar was whether the plaintiffs successfully alleged that the goods the defendants delivered under their contracts were nonconforming, resulting in a cognizable injury. The plaintiffs complained that the defendants delivered goods of lesser value that did not meet the governing standards and charged breach of warranty and breach of contract. The court dismissed this complaint on the ground that it did not allege any injury. An appellate court reversed the dismissal, concluding that the plaintiffs‘ complaint ―successfully alleged that the delivered goods were nonconforming. . . . If the goods that are delivered do not conform to the goods contemplated by the sale contract, the purchaser has a cause of action under the Uniform Commercial Code.‖ The goods ordered were specific grades of heating oil. According to the plaintiffs, the defendants delivered adulterated goods. The plaintiffs further

235

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

alleged that when used in their heating systems, the mixed oils produced more pollution, increased the risk of fire, and reduced the systems‘ efficiency, which necessitated the purchase of more oil to attain the same level of heat. Thus, at the crux of this case were the parties‘ contracts and the specific standards that applied to the goods involved—the definition of heating oil in the Administrative Code of the City of New York, which incorporated the requirements of the American Society for Testing and Materials, ―as well as common commercial usage, and . . . the UCC.‖ Any other policies of the state or federal government that allow or encourage the use of certain forms of used oil for fuel does not necessarily or automatically justify its use for purposes of the parties‘ contracts and does not provide a basis for dismissal of the plaintiffs‘ complaint. 383. The defendants did not inform the plaintiffs that the delivered oil was a blend. How does this reflect on the ethics of the defendants‘ conduct in this case? Discuss. Solution In certain circumstances, the blending of fuel oils for the purposes of heating systems is not illegal and may, in fact, be encouraged by state or federal policy. But in other situations—such as those presented by the plaintiffs in the BMW case—adulterating pure fuel oil can have significant, negative consequences. If the defendants had informed the plaintiffs that the delivered oil was a blend—for example, if the dealers had told their buyers that a mixed product was being submitted ―on spec‖—they would likely have been acting ethically. It is perhaps their failure to disclose the exact content of the delivered oil, which the plaintiffs had requested to conform to specific standards, that constitutes conduct for which the defendants may be held legally liable and can be considered ethically suspect.

Case 20.2 384. How did the ―usual and customary‖ methods of dealing in the art business help Malmberg deceive the other parties in this case? What additional steps might those parties have taken to protect themselves from such deceit? Solution The apparently heavy reliance in the art industry on dealers and their representations significantly helped Malmberg to deceive all of the parties in this case. As the Connecticut Supreme Court noted, ―in the art industry, it was the ordinary and customary practice that if an individual regularly worked with a particular art dealer or an art dealer was identified on the identification label of a loaned work of art, inquiries about an art transaction would be presented to the art dealer rather than directly to the principal. Buyers ordinarily and customarily relied on representations made by respected dealers regarding their authority to sell works of art. Purchases and sales of works of art were documented solely by a single invoice from seller to buyer. It was also ordinary and customary to proceed with the purchase of valuable works of art without requesting or receiving documentary proof that the selling dealer had the authority to sell the work of art.‖ To thwart such deceit as occurred here would likely take steps outside these practices. As inappropriate and extraordinary as it might seem, artwork owners could be approached directly. Buyers could ask for more substantial evidence of ownership and other authority to sell.

236

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Case 20.3 385. Generally, a broker who only arranges for shipment is not liable for damage or loss to goods during their transport. Why did TQL decide to pay C&C for the cost of the damage to the granite? Discuss. Solution Most likely, TQL decided to pay C&C for the cost of the damage to the granite to avoid legal action, and perhaps to maintain C&C as a customer (which also might have been why C&C chose to pay Sun City for the damage). Under federal law, a carrier is liable for damage or loss during a shipment of goods, but a broker, who in most cases only arranges for the transport, is not. In some situations, however, a broker could be perceived as providing motor vehicle transportation for compensation, which is the legal definition of a carrier. Courts, of course, have ruled both ways on this issue, but the current trend is to impose liability on brokers ―who act as motor carriers.‖ It may also have been possible in the case of TQL that the broker wanted to maintain C&C as a customer. By paying the claim, TQL hoped that the company would not turn to another broker to arrange future shipments. The cost of the claim to TQL might have been relatively small compared to the revenue generated by its relationship with C&C (and other shippers who might have been dissuaded from doing business if the broker appeared not willing to pay claims). 386. Should a risk-of-loss provision be included in a contract for the sale or transport of goods? Why or why not? Solution Yes, a risk-of-loss provision should be included in a contract for the sale or transport of goods. Its purpose is to spell out precisely the liability of the contracting parties for damage or loss to goods during their shipment. The provision should state who is liable, and when, and under what circumstances. The language could disclaim liability altogether or provide for the acceptance of liability only on proof of fault, and might place a limit on the amount of any liability. As added protection, a potentially liable party should obtain insurance coverage to protect against claims for loss or damage.

Chapter Review Practice and Review In December, Mendoza agreed to buy the broccoli grown on one hundred acres of Willow Glen‘s onethousand-acre broccoli farm. The sales contract specified F.O.B. Willow Glen‘s field by Falcon Trucking. The broccoli was to be planted in February and harvested in March of the following year. Using the information presented in the chapter, answer the following questions. 387. At what point is a crop of broccoli identified to the contract under the Uniform Commercial Code? Why is identification significant? Solution

237

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Identification takes place when specific goods are designated as the subject matter of a contract. If a sale involves crops that are to be harvested within twelve months (or during the next harvest season occurring after contracting, whichever is longer), identification takes place when the crops are planted or begin to grow. Identification is significant because it gives the buyer or lessee the right to insure (or to have an insurable interest in) the goods and the right to recover from third parties who damage the goods. 388. When does title to the broccoli pass from Willow Glen to Mendoza under the contract terms? Why? Solution Under the contract terms (―F.O.B. Willow Glen‘s field‖), the title passes to Mendoza at the time and place of shipment. F.O.B. (free on board) indicates that the selling price of goods includes transportation costs to the specific F.O.B. place named in the contract. When the specified F.O.B. place is the place from which the goods are shipped—in this case Willow Glen field—the contract is a shipment contract and the title passes to the buyer at the time of shipment. 389. Suppose that while in transit, Falcon‘s truck overturns and spills the entire load. Who bears the loss, Mendoza or Willow Glen? Solution If a seller is required or authorized to ship goods by carrier but is not required to deliver them to a particular final destination, as under the contract term (―F.O.B. Willow Glen‘s field‖) in this problem, the risk of loss passes to the buyer when the goods are duly delivered to the carrier. Thus, Mendoza assumes the risk when Willow Glen delivers the broccoli to Falcon Trucking. 390. Suppose that instead of buying fresh broccoli, Mendoza contracted with Willow Glen to purchase one thousand cases of frozen broccoli from Willow Glen‘s processing plant. The highest grade of broccoli is packaged under the ―FreshBest‖ label, and everything else is packaged under the ―FamilyPac‖ label. Further suppose that although the contract specified that Mendoza was to receive FreshBest broccoli, Falcon Trucking delivered FamilyPac broccoli to Mendoza. If Mendoza refuses to accept the broccoli, who bears the loss? Solution According to the contract between Willow Glen and Mendoza, Willow Glen was required to deliver the FreshBest broccoli to Falcon Trucking, after which the risk of loss would pass to Mendoza. If Willow Glen delivered the wrong grade of broccoli to Falcon, Willow Glen failed to perform its obligation and breached the contract. Consequently, Willow Glen would bear the loss, at least until the defect is cured.

Practice and Review: Debate This 391. The distinction between shipment and destination contracts for the purpose of deciding who will bear the risk of loss should be eliminated in favor of a rule that requires the buyer to always buy insurance for the goods being shipped. Solution One thing is certain if this rule was put into effect and that is that courts would no longer have to grabble with trying to determine whether the movement of purchased goods involved a shipment or a destination contract. Commerce would become more certain and more fluid. Buyers would

238

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

always know that they are responsible for buying insurance on any goods that they have bought, no matter who is responsible for the shipment and where the goods are to be delivered. If buyers always had to buy insurance to cover losses during the shipment of goods they had purchased, buyers would sometimes pay too much for insurance because sellers might, for example, use carriers with poor accident records. Moreover, buyers might not be able to insure purchased goods if those buyers had no control over how, when, and where the good were to be shipped.

Issue Spotters 392. Under a contract between Great Products, Inc., in New York and National Sales Corporation in Dallas, if delivery is ―F.O.B. New York,‖ the risk passes when the Great Products puts the goods in a carrier‘s hands. If delivery is ―F.O.B. Dallas,‖ the risk passes when the goods reach Dallas. What happens if the contract says only that Great Products is ―to ship goods at the seller‘s expense‖? Solution The result would be the same as if the contract stated, ―F.O.B. New York.‖ For the risk of loss to remain with the seller, a seller must specifically agree to deliver goods to a particular destination. Remember, all contracts are assumed to be shipment contracts unless they state otherwise. 393. Chocolate, Inc., sells five hundred cases of cocoa mix to Dessert Company, which pays with a bad check. Chocolate does not discover that the check is bad until after Dessert sells the cocoa to Eden Food Stores, which suspects nothing. Can Chocolate recover the cocoa from Eden? Explain. Solution No. A seller has voidable title if the goods being sold were paid for with a bad check (a check that is later dishonored). Normally, a buyer acquires only the title that the seller had, or had the power to transfer, but a seller with voidable title can transfer good title to a good faith purchaser (one who buys in good faith without knowledge that the seller did not have the right to sell the goods). Under those circumstances, an original owner cannot recover goods from a good faith purchaser. Here, the ultimate buyer is a good faith purchaser.

Business Scenarios and Case Problems 394. Sales by Nonowners. In the following situations, two parties lay claim to the same goods sold. Explain which party would prevail in each situation. (See Passage of Title.) 1.

Terry steals Dom‘s iPad and sells it to Blake, an innocent purchaser, for value. Dom learns that Blake has the iPad and demands its return. Solution A buyer acquires whatever title the seller has to the goods sold. If the seller is a thief, the seller‘s title is void (seller has no title). Thus, the buyer can acquire no title, and the real owner has superior rights. Dom can recover the set from Blake.

Karlin takes her laptop computer for repair to Orken, a merchant who sells new and used computers. By accident, one of Orken‘s employees sells Karlin‘s laptop computer to Grady, an

239

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

innocent purchaser-customer, who takes possession. Karlin wants her laptop back from Grady. Solution When a person ―entrusts‖ goods to a merchant (a person who deals in goods of that kind), the merchant has the power to transfer a good title to any purchaser who acquires the goods in the ordinary course of business. Karlin entrusted her set to merchant Orken. Orken deals in goods of that kind. Therefore, Orken could pass good title to the set sold to a customer (Grady) because Grady purchased the goods in the ordinary course of business. Consequently, Karlin cannot get the set back from Grady. (But the merchant is liable to the true owner, Karlin, for the equivalent value of the set). 395. Risk of Loss. When will risk of loss pass from the seller to the buyer under each of the following contracts, assuming the parties have not expressly agreed on when risk of loss will pass? (See Risk of Loss.) 1.

A New York seller contracts with a San Francisco buyer to ship goods to the buyer F.O.B. San Francisco. Solution In a destination contract, the risk of loss passes to the buyer when the goods are tendered to the buyer at the specified destination—in this case, San Francisco.

A New York seller contracts with a San Francisco buyer to ship goods to the buyer in San Francisco. There is no indication as to whether the shipment will be F.O.B. New York or F.O.B. San Francisco. Solution In a shipment contract, if the seller is required or authorized to ship goods by carrier, but the contract specifies no locale, the risk of loss passes to the buyer when the goods are duly delivered to the carrier.

A seller contracts with a buyer to sell goods located on the seller‘s premises. The buyer pays for the goods and arranges to pick them up the next week at the seller‘s place of business. Solution If the seller is a merchant, risk of loss to goods held by the seller passes to the buyer when the buyer actually takes physical possession of the goods. If the seller is not a merchant, the risk of loss to goods held by the seller passes to the buyer on tender of delivery.

A seller contracts with a buyer to sell goods located in a warehouse. Solution When a bailee is holding goods for a person who has contracted to sell them and the goods are to be delivered without being moved, risk of loss passes to the buyer when (1) the buyer receives a negotiable document of title for the goods, (2) the bailee acknowledges the buyer‘s right to possess the goods, or (3) the buyer receives a nonnegotiable document of title and has had a reasonable time to present the document to the bailee and demand the goods. (If the bailee refuses to honor the document, the risk of loss remains with the seller.) If the goods are to be delivered by being moved, but the contract does not specify whether it is a destination or a shipment contract, it is presumed to be a shipment contract. If no locale is

240

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

specified in the contract, risk of loss passes to the buyer when the seller delivers the goods to the carrier. 396. Sales by Nonowners. Julian Makepeace, who had been declared mentally incompetent by a court, sold his diamond ring to Golding for value. Golding later sold the ring to Carmichael for value. Neither Golding nor Carmichael knew that Makepeace had been adjudged mentally incompetent by a court. Farrel, who had been appointed as Makepeace‘s guardian, subsequently learned that the diamond ring was in Carmichael‘s possession and demanded its return from Carmichael. Who has legal ownership of the ring? Why? (See Passage of Title.) Solution Julian Makepeace is still the legal owner of the ring. Having been adjudged insane by a proper court, Makepeace lacked the capacity to sell his ring, and the contract between Makepeace and Golding was void (no contract at all). Golding thus acquired no ownership rights in the ring to transfer to Carmichael, and Carmichael, in turn, could not claim title to the ring. 397. Business Case Problem with Sample Answer— Passage of Title. Kenzie Godfrey was a passenger in a taxi when it collided with a car driven by Dawn Altieri. Altieri had originally leased the car from G.E. Capital Auto Lease, Inc. By the time of the accident, she had bought it, but she had not fully paid for it or completed the transfer- of-title paperwork. Godfrey suffered a brain injury and sought to recover damages from the owner of the car that Altieri was driving. Who had title to the car at the time of the accident? Explain. [Godfrey v. G.E. Capital Auto Lease, Inc., 89 A.D.3d 471, 933 N.Y.S.2d 208 (1 Dept. 2011)] (See Passage of Title.) —For a sample answer to Problem 20–4, go to Appendix E. Solution Altieri held title to the car that she was driving at the time of the accident in which Godfrey was injured. Once goods exist and are identified, title can be determined. Under the UCC, any explicit understanding between the buyer and the seller determines when title passes. If there is no such agreement, title passes to the buyer at the time and place that the seller physically delivers the goods. In lease contracts, title to the goods is retained by the lessor-owner of the goods. The UCC‘s provisions relating to passage to title do not apply to leased goods. Here, Altieri originally leased the car from G.E. Capital Auto Lease, Inc., but by the time of the accident she had bought it. Even though she had not fully paid for the car or completed the transfer-of-title paperwork, she owned it. Title to the car passed to Altieri when she bought it and took delivery of it. Thus, Altieri, not G.E., was the owner of the car at the time of the accident. In the actual case on which this problem is based, the court concluded that G.E. was not the owner of the vehicle when Godfrey was injured. 398. Goods Held by the Seller or Lessor. Douglas Singletary bought a manufactured home from Andy‘s Mobile Home and Land Sales. The contract stated that the buyer accepted the home ―as is where is.‖ Singletary paid the full price, and his crew began to ready the home to relocate it to his property. The night before the home was to be moved, however, it was destroyed by fire. Who suffered the loss? Explain. [Singletary, III v. P&A Investments, Inc., 712 S.E.2d 681 (N.C.App. 2011)] (See Risk of Loss.)

241

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Solution Singletary suffers the loss. If goods are in the possession of a seller or lessor, and the seller or lessor is not required to ship or to deliver them on their sale to a buyer, then a document of title is not usually used. If the seller or lessor is a merchant, the risk of loss passes to the buyer or lessee when that buyer or lessee takes physical possession of the goods. In the facts of this problem, Singletary was the owner of the manufactured home when it was destroyed by fire. The risk of loss passed to Singletary (the buyer) from the merchant seller (Andy‘s Mobile Home and Land Sales) on Singletary‘s acceptance and receipt of the goods. Because of the ―as is where is‖ clause, Singletary obtained possession and control over the home at the same time as the parties‘ contract. The risk of loss then fell squarely on Singletary. In the actual case on which this problem is based, the court concluded that Singletary bore the loss, on the reasoning stated above. 399. Risk of Loss. Ethicon, Inc., a pharmaceutical company, entered into an agreement with UPS Supply Chain Solutions, Inc., to transport pharmaceuticals. The drivers were provided by International Management Services Co. under a contract with a UPS subsidiary, Worldwide Dedicated Services, Inc. During the transport of a shipment from Ethicon‘s facility in Texas to buyers ―F.O.B. Tennessee,‖ one of the trucks collided with a concrete barrier near Little Rock, Arkansas, and caught fire, damaging the goods. Who was liable for the loss? Why? [Royal & Sun Alliance Insurance, PLC v. International Management Services Co., 703 F.3d 604 (2d Cir. 2013)] (See Risk of Loss.) Solution UPS Supply Chain Solutions, Inc., Worldwide Dedicated Services, Inc., (WDS), and International Management Services Co. (IMSCO)—which acted as the carrier transporting the shipment of pharmaceuticals for Ethicon, Inc., the seller—were jointly liable for the loss. In a destination contract, the risk of loss passes to the buyer when the goods are tendered at the specified destination [UCC 2–509(1)(b)]. In this problem, Ethicon contracted with UPS to transport pharmaceuticals. Under a contract with UPS‘s subsidiary, WDS, the drivers were provided by IMSCO. During a shipment from Ethicon‘s facility in Texas to buyers ―F.O.B. Tennessee,‖ one of the trucks collided with a concrete barrier and caught fire, damaging the goods. The ―F.O.B.‖ term indicated that the contract with the buyer was a destination contract, with the risk of loss to pass to the buyer only when the goods were tendered in Tennessee. Thus, at the time of the collision, the risk remained with the seller, on whose behalf UPS, WDS, and IMSCO were acting. Nothing in the problem indicates that the cause of the collision could be attributed to Ethicon, and so its carriers are ultimately liable. In the actual case on which this problem is based, Ethicon‘s insurer filed a suit in a federal district court against UPS and the others. The court held that under a contractual limitation-of-liability clause, UPS and WDS were liable for only $250,000 in damages. But IMSCO‘s liability was not restricted because its contract with WDS did not include a limitation-of-liability clause. IMSCO was thus liable for an additional $500,000. The U.S. Court of Appeals for the Second Circuit affirmed. 400. When Title Passes. James McCoolidge, a Nebraska resident, saw a used Honda Element for sale online. He contacted the seller, Daniel Oyvetsky, who offered to sell the vehicle for $7,500 on behalf of Car and Truck Center, LLC, a dealership in Nashville, Tennessee. McCoolidge paid the price and received the car and a certificate of title. Before he registered the certificate with the

242

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Nebraska Department of Motor Vehicles, he learned that the state of Tennessee had issued numerous certificates of title to the Element. Based on these documents, title could ultimately be traced to McCoolidge. But he chose to file a suit in a Nebraska state court against Oyvetsky, claiming that he had not received ―clear‖ title. What does the UCC provide with respect to the passage of title under a sales contract? How does that rule impact McCoolidge‘s claim? Discuss. [McCoolidge v. Oyvetsky, 292 Neb. 955, 874 N.W.2d 892 (2016)] (See Passage of Title.) Solution Under the UCC, before an interest in specific goods—including title—can pass from a seller to a buyer, the goods must exist and be identified as the specific goods designated in the parties‘ contract. For a sales contract involving specific goods that already exist, identification takes place at the time the contract is made. Once goods exist and are identified, the provisions of UCC 2–401 apply to the passage of title. Under those rules, without an explicit agreement to the contrary, title passes to the buyer at the time and the place the seller performs by delivering the goods. In this problem, McCoolidge contacted Oyvetsky about buying a used Honda Element. Oyvetsky offered to sell the vehicle on behalf of an auto and truck dealership for $7,500. McCoolidge paid the price, and received the car and a certificate of title. He could have registered the certificate with the state, which would have accepted it. But on learning that there were numerous certificates of title to the Element in existence, he hesitated. Based on all the certificates, title could ultimately be traced to McCoolidge. Despite this apparent assurance, he filed a suit in a state court against Oyvetsky, claiming that he had not received ―clear‖ title. Under the UCC rules stated above, McCoolidge‘s claim fails—title to the Element passed to him when Oyvetsky delivered the car (the parties made no agreement to the contrary). In the actual case on which this problem is based, the court issued a judgment in favor of Oyvetsky. A state intermediate appellate court affirmed, in part on the reasoning stated here. ―Between the buyer and seller of a motor vehicle, the certificate of title is only prima facie evidence of ownership.‖ 401. A Question of Ethics—Passage of Title. Indiana enacted the Vapor Pens and E-Liquid Act to regulate the manufacture and distribution of e-cigarettes. The act was based on the state‘s interest in public health and safety. Requirements included childproof packaging and labels designating active ingredients, nicotine content, and expiration dates. The act covered in-state and out ofstate production and sales. Legato Vapors, LLC, an out-ofstate maker of e-liquid products, filed a lawsuit in a federal district court against David Cook, head of the Indiana Alcohol and Tobacco Commission, seeking an injunction. Legato argued that the state‘s act violated the U.S. Constitution, which prohibits the application of a state statute to commerce that takes places completely outside of the state. Specifically, Legato noted that direct online sales by out-of-state manufacturers to Indiana consumers could not be regulated by the state act. [Legato Vapors, LLC v. Cook, 847 F.3d 825 (7th Cir. 2017)] (See Passage of Title.) 1.

Under the UCC, when does title to goods pass from the seller to the buyer? Solution Under the UCC, any explicit understanding between the buyer and the seller determines when title passes. If there is no such agreement, title passes to the buyer at the time and the place

243

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

the seller delivers the goods. The delivery arrangements determine when this occurs. Under a shipment contract, the seller is required to deliver the goods into the hands of a carrier. Title passes to the buyer at the time and place of that this occurs. 2.

Does this UCC provision support Legato‘s argument for an injunction of the state act? In any event, should Legato follow the act‘s requirements for ethical reasons? Discuss. Solution The UCC‘s provision for the passage of title on a sale of goods supports the plaintiff‘s argument as long as the terms of the sale do not specify otherwise. In this problem, Indiana‘s Vapor Pens and E-Liquid Act regulated the in-state and out-of-state production and sales of e-liquid products. Legato Vapors, LLC, an out-of-state manufacturer, filed a suit in a federal district court against the state, seeking to enjoin the act‘s enforcement. Legato argued that the statute violated the U.S. Constitution, which prohibits the application of state regulations to commerce that takes places wholly outside of the state. Legato contended that, for example, direct online sales by out-of-state manufacturers to Indiana consumers were impermissibly regulated by the act. Direct online sales by out-of-state manufacturers to Indiana consumers occur entirely outside of the state. Unless the terms of the sale express otherwise, title to the goods passes at the time and place of the sale. Thus, as Legato argued, Indiana‘s attempt to govern the making and selling of the goods exchanged in these transactions is impermissible extraterritorial regulation. An out-of-state manufacturer and seller may have an ethical obligation to comply with the act, however, or at least the spirit of the law. Like similar legislation, the act was based on the state‘s interest in public health and safety. Requirements included tamper-evident and childproof packaging, and labels designating active ingredients, nicotine content, and expiration dates. Other provisions stipulated details of the manufacturing process, including the use of certain sinks and cleaning products. An ethical manufacturer would want to keep its customers healthy and safe from any preventable ill effects. This would help to maintain and increase the maker‘s market share. In the actual case on which this problem is based, the court dismissed the suit. The U.S. Court of Appeals for the Seventh Circuit reversed the dismissal and remanded the case for the entry of an injunction to declare the act unenforceable against the plaintiff.

244

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 20: Title and Risk of Loss

Critical Thinking and Writing Assignments 402. Time-Limited Group Assignment—Shipment Contracts. Professional Products, Inc. (PPI), bought three pallets of computer wafers from Omneon Video Graphics. (A computer wafer is a thin, round slice of silicon from which microchips are made.) Omneon agreed to ship the wafers to the City University of New York ―FOB Omneon‘s dock.‖ Shipment was arranged through Haas Industries, Inc. The ―conditions of carriage‖ on the back of the bill of lading stated that Haas‘s liability for lost goods was limited to fifty cents per pound. When the shipment arrived, it included only two pallets. (See Passage of Title.) 1.

The first group will determine who suffers the loss in this situation. Solution PPI suffered the loss. In a shipment contact, if the seller or lessor is required or authorized to ship goods by carrier, but not required to deliver them to a particular destination, risk of loss passes to the buyer or lessee when the foods are delivered to the carrier. Buyers and lessees have recourse against carriers, and they also usually buy insurance to cover the goods. In this problem, the contract between PPI and Omneon stated that the sale was ―FOB Omneon‘s dock.‖ This meant that PPI (the buyer) paid the transportation charges from Omneon‘s dock. This authorized a shipment by carrier, but it did not require Omneon (the seller) to tender the wafers at the destination (the City University of New York). This also designated that the risk of loss passed to PPI when conforming goods were placed in the possession of Haas (the carrier).

The second group will discuss whether it is it fair for a carrier to limit its liability for lost goods. Solution Arguments in favor of a carrier‘s limitation of liability for lost goods include that parties are free to make a contract with whatever terms they can negotiate. Limiting liability encourages carriers to do business, and it supports carriage at more affordable rates. Buyers and sellers can—and usually do—obtain insurance to cover the risk of loss. Arguments against allowing carriers to limit their liability include that it may not be a term for negotiation, but a term imposed on shippers by carriers. Limiting liability can encourage carelessness or even reward negligence.

A third group will analyze whether this is a shipment or a destination contract. Solution This is a shipment contract. In a shipment contact, the seller or lessor may be required or authorized to ship goods by carrier, but it is not required to deliver them to a particular destination. In this problem, the contract between PPI and Omneon stated that the sale was ―FOB Omneon‘s dock.‖ This meant that PPI (the buyer) paid the transportation charges from Omneon‘s dock. This authorized a shipment by carrier, but it did not require Omneon (the seller) to tender the wafers at the destination (the City University of New York).

The fourth group will decide at what point the buyer (PPI) obtained an insurable interest in the goods. Solution

245

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

PPI obtained an insurable interest in the goods when Omneon identified them as the goods subject to the parties‘ contract, according to the UCC‘s provision on identification. The UCC allows buyers and sellers to vary this rule by agreement, but there is no indication in the problem that PPI and Omneon agreed otherwise. Once an insurable interest is obtained, a buyer can—and usually does—obtain insurance to cover the risk of loss. In the actual case on which this problem is based, PPI‘s insurer compensated the buyer for the value of the lost pallet, and then sought to recover that amount from the carrier.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 246 Case 17.1 ............................................................................................................................................... 246 Case 21.2 ............................................................................................................................................... 248 Case 21.3 ............................................................................................................................................... 248 Chapter Review ........................................................................................................................................................... 248 Practice and Review .............................................................................................................................. 248 Practice and Review: Debate This ......................................................................................................... 249 Issue Spotters ........................................................................................................................................ 250 Business Scenarios and Case Problems ................................................................................................. 250 Critical Thinking and Writing Assignments ............................................................................................ 256

Critical Thinking Questions in Cases Case 21.1 403. Suppose that Buck had completely fixed the truck by the fourth time it was tendered. Could All the Way continue to reject delivery of the truck? Why or why not? Solution Yes. Even if Buck had completely fixed the truck, it is likely that All the Way could have rightfully rejected its delivery. Delivery at a contractually specified time is part of perfect tender. Here, the time for delivery had expired. In the All the Way case, the parties‘ contract stipulated a date for delivery. Bucks did not tender the contracted-for goods by that date. Likewise, in the facts of this question, Bucks would not have tendered conforming goods by the specified time. Bucks might argue that All the Way should be considered to have waived the breach of untimeliness. The buyer gave the appearance of considering acceptance by examining the goods

246

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

sufficiently to point out the defects with each subsequent attempt at delivery. But the first rejection of untimely, nonconforming goods should have been enough for a court to hold that there was no waiver. 404. What provisions might the parties in this situation have included in their contract to protect themselves from this type of dispute?

247

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

Solution To protect itself from this type of dispute, Bucks, the seller, might have insisted on a ―time is not of the essence‖ clause to prevent All the Way from rejecting the goods or pursuing remedies on a timeliness basis. Or, Bucks, the truck maker, might have included a limitation-of-remedies provision. This might have limited All the Way‘s remedies to repair or replacement, for example. Alternatively, the contract might have set out specific consequences for either party‘s failure to conform to the contract—negotiation or arbitration in lieu of litigation, for instance

Case 21.2 405. Suppose that Fitl and Strek had included in their deal a written clause requiring Fitl to give notice of any defect in the card within ―7 days to 1 month‖ of its receipt. Would the result have been different? Why or why not? Solution Possibly. The parties to a sale of lease contract can insert such a provision, which can be enforceable. Of course, in that situation, Fitl might have acted quicker, and the defect might then have been discovered sooner.

Case 21.3 4.

If Webster had made the chowder herself from a recipe that she had found on the Internet, could she have successfully brought an action against its author for a breach of the implied warranty of merchantability? Explain. Solution No. An implied warranty of merchantability arises only in a sale or lease of goods by a merchant. This action would fail, among other reasons, because there would have been no sale and possibly neither goods nor a merchant. The question does not indicate that there would have been an exchange for a price, a communication over the Internet could arguably be construed intangible, the source of the recipe might easily have been a non-merchant. More importantly, perhaps, would be the fact that Webster would have made the ―product.‖

Chapter Review Practice and Review GFI, Inc., a Hong Kong company, makes audio decoder chips, one of the essential components used in the manufacture of MP3 players. Egan Electronics contracts with GFI to buy 10,000 chips on an installment contract, with 2,500 chips to be shipped every three months, F.O.B. Hong Kong via Air Express. At the time for the first delivery, GFI delivers only 2,400 chips but explains to Egan that even though the shipment is 4 percent short, the chips are of a higher quality than those specified in the contract and are worth 5 percent more than the contract price. Egan accepts the shipment and pays GFI the contract price. At the time for the second shipment, GFI makes a shipment identical to the first. Egan again accepts and pays for the chips. At the time for the third shipment, GFI ships 2,400 of the same chips, but this time GFI sends them via Hong Kong Air instead of Air Express. While in transit, the chips are destroyed. When it is time for the fourth shipment, GFI again sends 2,400 chips, but this time Egan rejects the chips without explanation. Using the information presented in the chapter, answer the following questions.

248

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

406. Did GFI have a legitimate reason to expect that Egan would accept the fourth shipment? Why or why not? Solution Yes, because Egan had accepted the previous shipments, the shipment was, like the others, only 5 percent short in quantity, and the quality of the chips was superior to those designated in the parties‘ contract. 407. Does the substitution of carriers for the third shipment constitute a breach of the contract by GFI? Explain. Solution The UCC allows the seller to substitute carriers if the carrier becomes unavailable or impracticable. Thus, if GFI can show that Air Express was unavailable or impracticable through no fault of either itself or Egan, the substitution of carriers would not be a breach of the contract. 408. Suppose that the silicon used for the chips becomes unavailable for a period of time and that GFI cannot manufacture enough chips to fulfill the contract but does ship as many as it can to Egan. Under what doctrine might a court release GFI from further performance of the contract? Solution The doctrine of commercial impracticability is the answer. Because GFI cannot obtain the silicon necessary to make enough chips to fulfill its obligations under the contract, it can ask the court to release it from further performance due to commercial impracticability. 409.

Under the UCC, does Egan have a right to reject the fourth shipment? Why or why not?

Solution Under the UCC, a buyer or lessee can reject an installment only if the nonconformity substantially impairs the value of the installment and cannot be cured. It seems unlikely that in light of the general circumstances stated in this problem a court would determine that a fourth shipment only 5 percent short in quantity but upgraded in quality would constitute a substantial nonconformity.

Practice and Review: Debate This 410. If a contract specifies a particular carrier, then the shipper must use that carrier or be in break of the contract—no exceptions should ever be allowed. Solution If both parties agree to a specific carrier for the goods, then of course, if there is a substitution of carriers, the seller is in breach and buyer cannot only refuse the shipment but also sue for damages. That‘s why we call such pieces of paper agreements—both parties agreed to the terms in the contract. To impose such a hard-and-fast rule about never being able to substitute carriers would impose an undue burden on all sellers of goods that have to be transported. If there are no exceptions, then even a bona fide reason for the substitution—such as a labor strike—will never prevail. Much economic damage will result, and for no benefit to society.

249

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

Issue Spotters 411. Country Fruit Stand orders eighty cases of peaches from Down Home Farms. Without stating a reason, Down Home untimely delivers thirty cases instead of eighty. Does Country have the right to reject the shipment? Explain. Solution Yes. A seller is obligated to deliver goods in conformity with a contract in every detail. This is the perfect tender rule. The exception of the seller‘s right to cure does not apply here, because the seller delivered too little too late to take advantage of this exception. 412. Brite Images, Inc. (BI), agrees to sell Catalog Corporation (CC) five thousand posters of celebrities, to be delivered on May 1. On April 1, BI repudiates the contract. CC informs BI that it expects delivery. Can CC sue BI without waiting until May 1? Why or why not? Solution Yes. When anticipatory repudiation occurs, a buyer (or lessee) can resort to any remedy for breach even if the buyer tells the seller (the repudiating party in this problem) that the buyer will wait for the seller‘s performance.

Business Scenarios and Case Problems 26. Remedies. Genix, Inc., has contracted to sell Larson five hundred washing machines of a certain model at list price. Genix is to ship the goods on or before December 1. Genix produces one thousand washing machines of this model but has not yet prepared Larson‘s shipment. On November 1, Larson repudiates the contract. Discuss the remedies available to Genix in this situation. (See Remedies of the Seller or Lessor.) Solution Basically, Genix has the following remedies: 1. Genix can identify the five hundred washing machines to the contract and resell the goods [UCC 2–704]. 2. Genix can withhold delivery and proceed with other remedies [UCC 2–703]. 3. Genix can cancel the contract and proceed with other remedies [UCC 2–703 and 2–106(4)]. 4. Genix can resell the goods in a commercially reasonable manner (public or private sale with notice to Larson, holding Larson liable for any loss and retaining any profits) [UCC 2–706]. If Genix cannot resell after making a reasonable effort, Genix can sue for the purchase price [UCC 2–709 (1)(b)]. 5. Genix can sue Larson for breach of contract, recovering as damages the difference between the market price (at the time and place of tender) and the contract price, plus incidental damages [UCC 2–708]. The student should note the combination of remedies that would be most beneficial for Genix under the circumstances. 27. Anticipatory Repudiation. Moore contracted in writing to sell her 2010 Hyundai Santa Fe to Hammer for $16,500. Moore agreed to deliver the car on Wednesday, and Hammer promised to pay the $16,500 on the following Friday. On Tuesday, Hammer informed Moore that he would not be buying the car after all. By Friday, Hammer had changed his mind again and tendered $16,500 to Moore. Although Moore had not sold the car to another party, she refused the tender and refused to deliver. Hammer claimed that Moore had breached their contract. Moore contended

250

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

that Hammer‘s repudiation had released her from her duty to perform under the contract. Who is correct, and why? (See Obligations of the Buyer or Lessee.) Solution Hammer is correct. Moore‘s refusal to deliver the car to Hammer on Friday, when Hammer tendered the $8,500 to Moore, constituted a breach of their contract. Moore could have canceled the contract on Hammer‘s anticipatory breach [UCC 2–610] but did not do so and did not change her position in any way as a result of Hammer‘s anticipatory breach. Hammer could retract his anticipatory repudiation of the contract at any time prior to the time performance was due [UCC 2–611]. Because Hammer did retract his repudiation and decided to buy the car at the time performance was due (and not later), Moore was obligated to abide by the terms of the contract. 28. Spotlight on Apple—Implied Warranties. Alan Vitt purchased an iBook G4 laptop computer from Apple, Inc. Shortly after the one-year warranty expired, the laptop stopped working due to a weakness in the product manufacture. Vitt sued Apple, arguing that the laptop should have lasted ―at least a couple of years,‖ which Vitt believed was a reasonable consumer expectation for a laptop. Vitt claimed that Apple‘s descriptions of the laptop as ―durable,‖ ―rugged,‖ ―reliable,‖ and ―high performance‖ were affirmative statements concerning the quality and performance of the laptop, which Apple did not meet. How should the court rule? Why? [Vitt v. Apple Computer, Inc., 469 Fed.Appx. 605 (9th Cir. 2011)] (See Warranties.) Solution The court should rule in favor of Apple. Apple‘s statements are generalized and nonactionable puffery because there are vague and generalized terms and not factual representations about a particular standard of quality. Apple‘s statements do not imply that the laptop would last a certain period of years. For example, a ―durable‖ laptop might imply that it is resistant to problems with being dropped and not that its lifespan would significantly exceed the warranty. The consumer bears the risk that a product will not match his economic expectations unless the manufacturer specifically agrees that it will do so. 29. The Right of Rejection. Erb Poultry, Inc., is a distributor of fresh poultry products in Lima, Ohio. CEME, LLC, does business as Bank Shots, a restaurant in Trotwood, Ohio. CEME ordered chicken wings and ―dippers‖ from Erb, which were delivered and for which CEME issued a check in payment. A few days later, CEME stopped payment on the check. When contacted by Erb, CEME alleged that the products were beyond their freshness date, mangled, spoiled, and the wrong sizes. CEME did not provide any evidence to support the claims or arrange to return the products. Is CEME entitled to a full refund of the amount paid for the chicken? Explain. [Erb Poultry, Inc. v. CEME, LLC, 20 N.E.3d 1228 (Ohio App. 2 Dist. 2014)] (See Remedies of the Buyer or Lessee.) Solution No. CEME is not entitled to a full refund of the amount paid for the chicken. If goods fail to conform to the contract in any respect, the buyer can normally reject them and recover as much of the price as has been paid. The buyer must exercise the right of rejection within a reasonable time and must notify the seller in a timely fashion—a failure to do so precludes the buyer from using the defects to establish a breach if the seller could have otherwise cured the defects. If a merchant buyer rejects the goods, that buyer must follow the seller‘s instructions with respect to the goods, or store them or reship

251

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

them to the seller. Of course, under any circumstances, the buyer cannot keep the goods and receive a full refund of the amount paid. In this problem, CEME ordered chicken products, which Erb delivered. CEME issued a check in payment but soon stopped the payment. When contacted by Erb, CEME claimed that the products were beyond their freshness date, mangled, spoiled, and the wrong sizes. But CEME did not provide any evidence to support these claims or arrange to return the products. Thus, CEME did not properly exercise the right of rejection. CEME failed to establish that the chicken as delivered did not conform to the contract. CEME‘s stop-payment order arguably does not constitute seasonable notice to Erb of the attempted rejection. And CEME did not comply with its duty to hold the products and permit Erb to reclaim them. Instead, CEME appears to have retained the goods and, by stopping payment, to have received a full refund. In the actual case on which this problem is based, Erb filed a suit in an Ohio state court against CEME to recover the unpaid amount under the contract. The court issued a judgment in Erb‘s favor, and a state intermediate appellate court affirmed the lower court‘s judgment. 30. Remedies for Breach. LO Ventures, LLC, doing business as Reefpoint Brewhouse in Racine, Wisconsin, contracted with Forman Awnings and Construction, LLC, for the fabrication and installation of an awning system over an outdoor seating area. After the system was complete, Reefpoint expressed concerns about the workmanship but did not give Forman a chance to make repairs. The brewhouse used the awning for two months and then had it removed so that siding on the building could be replaced. The parties disagreed about whether cracked and broken welds observed after the removal of the system were due to shoddy workmanship. Reefpoint paid only $400 on the contract price of $8,161. Can Reefpoint rescind the contract and obtain a return of its $400? Is Forman entitled to recover the difference between Reefpoint‘s payment and the contract price? Discuss. [Forman Awnings and Construction, LLC v. LO Ventures, LLC, 360 Wis.2d 492, 864 N.W.2d 121 (2015)] (See Remedies of the Buyer or Lessee.) Solution Reefpoint cannot rescind the contract and obtain a return of its $400, nor Is Forman entitled to recover the difference between Reefpoint‘s payment and the contract price. Under the UCC, if a buyer rightfully rejects delivered but nonconforming goods, the remedies available to the buyer include the right to rescind the contract. If the buyer keeps and uses the goods, however, acceptance has occurred and rescission is no longer available as a remedy. But damages are still available. When the goods delivered are not as promised, the measure of damages equals the difference between the value of the goods as accepted and their value if they had been delivered as promised. In this problem, Reefpoint had the benefit of its bargain when it kept and used the awning despite the concerns about the workmanship. In other words, Reefpoint accepted the goods. Its remedy was limited to a reduction in the price to account for the defects. Reducing Forman's damages to $2,000 accounts for those defects. Here, Reefpoint contracted with Forman for the fabrication and installation of an awning. After the awning was installed, Reefpoint disputed the workmanship but used the awning and did not give Forman a chance to repair it. Reefpoint paid Forman only $400 on the contract price of $8,161. Forman filed a suit to recover the difference. Reefpoint counterclaimed for rescission and

252

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

a return of its $400. Neither party was entitled to the relief that it sought. Forman could not recover the full unpaid price due to the defects in the awning. And Reefpoint had the benefit of its bargain when it kept and used the awning despite the concerns about the workmanship. In other words, Reefpoint accepted the goods. Its remedy was limited to a reduction in the price to account for the defects. Reducing Forman's damages to $2,000 accounts for those defects. In the actual case in which this problem is based, Forman filed a suit against Reefpoint‘s owner, LO Ventures LLC, to recover the difference between Reefpoint‘s payment and the contract price. Reefpoint counterclaimed for rescission of the contract and return of its $400. The court awarded Forman damages of $2,000. A state intermediate appellate court affirmed. 31. Business Case Problem with Sample Answer— Remedies of the Buyer or Lessee. M. C. and Linda Morris own a home in Gulfport, Mississippi, that was extensively damaged in Hurricane Katrina. The Morrises contracted with Inside Outside, Inc. (IO), to rebuild their kitchen. When the new kitchen cabinets were delivered, some defects were apparent, and as installation progressed, others were revealed. IO ordered replacement parts to cure the defects. Before the parts arrived, however, the parties‘ relationship deteriorated, and IO offered to remove the cabinets and refund the price. The Morrises also asked to be repaid for the installation fee. IO refused but emphasized that it was willing to fulfill its contractual obligations. At this point, are the Morrises entitled to revoke their acceptance of the cabinets? Why or why not? [Morris v. Inside Outside, Inc., 185 So.3d 413 (Miss.App. 2016)] (See Remedies of the Buyer or Lessee.) Solution No. At this point, the Morrises are not entitled to revoke their acceptance of the cabinets that IO delivered. Under the UCC, acceptance of a lot or a commercial unit can be revoked if a nonconformity substantially impairs the value of the lot or unit and acceptance was based on the reasonable assumption that the nonconformity would be cured, and it has not been cured within a reasonable period of time. One of the corollaries to this rule is, of course, that the seller must be given a reasonable time within which to affect a cure. Here, the Morrises contracted with IO to rebuild the kitchen in their home on the Gulf coast of Mississippi after it was extensively damaged in a hurricane. As part of the deal, IO delivered new cabinets. Some defects were apparent, and as installation progressed, others emerged. IO ordered replacement parts to cure the defects, and later offered to remove the cabinets and refund the price. The Morrises also asked to be reimbursed for the installation fee. IO refused this request, but at all times, the seller emphasized that it was willing to fulfill its contractual obligations. The buyers then attempted to revoke their acceptance of the cabinets—before the replacement parts arrived and without attempting to negotiate any other accommodation. In the actual case on which this problem is based, the Morrises filed a suit in a Mississippi state court against IO. The court dismissed the complaint and entered a judgment in the defendant‘s favor. A state intermediate appellate court affirmed. ―The Morrises were not entitled to recovery because they revoked acceptance of the cabinets before giving IO a reasonable opportunity to cure the defects.‖ 32. Warranty Disclaimers. Charity Bell bought a used Toyota Avalon from Awny Gobran of Gobran Auto Sales, Inc. The odometer showed that the car had been driven 147,000 miles. Bell asked whether it had been in any accidents, and Gobran replied that it was in good condition. The parties signed a warranty disclaimer that the vehicle was sold ―as is.‖ Problems with the car arose

253

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

the same day as the purchase. Gobran made a few ineffectual attempts to repair it before refusing to do more. Meanwhile, Bell obtained a vehicle history report from CARFAX, which showed that the Avalon had been damaged in an accident and that its last reported odometer reading was 237,271. Was the ―as is‖ disclaimer sufficient to put Bell on notice that the odometer reading could be false and that the car might have been in an accident? Can Gobran avoid any liability that might otherwise be imposed because Bell did not obtain the CARFAX report until after she bought the car? Discuss. [Gobran Auto Sales, Inc. v. Bell, 335 Ga.App. 873, 783 S.E.2d 389 (2016)] (See Warranties.) Solution No. The ―as is‖ disclaimer was not sufficient to put Bell on notice that the odometer reading could be false or that the car had been in an accident. And Gobran cannot avoid liability on the ground that Bell did not obtain a Carfax report on the vehicle until after she bought the car. A seller creates an express warranty by making representations concerning the quality, condition, description, or performance potential of the goods. Express warranties arise when a seller indicates that goods conform to any affirmation of fact or promise the seller makes to the buyer about the goods. In this problem, Bell bought a used car from Gobran Auto Sales, Inc. The odometer showed that it had been driven 147,000 miles. The parties signed a warranty disclaimer that the vehicle was sold ―as is.‖ Problems with the car arose almost immediately. Gobran failed to repair it after a few tries and refused to do more. Bell obtained a vehicle history report from Carfax, which showed that the Toyota had been damaged in an accident and that its last reported odometer reading was 237,271. Gobran‘s statements constituted affirmations of fact that created an express warranty of the car‘s conformance to those promises. Gobran lied—the statements proved not to be true. The seller cannot avoid liability on the basis of the disclaimer or Bell‘s belated acquisition of the Carfax report. In the actual case on which this problem is based, Bell filed a suit in a Georgia state court against Gobran, alleging breach of warranty. The court issued a judgment in Bell‘s favor. On appeal, Gobran argued that the ―as is‖ disclaimer was sufficient to put Bell on notice of the false odometer reading. A state intermediate appellate court disagreed, following the reasoning stated above. The court reversed and remanded the case, however, on other grounds. 33. Implied Warranties. Harold Moore bought a barrel-racing horse named Clear Boggy for $100,000 for his daughter from Betty Roper, who appraises barrel-racing horses. (Barrel racing is a rodeo event in which a horse and rider attempt to complete a cloverleaf pattern around preset barrels in the fastest time.) Clear Boggy was promoted for sale as a competitive barrel-racing horse. On inquiry, Roper represented that Clear Boggy did not have any performance issues or medical problems, and that the only medications the horse had been given were hock injections, a common treatment. Shortly after the purchase, Clear Boggy began exhibiting significant performance problems, including nervousness, unwillingness to practice, and stalling on the first barrel during runs. Roper then disclosed that the horse had been given shoulder injections prior to the sale and had previously stalled in competition. Moore took the horse to a veterinarian and discovered that it suffered from arthritis, impinged vertebrae, front-left-foot problems, and a right-hind-leg fracture.

254

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

The vet recommended, and Moore paid for, surgery to repair the hind leg fracture, but Clear Boggy remained unfit for competition. Moore also discovered that the horse had been scratched from competition prior to the sale because it was injured. Can Moore prevail in a lawsuit against Roper for breach of the implied warranty of fitness for a particular purpose? Why or why not? [Moore v. Roper, 2018 WL 1123868 (E.D.Okla. 2018)] (See Warranties.) Solution Yes. Moore most likely could prevail in a claim for breach of the implied warranty of fitness for a particular purpose. Moore must show that Roper knows both (1) the particular purpose for which a Moore will use the horse, and (2) that Moore was relying on the skill and judgment of the seller to select suitable goods. Based on the facts of this problem, both of these elements appear to be satisfied. Roper knew that Moore was looking for a barrel-racing horse for his daughter to use in competitions. Roper was also an appraiser of competitive barrel racing horses, so she had special skill in assessing their value (including medical condition, treatments, and performance history). She marketed Clear Boggy as a competitive barrel racing horse and the horse had previously raced in competitions. Even when the buyer had specifically inquired about the horse‘s medical condition and performance, Roper did not disclose a fractured hind leg, shoulder injections, or previous performance issues. In the actual case on which this problem is based, Roper filed a motion to dismiss Moore‘s implied warranty of fitness claim. The court reviewed the requirements and facts stated above, and concluded that Moore had adequately pled a claim for breach of implied warranty of fitness for a particular purpose. The court allowed Moore‘s claim to go forward to trial. 34. A Question of Ethics—The IDDR Approach and Buyer’s Remedies. Samsung Telecommunications America, LLC, makes Galaxy phones. Daniel Norcia bought a Galaxy S4 in a Verizon store in San Francisco, California. A Verizon employee opened the box, unpacked the phone, and helped Norcia transfer his contacts to the new phone. Norcia took the phone, and its charger and headphones, and left the store. Less than a year later, he filed an action on behalf of himself and other Galaxy S4 buyers in a federal district court against Samsung, alleging that the manufacturer misrepresented the phone‘s storage capacity and rigged it to operate at a higher speed when it was being tested. [Norcia v. Samsung Telecommunications America, LLC, 845 F.3d 1279 (9th Cir. 2017)] (See Remedies of the Buyer or Lessee.) 1.

Samsung included an arbitration provision in a brochure in the Galaxy S4 box. Would it be ethical of Samsung to assert the arbitration clause?

Solution There are several possible remedies in this problem, depending on the basis for the claims. Suppose that the case is proved on a theory of breach of contract. Under that theory, if goods fail to conform to a contract in any respect, the buyer can reject them. The buyer can then recover as much of the price as has been paid, as well as incidental and consequential damages. Or the buyer can keep the goods and sue for damages. The measure of recovery is the difference between the contract price and the market price of the goods—at the place the seller was supposed to deliver—at the time the buyer learned of the breach. The buyer can also recover incidental and consequential damages.

255

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

Suppose that the case is instead founded on breach of warranty. When a seller breaches a warranty, the measure of damages equals the difference between the value of the goods as accepted and the value if they had been delivered as warranted. For this and other types of breaches in which the buyer has accepted the goods, the buyer is entitled to recover for any loss resulting in the ordinary course of events. If each claim is arbitrated individually rather than litigated as a class action, many of the buyers might decide not to proceed. Those that do go ahead might recover less in arbitration than they could in litigation. Of course, sometimes, a class action may be based on a groundless claim and brought for the sole purpose of generating a fee for the lawyer who brings it. There is nothing ethical about a business exhausting its assets to litigate or settle such a case. Some persons would contend that a business‘s principal ethical obligation is to make a profit for its owners. Others might propose that a business take a number of stakeholders‘ perspectives into account when deciding on a course of action, or that a business has a responsibility to act chiefly in the best interest of society. From these perspectives, a class action may be the best means to curb a bad business practice. In those cases, engaging in harmful conduct is not made ethical by cutting off an important means of redress for those harmed by the conduct. In the actual case on which this problem is based, Samsung filed a motion to compel arbitration of Norcia‘s claim on the basis of a provision in a brochure in the Galaxy S4 box. The court denied the motion. The U.S. Court of Appeals for the Ninth Circuit affirmed the denial. An offeree ―is not bound by inconspicuous contractual provisions of which he was unaware, contained in a document whose contractual nature is not obvious.‖ 2.

Why would corporate decision makers choose to misrepresent their product? Explain, using the Discussion and Review steps of the IDDR approach.

Solution Corporate decision makers might choose to misrepresent the attributes of their product in order to enhance its sales. This would most likely be intended to improve the short-term success of their company and increase its market share. The immediate effect could be to improve the financial stake of the firm‘s owners and shareholders. The corporate actors might also have intended to preserve or further their careers, or those of other employees. The weaknesses of such a choice are obvious. There would follow all of the consequences of any fraud—a loss of goodwill, reputation, and trust, which would encourage customers to abandon the business‘s products, and thereby discourage long-term sales and profits. This would undercut the goal of most businesses to stay in business, expand, and otherwise be successful. It would not benefit any stakeholders, except some competitors who might gain in market share. But trust might also erode for their products.

Critical Thinking and Writing Assignments 7.

Business Law Writing. Suppose that you are a collector of antique cars and you need to purchase spare parts for a 1938 engine. These parts are not made anymore and are scarce. You discover that Beem has the spare parts that you need. You contract with Beem to buy the parts and agree to pay 50 percent of the purchase price in advance. You send the payment on May 1,

256

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

and Beem receives it on May 2. On May 3, Beem, having found another buyer willing to pay substantially more for the parts, informs you that he will not deliver as contracted. That same day, you learn that Beem is insolvent. Write three paragraphs fully discussing any possible remedies that would enable you to take possession of the parts. (See Remedies of the Buyer or Lessee.) Solution You can use any of three remedies to get the parts from Beem: 1. Because the parts are scarce, you can seek, through an action in equity, specific performance requiring Beem to transfer the parts to you as contracted [UCC 2–716(1)]. 2. Because the parts are identified to the contract and you could not purchase substitute goods by cover, you have a right of replevin. This action will require Beem‘s transfer of the parts to you [UCC 2–716(2)]. 3. Even though Beem has not shipped the goods, you have paid a part of the purchase price. If the payment is received and Beem becomes insolvent within ten days after receipt of this payment, you can tender the balance and recover the parts from Beem [UCC 2–502]. You are definitely entitled to get the parts from Beem. Practically speaking, however, Beem will have already sold the parts at the higher price to the other buyer. 8.

Time-Limited Group Assignment—Warranties. Milan purchased saffron extract, marketed as ―America‘s Hottest New Way to a Flat Belly,‖ online from Dr. Chen. The website stated that recently published studies showed a significant weight loss (more than 25 percent) for people who used pure saffron extract as a supplement without diet or exercise. Dr. Chen said that the saffron suppresses appetite by increasing levels of serotonin, which reduces emotional eating. Milan took the extract as directed without any resulting weight loss. (See Warranties.) 1.

The first group will determine whether Dr. Chen‘s website made any express warranty on the saffron extract or its effectiveness in causing weight loss.

Solution A seller can create an express warranty by making representations concerning the quality, condition, description, or performance potential of the goods. An express warranty arises when a seller or lessor indicates that the goods conform to (1) any affirmation of fact or promise that the seller makes to the buyer about the goods, (2) any description of the goods, and (3) any sample or model of the goods shown to the buyer. Express warranties can be found in a seller‘s ad, brochure, or other promotional materials, in addition to being made orally or in a written contract. The buyer must rely on the representation at the time of entering into the agreement, and the reliance must be reasonable. In this problem, Chen‘s website stated that studies showed a significant weight loss (over 25 percent) for people who used Chen‘s product without diet and exercise. This would seem to be an express warranty—an affirmation of fact or a promise as to what a buyer could expect of the goods. 2.

The second group will discuss whether the implied warranty of merchantability applies to the purchase of weight-loss supplements.

Solution Every sale of goods made by a merchant who deals in goods of the kind sold automatically gives rise to an implied warranty of merchantability. Weight loss supplements are not services, real

257

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 21: Performance and Breach of Sales and Lease Contracts

estate, or securities—they are goods. Thus, the implied warranty of merchantability applies to the purchase of weight loss supplements. 3.

The third group will decide if Dr. Chen‘s sale of saffron extract breached the implied warranty of fitness for a particular purpose.

Solution The implied warranty of fitness for a particular purpose arises in the sale of goods when a seller knows the particular purpose for which a buyer will use the goods and that the buyer is relying on the skill and judgment of the seller to select suitable goods. A seller need not have actual knowledge of the buyer‘s particular purpose. It is sufficient if a seller has reason to know the purpose. In this problem, Chen promoted and sold his product as a weight loss supplement. This would give him reason to know a buyer‘s particular purpose in purchasing the product was to lose weight. Milan bought the product from Chen. Its failure to fulfill its advertised promise would seem to breach the implied warranty of fitness for a particular purpose. 4.

The fourth group will determine if current common knowledge that weight loss can only occur if one burns more calories than one consumes makes it impossible to sue any company that offers weight-loss products that require no dieting and no exercise.

Solution The question states the assertion that ―common knowledge that weight loss can only occur if one burns more calories than one consumes‖ and asks whether this ―makes it impossible to sue any company that offers weight-loss products that require no dieting and no exercise.‖ The efficacy of this contention of ―common knowledge‖ can be considered in the context of the claim it would be asserted to support or deny. For example, a plaintiff might claim a breach of contract for a product‘s failure to effect weight loss without diet and exercise as its seller promises in its marketing. Or, the plaintiff might assert breach of warranty, product liability, or deceptive or misleading advertising. To support these claims, the plaintiff might make the ―common knowledge‖ assertion—that the seller knew the product would not do what its ads promise. In making this assertion, however, the plaintiff would effectively defeat the case. To use an analogy, if it is ―commonly known‖ that beans are not magical, the plaintiff can be imputed with the knowledge that if planted, the beans will not grow a stalk rising through the sky. There could be no reliance or deceit—only a wish and an imagination. To contravene the plaintiff‘s claims, the defendant might respond with the ―common knowledge‖ assertion. In raising this defense, however, the defendant would all but admit its product‘s failure to perform. This would also be to admit the defects in the product and the seller‘s breach of warranty—as indicated by the answers to the previous questions—and suggest fraud, as well as deceptive or misleading advertising. To continue the analogy, there would be no legitimate promise—only the tale of a castle in the clouds. Thus, even if it is ―common knowledge that weight loss can only occur if one burns more calories than one consumes,‖ in the context of the claims discussed in this problem and answers, it might

258

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

not be impossible to sue without making this argument but neither party is likely to assert it. And without this argument, the court is more likely to cite science, facts, and evidence of the parties‘ specific knowledge, intent, reliance, deceit, and injury to support its decision.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 259 Adapting the Law to the Online Environment ....................................................................................... 259 Critical Thinking Questions in Cases ................................................................................................................... 261 Case 22.1 ............................................................................................................................................... 261 Case 22.2 ............................................................................................................................................... 261 Case 22.3 ............................................................................................................................................... 262 Chapter Review ........................................................................................................................................................... 262 Practice and Review .............................................................................................................................. 262 Practice and Review: Debate This ......................................................................................................... 263 Issue Spotters ........................................................................................................................................ 264 Business Scenarios and Case Problems ................................................................................................. 264 Critical Thinking and Writing Assignments ............................................................................................ 270

Critical Thinking Questions in Features Adapting the Law to the Online Environment

413. The Electronic Fund Transfer Act (EFTA) is a federal law that protects consumers who transfer funds electronically. Among other safeguards, EFTA limits the liability that results from a lost or stolen electronic financial information and requires banks to provide information to consumers concerning potentially fraudulent electronic transactions. EFTA does not cover mobile payments. Should it? Why or why not? Solution If a major stumbling block for widespread use of mobile payments is lack of consumer confidence, then a federal law such as EFTA—designed to protect consumers when they make electronic fund transfers—would seem to be a boon for this emerging field of personal finance. One reason that consumers are so confident in using credit and debit cards, making ATM transactions, and conducting online banking is that these activities are somewhat protected from fraud or breach by federal laws such as EFTA and, in some circumstances, state law. Because regulation of mobile payments is still unsettled in the United States, consumer confidence in such systems will continue to lag. As a result, the many benefits offered by this technology will go unrealized by a majority of American consumers.

259

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

260

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

(Interestingly, though not surprisingly, there is a generation gap in the use of mobile payments. Approximately three-quarters of all mobile payment users were born after 1964, while those born from 1946 to 1964 remain ―traditional payers,‖ relying on credit cards and cash. Thus, with mobile payments as with many other areas, the younger one is, the more likely one is to trust new technology.)

Critical Thinking Questions in Cases Case 22.1 414. Suppose that the note in this case had stated, ―The terms of the mortgage are by this reference made a part hereof.‖ Would the result have been different? Solution If the note in the OneWest case had stated, ―The terms of the mortgage are by this reference made a part hereof,‖ the result might not have been different—the negotiability of the note would not have affected the bank‘s ability to enforce it—but the appellate court‘s conclusion about the negotiability would likely have been different. Here, three borrowers signed a note that included a reference to a mortgage, which ―describes how and under what conditions‖ acceleration may be invoked. The payee assigned the note to OneWest Bank. When the debtors defaulted on the payments, the bank asked a state court to enforce the note. The defendants responded that the note‘s reference to the mortgage made the note conditional, non-negotiable, and unenforceable. The court agreed, but a state intermediate appellate court disagreed. Under the UCC ―the mention of the mortgage instrument as to the . . . rights of acceleration in the promissory note does not destroy the unconditional nature of the note.‖ It was thus negotiable and enforceable. If the court had concluded that the note was non-negotiable, however, it could still be enforceable. Negotiability is one requirement for a transferee to attain the status of a holder in due course. An assignee that does not acquire this status due to an instrument‘s non-negotiability may be subject to additional defenses, but the assignee may still be able to enforce the instrument.

Case 22.2 415.

What advantage does an acceleration clause in a note provide to a creditor?

Solution The advantage that an acceleration clause in a note gives to a lender or other creditor or investor is the option to sue on the instrument to recover the entire balance due. An acceleration clause can protect an investment in the note against the risk of a loss of the investment on the maker‘s default. With the clause, the creditor, or other rightful holder, can sue on the maker‘s default to obtain the payment of the whole debt. Without the clause, it would be possible to recover only the amount of the unpaid installments. 416. Why would an investor accept a mortgage note on which the maker has already defaulted? Discuss. Solution

261

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

An investor might accept a mortgage note on which the maker has already defaulted with the intent of negotiating a new payment schedule pursuant to a refinancing of the debt represented by the note. Or the investor might intend to acquire the property or to profit from its sale, pursuant to a foreclosure. An investor who buys a note on which the maker has already defaulted may not realistically expect the debtor to pay the unpaid balance and begin making payments according to the existing mortgage. But it might be reasonably anticipated that the borrower would be willing to refinance the debt. As a result of a transaction to refinance, the investor might obtain fees and, going forward, a positive, passive stream of income. If the debtor remains in default, the property that the note secures could become the property of the investor. (Of course, before accepting the note, the investor should determine the value of the property. Important factors include the condition of the property, the tax rate, the existence of liens, and the debtor‘s income, credit, and payment history.) To transfer title to the property, and eliminate the obligation to pay the debt, the debtor might simply sign the deed over to the investor. To otherwise obtain title, the investor might initiate a foreclosure or, as in the Collins case, file a claim to recover on the note. Once the investor has title, there are several options to generate revenue from the property. One possibility is to sell the property with a seller-financed mortgage and note. This would renew the passive income, which would include the amount of the loan plus interest.

Case 22.3 5.

If Jarrell had simply invested in K & M, but was not a co-owner and did not interact with Conerly, how might this have affected the outcome of this case? Solution If Jarrell had loaned funds to K & M and was the payee on the note, but did not have direct and meaningful contact with the maker of the note (Conerly), he may have qualified as an HDC. The court would look at the requirements to become an HDC, including the requirement that the holder take without notice. If Jarrell had no reason to know that there was a defense against the instruments or a claim to them (or that there were any other defects in the instruments), then he would qualify as an HDC. This would have significantly changed the outcome of this case, because Conerly would not be allowed to assert his (according to the court, legitimate) defenses to the notes. As a result, the appellate court would likely have affirmed the lower court‘s summary judgment in favor of Jarrell.

Chapter Review Practice and Review Robert Durbin, a student, borrowed funds from a bank for his education and signed a promissory note for their repayment. The bank loaned the funds under a federal program designed to assist students at postsecondary institutions. Under this program, repayment ordinarily begins nine to twelve months after the student borrower fails to carry at least one-half of the normal full-time course load. The federal government guarantees that the note will be fully paid. If the student defaults on the payments, the lender presents the current balance—principal, interest, and costs—to the government. When the government pays the balance, it becomes the lender, and

262

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

the borrower owes the government directly. After Durbin defaulted on his note, the government paid the lender the balance due and took possession of the note. Durbin then refused to pay the government, claiming that the government was not the holder of the note. The government filed a suit in a federal district court against Durbin to collect the amount due. Using the information presented in the chapter, answer the following questions. 417.

Was the note that Durbin signed an order to pay or a promise to pay? Explain.

Solution Durbin‘s note was a promissory note—a written promise made by one person (the maker of the promise to pay) to another (usually a payee). This instrument is, as defined, a promise to pay. 418. Suppose that the note did not state a specific interest rate but instead referred to a statute that established the maximum interest rate for government-guaranteed student loans. Would the note fail to meet the requirements for negotiability in that situation? Why or why not? Solution No. The note would not fail to meet the requirements for negotiability on this basis. Negotiable instruments must state with certainty a fixed amount of money to be paid at any time the instrument is payable. The term fixed amount means an amount that is ascertainable from the face of the instrument. A note payable with a certain percent of interest meets the requirement of a fixed amount because its amount can be determined at the time it is payable or at any time thereafter. The rate of interest may be determined with reference to information that is not contained in the instrument if the information is readily ascertainable by reference to a source, including a statute, described in the instrument. 419. How does a party who is not named in a negotiable instrument (in this situation, the government) obtain a right to enforce the instrument? Solution Only a transfer by negotiation can result in a party who obtains an instrument receiving the rights of a holder. Thus, for the government to be a holder, the note would have to have been transferred by negotiation. 420. Now suppose that the school Durbin attended closed down before he could finish his education. In court, Durbin argues that this resulted in a failure of consideration: he did not get something of value in exchange for his promise to pay. Assuming that the government is a holder of the promissory note, will this argument likely be successful against it? Why or why not? Solution No. The consideration that Durbin received in exchange for his promise to pay consisted of the funds that he was paid when he signed the note, not the quantity or quality of the education that the school provided, or failed to provide, which Durbin bought with those funds.

Practice and Review: Debate This 421. We should eliminate the status of holder in due course for those who possess negotiable instruments. Solution

263

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

No one can deny that HDC status allows holders of negotiable instruments to collect payment even when there has been some underlying misrepresentation or even fraud. Thus, if holder in due course were eliminated, such misrepresentation or fraud would no longer be as easily avoided by those who perpetuate it. If we eliminated the possibility of HDC status for negotiable instruments, we would reduce severely the amount of negotiable instruments use in commerce. Hence, eliminating HDC status would cause a reduction in economic activity and therefore cause a reduced rate of economic growth. On net, we would be worse off.

Issue Spotters 422. Sabrina owes $600 to Yale, who asks Sabrina to sign an instrument for the debt. If written on the instrument by Sabrina, which of the following would prevent its negotiability: ―I.O.U. $600,‖ ―I promise to pay $600,‖ or an instruction to the bank stating, ―I wish you would pay $600 to Yale‖? Why? Solution A statement that ―I.O.U.‖ money (or anything else) or an instruction to a bank stating, ―I wish you would pay,‖ would render any instrument nonnegotiable. To be negotiable, an instrument must contain an express promise to pay. An I.O.U. is only an acknowledgment of indebtedness. An order stating, ―I wish you would pay,‖ is not sufficiently precise. 423. Rye signs corporate checks for Suchin Corporation. Rye writes a check payable to U-All Company, even though Suchin does not owe U-All anything. Rye signs the check, forges U-All‘s indorsement, and cashes the check at Viceroy Bank, the drawee. Does Suchin have any recourse against the bank for the payment? Why or why not? Solution No. When a drawer‘s employee provides the drawer with the name of a fictitious payee (a payee whom the drawer does not actually intend to have any interest in an instrument), a forgery of the payee‘s name is effective to pass good title to subsequent transferees.

Business Scenarios and Case Problems 35. Negotiable Instruments. Muriel Evans writes the following note on the back of an envelope: ―I, Muriel Evans, promise to pay Karen Marvin or bearer $100 on demand.‖ Is this a negotiable instrument? Discuss fully. (See Formation of Negotiable Instruments.) Solution For an instrument to be negotiable, it must meet the following requirements: 1. Be in writing. 2. Be signed by the maker or the drawer. 3. Be an unconditional promise or order to pay. 4. State a fixed amount of money. 5. Be payable on demand or at a definite time. 6. Be payable to order or to bearer, unless it is a check. The instrument in this case meets the writing requirement in that it is handwritten and on something with a degree of permanence that is transferable. The instrument meets the requirement of being signed by the maker, as Muriel Evans‘s signature (her name in her

264

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

handwriting) appears in the body of the instrument. The instrument‘s payment is not conditional and contains Muriel Evans‘s definite promise to pay. In addition, the sum of $100 is both a fixed amount and payable in money (U.S. currency). Because the instrument is payable on demand and to bearer (Karen Marvin or any holder), the instrument is negotiable. 36. Material Alteration. Williams purchased a used car from Stein for $1,000. Williams paid for the car with a check (written in pencil) payable to Stein for $1,000. Stein, through careful erasures and alterations, changed the amount on the check to read $10,000 and negotiated the check to Boz. Boz took the check for value, in good faith, and without notice of the alteration and thus met the Uniform Commercial Code‘s requirements for the status of a holder in due course. Can Williams successfully raise the universal (real) defense of material alteration to avoid payment on the check? Explain. (See Defenses, Limitations, and Discharge.) Solution No. Material alteration of a negotiable instrument may be a real defense against payment on the instrument. As against a holder in due course, the raising of the amount (material alteration) is only a defense as to the altered amount, and the HDC can recover according to the original tenor of the instrument [UCC 3–407(b)]. In this case, however, Williams materially contributed to the alteration by his negligence in writing the check in pencil. Thus, the defense of material alteration was not available to him, and Williams is liable to Boz for the $10,000 [UCC 3–406]. If Williams had written the check in ink, and Stein had altered the amount in such a clever fashion that Boz could take the check without notice and become an HDC, then Williams would have a real defense against paying $10,000. In the latter case, Boz, as an HDC, could collect only $1,000, the original amount of the check. 37. Indorsements. Angela Brock borrowed $544,000 and signed a note payable to Amerifund Mortgage Services, LLC, to buy a house in Silver Spring, Maryland. The note was indorsed in blank and transferred several times ―without recourse‖ before Brock fell behind on the payments. On behalf of Deutsche Bank National Trust Co., BAC Home Loans Servicing LP initiated foreclosure. Brock filed an action in a Maryland state court to block it, arguing that BAC could not foreclose because Deutsche Bank, not BAC, owned the note. Can BAC enforce the note? Explain. [Deutsche Bank National Trust Co. v. Brock, 63 A.3d 40 (Md. 2013)] (See Transfer of Instruments.) Solution Yes. BAC can enforce the note. Under the UCC, the right to enforce an instrument and the ownership of the instrument are two different concepts. The holder of a note is entitled to enforce the instrument even if it is not the owner of the instrument or is in wrongful possession of it. An instrument indorsed in blank can be transferred by delivery alone. In this problem, the note was indorsed in blank and thus could be transferred by delivery alone. There was no dispute that BAC was in possession of the note. BAC was therefore the holder of the note and entitled to enforce it. There is no additional requirement that BAC prove that it was the owner of the note—whether or not it was the owner is irrelevant—or otherwise how it came into possession of the note. In the actual case on which this problem is based, the court issued a judgment in BAC‘s favor, but on Brock‘s appeal, a state intermediate appellate court reversed. On BAC‘s appeal, the Court of Appeals of Maryland reversed the lower court‘s decision. ―BAC is in possession of the Note that is indorsed in blank. BAC is therefore the holder of the Note and . . . entitled to enforce it.‖

265

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

38. Transfer by Negotiation. Thao Thi Duong signed a note in the amount of $200,000 in favor of Country Home Loans, Inc., to obtain a loan to buy a house in Marrero, Louisiana. The note was indorsed ―PAY TO THE ORDER OF [blank space] WITHOUT RECOURSE COUNTRY HOME LOANS, INC.‖ Almost five years later, Duong defaulted on the payments. The Federal National Mortgage Association (Fannie Mae) had come into possession of the note. Fannie Mae wanted to foreclose on the house and sell it to recover the balance due. Duong argued that the words ―to the order of [blank space]‖ in the indorsement made the note an incomplete order instrument and that Fannie Mae thus could not enforce it. What is Fannie Mae‘s best response to this argument? [Federal National Mortgage Association v. Thao Thi Duong, 167 So.3d 920 (La.App. 5 Cir. 2015)] (See Transfer of Instruments.) Solution Fannie Mae‘s best response to Duong‘s argument is that the indorsement was a blank indorsement making the note payable to bearer. Thus, by coming into possession of the note, Fannie Mae became its holder with the ability to enforce it. A bearer instrument is an instrument that does not designate a specific payee. If an instrument is payable to bearer, it is negotiated by delivery—by transfer into another party‘s possession. Indorsement is not necessary. In this problem, Duong signed a note in favor of Country Home Loans, Inc. to obtain a loan to buy a house. The note was indorsed ―PAY TO THE ORDER OF [blank space] WITHOUT RECOURSE COUNTRY HOME LOANS, INC.‖ The Fannie Mae was in possession of the note when Duong defaulted on the payments. Fannie Mae wanted to foreclose on the house and sell it to recover the balance due. Duong argued that Fannie Mae could not enforce the note because the words ―to the order of [blank]‖ in the indorsement made the note incomplete order paper. But a note that does not identify a specific payee and is indorsed in blank is a bearer instrument, negotiable by delivery alone, and enforceable by its holder—here, Fannie Mae. In the actual case in which this problem is based, Fannie Mae foreclosed on the house and sold it to recover the balance due on the note. Duong filed a petition in a Louisiana state court against Fannie Mae, seeking damages. The court issued a judgment in the defendant‘s favor. A state intermediate appellate court rejected Duong‘s argument as phrased in this problem and affirmed the lower court‘s judgment. 39. Payable to Order or to Bearer. Thomas Caraccia signed a note and mortgage in favor of VirtualBank to obtain funds to buy property in Palm Beach Gardens, Florida. VirtualBank indorsed the note in blank, making it bearer paper, and transferred possession of the note to Bank of America. Bank of America transferred the note to U.S. Bank, which later gave the note back to Bank of America to collect Caraccia‘s payments on behalf of U.S. Bank. When Caraccia defaulted on the payments, U.S. Bank filed a suit in a Florida state court against him, seeking to enforce the note and foreclose on the property. Caraccia contended that because the note was indorsed in blank and was not in the physical possession of U.S. Bank, the bank could not enforce it. Could the bank successfully argue that although it did not physically possess the note, it constructively possessed (exercised legal control over) it? Explain. [Caraccia v. U.S. Bank, National Association, 41 Fla.L.Weekly. D476, 185 So.3d 1277 (Dist.Ct.App. 2016)] (See Formation of Negotiable Instruments.) Solution Yes, U.S. Bank could successfully argue that although it did not physically possess the note at issue in these facts, the bank constructively possessed it. A bearer instrument is an instrument

266

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

that does not designate a specific payee. A bearer is a person in possession of an instrument that is payable to bearer or indorsed in blank. Under a bearer instrument, the maker or drawer agrees to pay anyone who presents it for payment. In this problem, Caraccia (the maker) signed a note and mortgage in favor of VirtualBank. The payee indorsed the note in blank, making it bearer paper, and transferred possession to Bank of America. Bank of America transferred the note to U.S. Bank, which gave it back to Bank of America to collect Caraccia‘s payments on it on behalf of U.S. Bank. Caraccia defaulted, and U.S. Bank sought to enforce the note and foreclose on the property. Caraccia contended that because the note was not in the physical possession of U.S. Bank, the bank could not enforce it. It is true that possession of a bearer instrument is a crucial element in its enforcement. But this element can be met through either actual, physical possession or constructive possession. In the latter situation, a party may be entitled to enforce an instrument that it does not physically possess if the party otherwise has the power to control it. Here, U.S. Bank had constructive possession—it had the authority to control the note because Bank of America possessed it only on behalf of U.S. Bank. In the actual case on which this problem is based, the court authorized a foreclosure. A state intermediate appellate court affirmed, on the reasoning stated above. 40. Business Case Problem with Sample Answer—Signature Liability. Guillermo and Guadalupe Albarran and their sons, Ruben and Rolando, owned R Cleaning Impact, Inc. (RCI). Neresh Kumar owned Amba II, Inc., a check-cashing business. The Albarrans cashed checks through Amba on a regular basis, often delivering a stack of employee paychecks to Amba for cashing. Later, the Albarrans‘ bank refused payment on some of the checks. Kumar learned that some of these items were payable to fictitious payees with fictitious addresses. Others had been filled out for amounts greater than real employees‘ pay. Meanwhile, RCI became insolvent and closed its account, and Guillermo and Guadalupe filed for bankruptcy. Amba was left with many unpaid checks. Among these parties, who can be held liable for the loss on the unpaid checks? Explain. [Albarran v. Amba II, Inc., 2016 WL 688924 (Md. 2016)] (See Signature and Warranty Liability.) Solution The parties who can be held liable for the loss on the unpaid checks in the Albarran case are R. Cleaning Impact, Inc. (RCI), and its owners, Guillermo, Guadalupe, Ruben, and Rolando Albarran. Generally, when an indorsement is forged or unauthorized, the burden of loss falls on the first party to take the instrument with the forged or unauthorized indorsement. But this rule has an important exception that causes the loss to fall on the drawer of the check rather than the first party to take it—the fictitious payee rule. This rule applies when a person causes an instrument to be issued to a payee (fictitious or real) who will have no interest in it. In that situation, the payee‘s indorsement is not treated as a forgery, and an innocent holder can hold the maker or drawer liable on the instrument. In this problem, Amba, a check-cashing service, and the Albarrans and their sons, owners of a cleaning company, established a regular check-cashing relationship between their respective businesses. The Albarrans often delivered a stack of their employees‘ paychecks for cashing through Amba. Later, the Albarrans‘ bank began refusing payment on some of the checks. Amba learned that the unpaid items were payable to fictitious payees with fictitious addresses, or for

267

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

amounts more than the actual employees‘ pay. Under normal circumstances, Amba would be most likely to suffer the loss. But under the fictitious payee rule, RCI or its owners, as the drawers of the checks, could be held liable. Because RCI is insolvent, and its accounts are closed, and Guillermo and Guadalupe filed for bankruptcy protection, the parties most likely to be assessed with liability are Ruben and Rolando. In the actual case on which this problem is based, Amba filed a suit in a Maryland state court against the Albarrans to recover the amount of the unpaid checks. The defendants did not respond. The court entered a default judgment against them. On the defendants‘ later motion, the court vacated the award of damages with respect to the parents, because they had filed for bankruptcy, but not the sons, who remained liable. A state intermediate appellate court affirmed. 41. Holder in Due Course. Robert Triffin purchased a dishonored payroll check from Fair Law Financial Services (doing business as United Check Cashing) and filed a complaint against the maker seeking to collect on the check. The check was issued by Extensis Group, LLC, to Maria Pagan in the amount of $610. The face of the check clearly stated ―THE FACE OF THIS DOCUMENT HAS A COLORED BACKGROUND NOT A WHITE BACKGROUND.‖ But the check that Triffin introduced into evidence had a white background. The check also stated ―THE BACK OF THIS DOCUMENT CONTAINS A UNIQUE IDENTITY BARCODE AND AN ARTIFICIAL WATERMARK— HOLD AT AN ANGLE TO VIEW,‖ but Triffin‘s check did not have this barcode or watermark. Was Triffin an HDC? Why or why not? [Triffin v. Extensis Group, LLC, 2018 WL 548613 (N.J.Super.Ct.App.Div. 2018)] (See Holder in Due Course.) Solution No. Triffin cannot be an HDC under these circumstances. To become an HDC, a holder of a negotiable instrument must take the instrument (1) for value, (2) in good faith, and (3) without notice that it is defective. Triffin did take the check for value and probably in good faith (honestly). Nevertheless, because the instrument had been dishonored and contained irregularities that called into question its authenticity, he cannot meet the requirement of taking without notice. The lack of a colored background on the front of the check, and missing barcode and watermark on the back, are irregularities. Combined with specific language on the check stating those items should be present if the check is authentic, a holder would have been on notice of defects. Therefore, Triffin cannot establish status as an HDC. In the actual case on which this problem is based, the trial court found that Triffin was not an HDC and dismissed the complaint. Triffin appealed, and the state appellate court affirmed the lower court‘s conclusion and dismissal. 42. A Question of Ethics—The IDDR Approach and Unconditional Promise or Order to Pay. Carlos Pardo signed a note to obtain $627,500 to buy a house in Stamford, Connecticut. The note was secured by a mortgage. Later, Pardo signed a loan modification agreement that increased the balance due. The modification was not referenced in the note. Deutsche Bank National Trust Company came to possess the note. When Pardo defaulted on the payments, Deutsche Bank filed a suit in a Connecticut state court against him to recover the unpaid balance. Pardo maintained that the bank could not enforce the note. He argued that the bank was not a holder because the note was not a negotiable instrument— the loan modification agreement rendered it conditional. [Deutsche Bank National Trust Co. v. Pardo, 170 Conn.App. 642, 155 A.3d 764 (2017)] (See Formation of Negotiable Instruments.)

268

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

Was it ethical of Deutsche Bank to sue to recover the unpaid balance on Pardo‘s note? Explain, using the steps of the IDDR approach.

Solution Yes. It was ethical of Deutsche Bank to foreclose on Pardo‘s note. Pardo signed the note to buy a house. Later, he signed a loan-modification agreement that increased the balance due, and still later, he defaulted on the payments. Meanwhile, Deutsche Bank had come to possess the note. The bank filed a suit against Pardo to recover the unpaid balance. The IDDR approach begins with an Inquiry, which phrases the issue, and identifies its stakeholders and the relevant standards. The issue is framed here by the facts and the question—would it be ethical to foreclose on the note? The stakeholders include Deutsche Bank, its owners, its personnel, Pardo, other borrowers, other homeowners, and perhaps all of the participants in the home-lending market. Relevant standards would be the terms of the note, principles in Deutsche Bank‘s company policies, and guidelines in a professional lenders code. The IDDR approach continues with a Discussion of actions to resolve the issue, and the effects and consequences. There can be a variety of actions that the possessor of a note might pursue against its defaulting maker, when the note has been signed to obtain the funds to buy a house. These actions can differ among jurisdictions. The possessor might offer to rework the terms of the note, or take no action in the expectation that the maker will ultimately pay up. To recover an unpaid balance, the possessor might sue on the note or foreclose on the property by a judicial or nonjudicial sale. When deciding what to do, Deutsche Bank should ask which action is most beneficial for itself and its stakeholders. The bank is in business to do business—any decision that would undercut that purpose would impose negative consequences on all of the stakeholders. The final steps in the IDDR approach are a Decision to act, and its reasons, and a Review of the results. In this case, as evidenced by the loan modification agreement, reworking the terms had been tried. The bank chose to attempt to recover the unpaid balance. There can be a long delay between the initiation and conclusion of such an action, which could be to the advantage of Pardo as the maker to pay off the note. In other words, the bank‘s choice of action could effectively satisfy all of the stakeholders. 2.

Is Pardo correct about the status of the note? Was it ethical to make this argument? Discuss.

Solution No. Pardo is not correct. Only instruments with unconditional promises or orders can be negotiable. Thus, instruments that include conditions, such as that its terms are subject to another writing, cannot be negotiable. But an instrument cannot be rendered conditional by a writing that is not referenced in the instrument. In this problem, Pardo signed a note to obtain $627,500 to buy a house. Later, he signed a loan modification agreement that increased the balance due, and still later, he defaulted on the payments. Meanwhile, Deutsche Bank National Trust Co. had come to possess the note. The bank filed a suit against Pardo to recover the unpaid balance. He argued that the bank could not enforce the note, because it was not a holder—the note was not negotiable because the modification rendered it conditional. But the note did not state that its terms were subject to any other writing. The ethics of Pardo‘s argument can be considered through his perspective. When he defaulted on

269

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 22: Negotiable Instruments

the note and the bank sought to recover the balance, his probable desire was to keep his house. The problem was how to do it. Paying off the note must not have been possible. Frustrating the bank‘s ability to collect seems to have been the sole alternative. This meant attacking the bank‘s status as a holder and the negotiability of the note. But there was nothing on which to pin such an argument except the loan modification agreement. Pardo was honest and clear in the presentation of his case. What makes Pardo‘s assertion unethical was that he presumably asked for the loan modification agreement and that it was not referenced in the note. This amounts to deceit. There is nothing ethical about such dishonesty. In the actual case on which this problem is based, the court found the note to be negotiable and thereby allowed Deutsche Bank to foreclose on the mortgage to recover the balance due. On Pardo‘s appeal, a state intermediate appellate court affirmed the decision in the bank‘s favor.

Critical Thinking and Writing Assignments 9.

Time-Limited Group Assignment—Negotiability. Peter Gowin was an employee of a granite countertop business owned by Joann Stathis. In November 2022, Gowin signed a promissory note agreeing to pay $12,500 in order to become a co-owner of the business. The note was dated January 15, 2022 (ten months before it was signed), and required him to make installment payments starting in February 2022. Stathis told Gowin not to worry about the note and never requested any payments. Gowin continued to work at the business until 2024, when he quit, claiming that he owned half of the business. Stathis argued that Gowin was not a co-owner because he had never paid the $12,500 into the business. (See Formation of Negotiable Instruments.) 1.

The first group will argue in favor of Stathis that Gowin did not own any interest in the business.

Solution The contention in Stathis‘s favor is stated in the question—Gowin did not own any interest in the business because he never paid the $12,500 note. Stathis‘s oral waiver was arguably not enough to relieve Gowin of the obligation to pay the amount of the note to the countertop business. The parties should have put the waiver in writing. 1.

The second group will evaluate the strength of Gowin‘s argument. Gowin claimed that because compliance with the stated dates was impossible, the note effectively did not state a date for its payment. It therefore was a demand note under UCC 3–108(a). Because no demand for payment had been made, Gowin‘s obligation to pay had not arisen, and the termination of his ownership interest was improper.

Solution Gowin‘s argument is correct. The termination of his interest was improper because compliance with the dates on the note was impossible, given that it was not signed until months after the first payment was due. Because compliance was not possible, the note effectively did not state a date for its payment, and it was a demand note. (The chief reason for regarding the note as a demand note instead of an unenforceable note is that the parties to it regarded it as a binding obligation. Under other circumstances, the note could be construed as incomplete and for that reason invalid.) A demand note does not become overdue until the day after demand is made or the

270

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

note has been outstanding for an unreasonably long time, whichever occurs first. Here, the note never became overdue because payment was never demanded.

2. The third group will create a list with expanation and examples detailing under what circumstances oral statements by Stathis to Gowin can be enforced or can be used as a defense by Gowin. Solution The question is the circumstances in which oral statements by Stathis to Gowin can be enforced or can be used as a defense by Gowin. According to the terms of the note provided in this problem, Gowin could become a co-owner of the business with Stathis by paying the amount of the note. As stated in the facts, no demand for payment of the note had been made. And because the note was a demand note, as contended in the previous question and explained in its answer, Gowin‘s obligation to pay it had not arisen. Thus, Stathis‘s attempt to deny Gowin the right to an ownership interest in the business on the ground that the note had never been paid was improper. In the circumstances of a legal proceeding, such as a trial before a court, the written note and the credible testimony of the parties could prove these points. For example, by arguing that Gowin was not a co-owner of the business because he had never paid the amount of the note, Stathis in effect admitted that the purpose of the note was to buy an interest in the business. Both parties admitted that the note had not been paid. Stathis‘s failure to deny Gowin‘s assertion that no demand for payment had been made would support the enforcement of Stathis‘s assurance ―not to worry about the note.‖ And this assurance, with the admission implicit in Stathis‘s argument stated above, could present an effective defense to Stathis‘s attempt to deny Gowin‘s right to an ownership interest in the business.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 111 Case 23.1 ............................................................................................................................................... 111 Case 23.2 ............................................................................................................................................... 112 Case 23.3 ............................................................................................................................................... 113 Chapter Review ........................................................................................................................................................... 113 Practice and Review .............................................................................................................................. 113 Practice and Review: Debate This ......................................................................................................... 114 Issue Spotters ........................................................................................................................................ 115 Business Scenarios and Case Problems ................................................................................................. 115 Critical Thinking and Writing Assignments ............................................................................................ 122

271

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Critical Thinking Questions in Features Adapting the Law to the Online Environment 424.

Why is international law better suited for satellite regulation than national law?

Solution Once launched and having entered orbit, a satellite will spend relatively little time directly above the territory of the government or private company that manufactured it. Therefore, a legal regime in which individual countries retained jurisdiction over satellite activity in low earth orbit (an altitude of approximately 1,200 miles where most satellites operate) above their earthly boundaries would be prohibitively complex and contentious. Clearly, the future of satellite law going to be governed by international law. As has been discussed at length in this chapter, the purpose of international law is the orderly settlement of disputes between nations. Indeed, the U.N.‘s Outer Space Treaty does provide a broad framework for international space law. More specifically, as noted in the text, under the Liability Convention any harm caused by a satellite on Earth is the financial responsibility of the country that launched it, regardless of who or what actually caused the damage. It should be noted that, in the context of twenty-first century cybersecurity and widespread computer hacking by malicious third parties, the Liability Convention is somewhat outdated. A more helpful model for such satellite-related disputes can be found in the treaties and established practices that govern international waters. Customarily, the law of the sea holds that damages caused by ships or other vessels are the financial responsibility of the party that controls the vessel, not the party that owns it.

Critical Thinking Questions in Cases Case 23.1 425. Is the Court‘s interpretation of Section 1610(g) consistent with the purpose of the FSIA? Explain. Solution Yes. The Court‘s interpretation of Section 1610(g) is consistent with the purpose of the FSIA. The act expressly provides that states are not immune from the jurisdiction of U.S. courts ―insofar as their commercial activities are concerned, and their commercial property may be levied upon for the satisfaction of judgments rendered against them in connection with their commercial activities.‖ This point is reflected in the subsections of Section 1610, as noted in the excerpt of the Rubin case. For example, Section 1610(a) provides that ―‗property in the United States . . . used for a commercial activity in the United States . . . shall not be immune‘ from attachment and execution in seven enumerated circumstances . . . . [Section 1610(b), (d), (e), and (f)] similarly set out circumstances in which certain property of a foreign state ‗shall not be immune.‘‖ In other words, these subsections outline exceptions to immunity when a foreign state‘s property is used for commercial activity. The Court‘s interpretation of Section 1610(g) simply means that a

272

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

party with an applicable judgment must rely on at least one of those other provisions to attach and execute property in satisfaction. This reading also aligns with the principle of interpretation to construe a statute so as to give effect to all of its provisions. A holding that Section 1610(g) establishes a basis for the attachment and execution against otherwise immune property would have rendered the other provisions of the statute superfluous. 426. What practical lesson might be learned from the decision and result in the Rubin case? Discuss. Solution One lesson that might be learned from the holding of the Rubin case is that, in terms of filing an action, a plaintiff should carefully determine the legal basis for the claim. Here, in the eyes of the appellate courts, the plaintiffs‘ attorneys relied on the wrong section of the Foreign Sovereign Immunities Act to support their claims. A careful reading of that statute and its sections might have led to a very different result. There might then have been no dispensing of legal fees and a lawyer‘s expensive time on an unrewarding attempt. A second message that could be inferred from the facts and the conclusion in the Rubin case relates to the property sought to satisfy a judgment. In the Rubin case, the plaintiffs attempted to attach and execute against a cultural asset, the Persepolis Collection. Obviously, these items are significant in terms of the history of Iran—they are on loan to the University of Chicago for cataloging, translation, and study—but also they might arguably be important to the cultural heritage of all civilization. Under different circumstances, would a court be likely to allow the sale of Native American artifacts to pay damages resulting from a violent activist‘s purportedly political act? Or would a court order the forfeiture of an original copy of the Declaration of Independence on tour in a foreign nation to satisfy a levy against an American agent whose actions caused harm in that land? Plaintiffs are more likely to succeed, at least in terms of the Foreign Sovereign Immunities Act, if they seek to execute a judgment against property used in a commercial activity. In the Rubin case, the Court provides an example of the assets of a state-owned telecommunications company. Although cited for a different point, the Court adds that ―the plaintiffs could attach and execute against the property of the state-owned entity . . . , so long as the plaintiffs can establish that the property is otherwise not immune (e.g., pursuant to Section 1610(a) because it is used in commercial activity in the United States).‖

Case 23.2 427. How does the Changzhou case illustrate that dumping is an unfair international trade practice? Discuss. Solution The factual findings and legal conclusions in the Changzhou case underscore the unfairness of dumping as an international trade practice. Dumping is the sale of imported goods at less than fair value. Fair value is the price of the goods in the exporting country. Foreign firms that practice dumping in the United States intend to undersell domestic businesses to obtain an increased

273

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

share of the domestic market. Dumping is generally subsidized by the government of the foreign exporting country. This makes the practice unfair. In the Changzhou case, Changzhou, a Chinese firm, made crystalline silicon photovoltaic (CSPV) cells and related products that Trina imported into the United States. The U.S. Department of Commerce found that the imports were subsidized by the Chinese government and sold in the United States at less than fair value. The International Trade Commission (ITC) determined that the Chinese imports materially injured the domestic CSPV industry. On appeal, the U.S. Court of Appeals for the Federal Circuit referred to the ITC‘s detailed findings and variety of evidence. The court listed the subject areas that the ITC reviewed. Finally, the court reiterated the ITC‘s conclusion that the effect of the ―unfairly priced and subsidized subject imports‖ on the domestic industry was ―more than inconsequential, immaterial, or unimportant‖ and led to the U.S. producers‘ loss of market share. 428. Suppose that the ITC had not issued detailed findings supported by a variety of evidence, but had only released a statement that the subject imports seemed to have a negative effect on the domestic industry. Would the result have been different? Explain. Solution Most likely, yes, the result in the Changzhou case would have been different if the ITC had released a conclusory statement that the subject imports seemed to have a negative effect on the domestic industry, without findings and evidence. The ITC‘s findings, supported by substantial evidence, formed the basis on which the U.S. Court of Appeals for the Federal Circuit affirmed the ITC‘s determination ―that subject imports were a significant cause of the decline in prices.‖ If the court had not had this material on which to base a conclusion, the court would have had to look elsewhere in the record for support. There is nothing provided in the facts or reasoning of this case to indicate another basis beyond the apparent ―coincidence‖ of the imports and the decline in domestic prices. This would not likely have been sufficient.

Case 23.3 6.

What are the consequences for Daimler of the decision in this case? Solution Daimler AG was not exonerated by the decision in this case, but the corporation did avoid liability under the Court‘s ruling. Otherwise, it might have been subject to huge claims for collaborating with the state security services of the Argentinian government‘s alleged atrocities (extremely cruel acts). Of course, the plaintiffs might still seek other laws in other forums to obtain relief.

Chapter Review Practice and Review Robco, Inc., was a Florida arms dealer. The armed forces of Honduras contracted to purchase weapons from Robco over a six-year period. After the government was replaced and a democracy installed, the Honduran government sought to reduce the size of its military, and its relationship with Robco deteriorated.

274

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Honduras refused to honor the contract by purchasing the inventory of arms, which Robco could sell only at a much lower price. Robco filed a suit in a federal district court in the United States to recover damages for this breach of contract by the government of Honduras. Using the information provided in the chapter, answer the following questions. 429.

Should the Foreign Sovereign Immunities Act preclude this lawsuit? Why or why not?

Solution Because the armed forces of Honduras contracted to purchase weapons from a U.S. company (Robco), this would fall under the commercial activity exception to the FSIA. The sales contract was an action taken in connection with a commercial activity carried on in the United States, and the sale has a direct effect in the United States. Therefore, the FSIA would not bar this lawsuit. 430.

Does the act of state doctrine bar Robco from seeking to enforce the contract? Explain.

Solution The act of state doctrine provides that the judicial branch of one country will not examine the validity of public acts committed by a recognized foreign government within its own territory. Here, the newly democratic government of Honduras is seeking to reduce the size of its military. The U.S. government likely recognized the new democratic regime since the United States supports democratization globally. The United States is also likely to be supportive of its efforts to reduce the size of its military and its inventory of weapons. Because the Honduran government‘s policy decision is public act within its own territory, the U.S. judicial branch will most likely be unwilling to intervene and force the government to fulfill its contract to purchase arms. There is more at stake than a simple contract because enforcing an arms deal may harm international relations between the United States and the new government of Honduras. 431. Suppose that before Robco filed its lawsuit, the new government of Honduras enacted a law making it illegal to purchase weapons from foreign arms dealers. What doctrine might lead a U.S. court to dismiss Robco‘s case in that situation? Solution The principle of comity might apply here. This principle is a doctrine of deference. Under this principle, one nation will defer and give effect to the laws and judicial decrees of another country, as long as those laws are consistent with the law and public policy of the accommodating nation. The principle of comity is based on respect and is a customary courtesy extended to other nations. If a U.S. court extends comity to the new Honduran government‘s law pertaining to arms dealing, then it would dismiss Robco‘s case. 432. Now suppose that the U.S. court hears the case and awards damages to Robco, but the government of Honduras has no assets in the United States that can be used to satisfy the judgment. Under which doctrine might Robco be able to collect the damages by asking another nation‘s court to enforce the U.S. judgment? Solution Under the principle of comity, one nation will defer and give effect to the laws and judicial decrees of another country, as long as those laws are consistent with the law and public policy of the accommodating nation. This would be very useful to Robco in its attempt to collect damages under the award. Robco could take the judgment issued by a U.S. court to any nation in which the

275

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

government of Honduras does have assets and ask that nation‘s court to enforce the judgment under the principle of comity.

Practice and Review: Debate This 433. The U.S. federal courts are accepting too many lawsuits initiated by foreigners that concern matters not relevant to this country. Solution Our federal courts are already overwhelmed by normal lawsuits that concern purported wrongs committed on U.S. soil that involve residents of this country. Why should we become the preferred jurisdiction for lawsuits that involve human rights issues in other countries? Why should we become the preferred jurisdiction for purported employment discrimination that might have taken place outside of the United States? We are not the world‘s conscience. The United States has one of the best-run and most fair federal judiciaries in the world. We still support freedom and democracy. Therefore, it is appropriate that when, for example, human rights are violated by companies that operate in other countries, the aggrieved can avail themselves of our federal courts. Also, if a U.S. company that operates abroad violates our employment discrimination or antitrust laws, then that company should be sued in the United States. Obviously, other countries do not have the same high standards that we have in these matters.

Issue Spotters 434. Café Rojo, Ltd., an Ecuadoran firm, agrees to sell coffee beans to Dark Roast Coffee Company, a U.S. firm. Dark Roast accepts the beans but refuses to pay. Café Rojo sues Dark Roast in an Ecuadoran court and is awarded damages, but Dark Roast‘s assets are in the United States. Under what circumstances would a U.S. court enforce the judgment of the Ecuadoran court? Solution Under the principle of comity, a U.S court would defer and give effect to foreign laws and judicial decrees that are consistent with U.S. law and public policy. 435. Gems International, Ltd., is a foreign firm that has a 12 percent share of the U.S. market for diamonds. To capture a larger share, Gems offers its products at a below-cost discount to U.S. buyers (and inflates the prices in its own country to make up the difference). How can this attempt to undersell U.S. businesses be defeated? Solution The practice described in this problem is known as dumping, which is regarded as an unfair international trade practice. Dumping is the sale of imported goods at ―less than fair value.‖ Based on the price of those goods in the exporting country, an extra tariff—known as an antidumping duty—can be imposed on the imports.

Business Scenarios and Case Problems 43. Doing Business Internationally. Macrotech, Inc., develops an innovative computer chip and obtains a patent on it. The firm markets the chip under the trademarked brand name ―Flash.‖ Macrotech wants to sell the chip to Nitron, Ltd., in Pacifica, a foreign country. Macrotech is concerned, however, that after an initial purchase Nitron will duplicate the chip, pirate it, and sell the pirated version to computer manufacturers in Pacifica. To avoid this possibility, Macrotech

276

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

could establish its own manufacturing facility in Pacifica, but it does not want to do this. How can Macrotech, without establishing a manufacturing facility in Pacifica, protect Flash from being pirated by Nitron? (See Doing Business Internationally.) Solution An alternative to exporting is the establishment of foreign manufacturing facilities, which Macrotech does not want to do in this problem. A U.S. firm can also manufacture goods in other countries by licensing, franchising, and investing in a wholly owned subsidiary or joint venture. Licensing is an attractive alternative to establishing a foreign production facility when a process or product has been patented, because the patent protects against the possibility that the innovation could be pirated. Licensing generally involves a payment of royalties, such as a percentage of profits from units sold. Licensing can benefit all of the parties involved. A firm that receives a license gains an established reputation for quality, and a firm that grants a license gets income from foreign sales and expands the scope of its reputation and possible demand for its products. Franchising is a form of licensing that generally involves trademarks more than patented products. If Macrotech had not obtained a patent on its chip but had trademarked the brand name ―Flash,‖ for example, the firm could license Nitron to use the mark, probably under certain conditions or limitations, in exchange for a fee, based on a percentage of sales. Another way to expand into the Pacifica market would be to establish a wholly owned subsidiary in Pacifica. Macrotech would own the facility and could maintain authority and control over all phases of the operation. Macrotech might alternatively enter into a joint venture with Nitron. In a joint venture, Macrotech and Nitron would each own only part of the operation, and they would both share responsibilities, profits, and liabilities. 44. Dumping. U.S. pineapple producers alleged that producers of canned pineapple from the Philippines were selling their canned pineapple in the United States for less than its fair market value (dumping). The Philippine producers also exported other products, such as pineapple juice and juice concentrate, which used separate parts of the same pineapple used for the canned pineapple. All these products shared raw material costs, according to the producers‘ own financial records. To determine fair value and antidumping duties, the plaintiffs argued that a court should calculate the Philippine producers‘ cost of production and allocate a portion of the shared fruit costs to the canned fruit. The result of this allocation showed that more than 90 percent of the canned fruit sales were below the cost of production. Is this a reasonable approach to determining the production costs and fair market value of canned pineapple in the United States? Why or why not? (See Regulation of Specific Business Activities.) Solution Yes. It is reasonable to rely on the producers‘ financial records, which are reasonably reflective of their costs because their normal allocation methods were used for a number of years. These records are historically relied on to present important financial information to shareholders, lenders, tax authorities, auditors, and other third parties. Provided that the producers‘ records and books comply with generally accepted accounting principles and were verified by independent auditors, it is reasonable to use them to determine the production costs and fair market value of canned pineapple in the United States.

277

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

45. Sovereign Immunity. Bell Helicopter Textron, Inc., designs, makes, and sells helicopters with distinctive and famous trade dress that identifies them as Bell aircraft. Bell also owns the helicopters‘ design patents. Bell‘s Model 206 Series includes the Jet Ranger. Thirty-six years after Bell developed the Jet Ranger, the Islamic Republic of Iran began to make and sell counterfeit Model 206 Series helicopters and parts. Iran‘s counterfeit versions—the Shahed 278 and the Shahed 285—used Bell‘s trade dress. The Shahed aircraft was promoted at an international air show in Iran to aircraft customers. Bell filed a suit in a U.S. district court against Iran, alleging violations of trademark and patent laws. Is Iran—a foreign nation—exempt in these circumstances from the jurisdiction of U.S. courts? Explain. [Bell Helicopter Textron, Inc. v. Islamic Republic of Iran, 734 F.3d 1175 (C.A.D.C. 2013)] (See International Law.)

278

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Solution The doctrine of sovereign immunity exempts foreign nations from the jurisdiction of U.S. courts, subject to certain conditions. The Foreign Sovereign Immunities Act (FSIA) of 1976 codifies this doctrine and exclusively governs the circumstances in which an action may be brought in a U.S. court against a foreign nation. A foreign state is not immune from the jurisdiction of U.S. courts when the state (1) waives immunity, (2) engages in commercial activity, or (3) commits a tort in the United States or violates certain international laws. Under the FSIA, a foreign state includes its political subdivisions and ―instrumentalities‖—departments and agencies. A commercial activity is a regular course of commercial conduct, transaction, or act that is carried out by the foreign state within the United States or has a direct effect in the United States. The details of what constitutes a commercial activity are left to the courts. But it seems clear that a foreign government can be considered to engage in commercial activity when, instead of regulating a market, the government participates in it. In other words, when a foreign state, or its political subdivisions or instrumentalities, performs the type of actions in which a private party engages in commerce, the state‘s actions are likewise commercial. In the facts of this problem, Iran engaged in commercial activity outside the United States by making and marketing its counterfeit versions of Bell‘s Model 206 Series helicopters. This activity caused a direct effect in the United States by the consumer confusion that will likely result from Iran‘s unauthorized use of Bell‘s trade dress. Thus, the court can exercise jurisdiction in these circumstances, and Iran may be as liable as a private party would be for the same acts. In the actual case on which this problem is based, Iran did not respond to Bell‘s complaint. The court held that it had jurisdiction under the FSIA‘s commercial activity exception, as explained above. The court entered a default judgment against Iran and awarded damages and an injunction to Bell. 46. Sovereign Immunity. In 1954, the government of Bolivia began expropriating land from Francisco Loza for public projects, including an international airport. The government directed the payment of compensation in exchange for at least some of his land. But the government never paid the full amount. Decades later, his heirs, Genoveva and Marcel Loza, who were both U.S. citizens, filed a suit in a federal district court in the United States against the government of Bolivia, seeking damages for the taking. Can the court exercise jurisdiction? Explain. [Santivanez v. Estado Plurinacional de Bolivia, 2013 WL 879983 (11th Cir. 2013)] (See International Law.) Solution No. A U.S. court does not have jurisdiction in the Santivanez case. When applicable, the doctrine of sovereign immunity shields a foreign nation from the jurisdiction of a U.S. court. In such a case, individuals who own (or owned) property overseas generally have little legal protection against government actions with resp3ect to their property in those countries. The federal Foreign Sovereign Immunities Act (FSIA) exclusively governs the circumstances in which an action may be brought in the United States against a foreign nation, including attempts to attach a foreign nation‘s property. Under the law, a plaintiff generally has the burden of showing that a defendant is not entitled to sovereign immunity. An exception exists when a foreign nation has (1) waived its immunity, (2) engaged in commercial activity in the United States, or (3) committed a tort here. In this problem, the government of Bolivia expropriated land from Francisco Loza for public projects and directed compensation in exchange for his land, but never paid. His heirs, Genoveva

279

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

and Marcel Loza, filed a suit in a U.S. federal district court against Bolivia seeking damages for the taking. The FSIA provides for U.S. jurisdiction over cases in which rights in property are taken in violation of international law. But when a foreign nation confiscates the property of its own citizens, a U.S. court does not have jurisdiction. None of the exceptions under the FSIA apply here. In the actual case on which this problem is based, a federal district court ruled in Bolivia‘s favor. On the Lozas‘ appeal, the U.S. Court of Appeals for the Eleventh Circuit affirmed, based on the reasoning above. 47. Business Case Problem with Sample Answer— Import Controls. The Wind Tower Trade Coalition is an association of domestic manufacturers of utility-scale wind towers. The coalition filed a suit in the U.S. Court of International Trade against the U.S. Department of Commerce. It challenged the Commerce Department‘s decision to impose only prospective antidumping duties, rather than retrospective (retroactive) duties, on imports of utility-scale wind towers from China and Vietnam. The department had found that the domestic industry had not suffered any ―material injury‖ or ―threat of material injury‖ from such imports and that it would be protected by a prospective assessment. Can an antidumping duty be assessed retrospectively? If so, should it be assessed here? Discuss. [Wind Tower Trade Coalition v. United States, 741 F.3d 89 (Fed. Cir. 2014)] (See Regulation of Specific Business Activities.) Solution Yes. An antidumping duty can be assessed retrospectively (retroactively). But it does not seem likely that such a duty should be assessed here. In this problem, the Wind Tower Trade Coalition (an association of domestic manufacturers of utility scale wind towers) filed a suit in the U.S. Court of International Trade against the U.S. Department of Commerce, challenging its decision to impose only prospective antidumping duties on imports of utility scale wind towers from China and Vietnam. The Commerce Department had found that the domestic industry had not suffered any ―material injury‖ or ―threat of material injury,‖ and that it would be protected by a prospective assessment. Without a previously cognizable injury—and the fact that any retrospective duties collected would not by payable to the members of the domestic industry in any event—it does not seem likely that retroactive duties should be imposed. In the actual case on which this problem is based, the court denied the plaintiff‘s request for an injunction. On appeal, the U.S. Court of Appeals for the Federal Circuit affirmed the denial, holding that the lower court acted within its discretion in determining that retrospective duties were not appropriate. 48. The Principle of Comity. Holocaust survivors and the heirs of Holocaust victims filed a suit in a federal district court in the United States against the Hungarian national railway, the Hungarian national bank, and several private Hungarian banks. The plaintiffs alleged that the defendants had participated in expropriating the property of Hungarian Jews who were victims of the Holocaust. The claims arose from events in Hungary seventy years earlier. The plaintiffs had not exhausted remedies available through Hungarian courts. Indeed, they had not even attempted to seek remedies in Hungarian courts, and they did not provide a legally compelling reason for their failure to do so. The defendants asked the court to dismiss the suit. Does the principle of comity support the defendants‘ request? Explain. [Fischer v. Magyar Államvasutak Zrt., 777 F.3d 847 (7th Cir. 2015)] (See International Law.)

280

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Solution Yes. The principle of comity supports the defendants‘ request to dismiss the plaintiffs‘ claims. Under the principle of comity, one nation defers to and gives effect to the laws and judicial decrees of another country when those are consistent with the laws and public policy of the accommodating nation. In the fact of this problem, Holocaust survivors and the heirs of other Holocaust victims filed a suit in a federal district court in the United States against a variety of entities based in Hungary—the national railway, the national bank, and several private banks—alleging that the defendants expropriated property from Hungarian Jews who were victims of the Holocaust seventy years ago. The plaintiffs had not tried to exhaust remedies available through Hungarian courts nor did they provide a legally compelling reason for not making the attempt. As the defendants requested, the court should dismiss the suit. Comity requires that Hungarian courts be given the first opportunity to hear the claims. Of course, the U.S. court could agree to hear the suit if the plaintiffs could show that Hungarian remedies were inadequate, procedural rules would unreasonably bar their claims, or other circumstances would prevent a fair and impartial hearing. In the actual case on which this problem is based, the court dismissed the complaint. The U.S. Court of Appeals for the Seventh Circuit affirmed the dismissal for the reason stated above. 49. International Law. For fifty years, the Soviet Union made and sold Stolichnaya vodka. At the time, VVO-SPI, a Soviet state enterprise, licensed the Stolichnaya trademark in the United States. When the Soviet Union collapsed, VVO-SPI was purportedly privatized and fell under the control of Spirits International B.V. (SPI). In 2000, a Russian court held that VVO-SPI had not been validly privatized under Russian law. Thus, ownership of the Stolichnaya mark remained with the Soviet Union‘s successor, the Russian Federation. The Russian Federation assigned the mark to Federal Treasury Enterprise Sojuzplodoimport, OAO (FTE). FTE then filed a suit in a U.S. federal district court against SPI, asserting unlawful misappropriation and commercial exploitation of the mark in violation of federal law. Is the validity of the assignment of the mark to FTE a question to be determined by the court? Why or why not? [Federal Treasury Enterprise Sojuzplodoimport v. Spirits International B.V., 809 F.3d 737 (2d Cir. 2016)] (See International Law.)

281

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

Solution No. The validity of the assignment of the Stolichnaya mark by the Russian Federation to FTE is not a question to be determined by a U.S. court. Under the international act of state doctrine, the judicial branch of one country does not review the validity of public acts committed by a recognized foreign government within the latter‘s own boundaries. Here, the Soviet Union made and sold Stolichnaya vodka, and licensed its trademark for use in the United States. After the Soviet Union collapsed, the state enterprise that had managed the mark was privatized and later came under the control of Spirits International B.V. (SPI).Still later, a Russian court held that the enterprise had not been validly privatized under Russian law and that ownership of the Stolichnaya mark remained with the Soviet Union‘s successor, the Russian Federation. The Russian Federation assigned the mark to Federal Treasury Enterprise Sojuzplodoimport, OAO (FTE). In FTE‘s suit in a U.S. federal district court against SPI for unlawful misappropriation and commercial exploitation of the mark in violation of the Lanham Act, a question arose as to the validity of the assignment. But under the act of sate doctrine, this is not an issue for a U.S. court to decide. In the actual case on which this problem is based, the court ruled that the assignment to FTE was invalid under Russian law. On FTE‘s appeal, the U.S. Court of Appeals for the Second Circuit reversed. The validity of the assignment ―is a question of Russian law decided within Russia‘s borders.‖ The act of state doctrine precludes the review of an act of a foreign government done within its own territory by a U.S. court. 50. Import Controls. Goods exported to a foreign country for repair or alteration can qualify for tariff-free or reduced-tariff treatment when they re-enter the United States. But the goods do not qualify for favorable import-duty treatment if, in the foreign country, they are transformed into commercially different goods. Daimler-Chrysler AG Sprinter vans are marketed in the United States as cargo vans. Pleasure-Way Industries, Inc., bought 144 Sprinter vans and exported them to Canada for conversion into motorhomes. This included the installation of fully plumbed and furnished kitchens, bathrooms, and sleeping quarters. After the conversion, Pleasure-Way sought to import the vehicles back into the United States to market the motorhomes under new model names as upscale leisure vehicles at prices double or triple the price for Sprinter vans. Do the converted vans qualify for favorable import-tariff treatment? Discuss. [Pleasure-Way Industries, Inc.v. United States, 878 F.3d 1348 (Fed.Cir. 2018)] (See Regulation of Specific Business Activities.) Solution No. Pleasure-Way‘s vans do not qualify for favorable import-tariff treatment. Goods exported to a foreign country for repair or alteration can qualify for tariff-free or reduced tariff treatment when they re-enter the United States. But the goods do not qualify for favorable import-duty treatment if, in the foreign country, they are transformed into commercially different goods. Tariffs are taxes on imports. A tariff may be assessed as a percentage of the value of the import or as a flat rate per unit. Tariffs raise the prices of goods. The ultimate effect is to cause some consumers to buy more domestically produced goods. In this problem, Pleasure-Way bought Sprinter cargo vans and exported them to Canada for conversion into motorhomes. This included the installation of plumbed and outfitted kitchens, bathrooms, and sleeping quarters. After the conversion, Pleasure-Way sought to import the vehicles back into the United States for sale under new model names—the Ascent TS or Plateau

282

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

TS—as upscale leisure vehicles at prices double or triple the price for Sprinter vans. In Canada, Pleasure-Way‘s vans were not just repaired or altered; they were transformed into commercially different goods. For this reason, they fail to qualify for favorable import-tariff treatment. In the actual case on which this problem is based, the U.S. Bureau of Customs and Border Protection determined that the converted vans did not qualify for favorable import-tariff treatment. The U.S. Court of Appeals for International Trade and, on further appeal, the U.S. Court of Appeals for the Federal Circuit affirmed. 51. Question of Ethics—The IDDR Approach and Doing Business Internationally. Incorporated under Venezuelan law, a subsidiary of U.S.-based Helmerich & Payne International Drilling Co. supplied oil-drilling rigs to entities that were part of the government of Venezuela. The government fell behind in payment on contracts for the use of the rigs. When the overdue amounts topped $100 million, the government nationalized the rigs and took possession. Helmerich filed a suit in a U.S. federal district court against Venezuela, claiming expropriation of property in violation of international law. Helmerich asserted that the U.S. court had jurisdiction under the Foreign Sovereign Immunities Act (FSIA). [Bolivarian Republic of Venezuela v. Helmerich & Payne International Drilling Co., 581 U.S. __, 137 S.Ct. 1312, 197 L.Ed.2d 663(2017)] (See International Law.) 1.

Venezuela argued that the FSIA did not apply because Helmerich did not have rights in the rigs, which were the subsidiary‘s property. Does that fact make Helmerich‘s claim frivolous and unethical? Explain.

Solution No. Helmerich‘s claim is neither frivolous nor unethical. A claim that is frivolous lacks substance and is not to be taken seriously. Such a claim would be unethical if it were asserted with an intent that matched its lack of substance or had a nefarious purpose. In this problem, U.S.-based Helmerich incorporated a subsidiary under Venezuelan law that supplied oil-drilling rigs to entities that were part of the government of Venezuela. When the government failed to pay $100 million on its contracts to use the rigs, it nationalized the equipment and took possession. Helmerich filed a suit in a U.S. federal district court against Venezuela, claiming expropriation in violation of international law. Helmerich asserted that the U.S. court had jurisdiction under the Foreign Sovereign Immunities Act (FSIA). Venezuela argued that the FSIA did not apply because the rigs were the property of the subsidiary—a Venezuelan company. Of course, Helmerich knew that the rigs were the property of its subsidiary. The amounts owed on the contracts were significant, however, and the rigs were presumably valuable. The parent company was obligated to its shareholders—ethically, if not legally—to attempt to achieve a remedy for the taking of the equipment in as favorable a forum as possible. Undoubtedly, Helmerich believed that it was unlikely to obtain adequate relief in a Venezuelan court. So, the company filed a suit against Venezuela in a U.S. court. In sum, Helmerich asserted its claim with a serious intent and an ethical purpose. (It might be noted that simply arguing in a ―non-frivolous‖ way that property has been taken in violation of international law is not sufficient to confer jurisdiction under the FSIA. If the situation were otherwise, the only limits to bringing a claim under the act would be the bounds of a

283

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 23: International and Space Law

lawyer‘s ―non-frivolous‖ imagination. Such claims could cause friction with other nations, leading to reciprocal actions against the United States.) In the actual case on which this problem is based, the court rejected the argument that Helmerich had no rights in the subsidiary‘s property and held that the parent‘s claim fell within the jurisdiction of the court under the FSIA. The U.S. Court of Appeals for the District of Columbia Circuit agreed, concluding that Helmerich had asserted its rights in a ―non-frivolous‖ way and that was enough to bring the case within the FSIA‘s scope. The United States Supreme Court vacated this decision and remanded the case. The Court held that a party‘s ―non-frivolous, but ultimately incorrect,‖ argument is not enough to confer FSIA jurisdiction. 2.

Using the IDDR approach, determine whether a company is ethically obligated to become familiar with the political situation before doing business in another country.

Solution Yes. A company is ethically obligated to become familiar with the political situation in another country before doing business there. Politics can affect the success or failure of a business. To satisfy a company‘s stakeholders, local politics should be as thoroughly researched as the sources for the company‘s resources and labor, and the market for its products. The IDDR approach begins with an Inquiry, which spells out the issue, the stakeholders, and relevant ethical standards. Conducting business legally in another nation requires a familiarity with that nation‘s laws. Doing business successfully in another nation requires a familiarity with that nation‘s business climate. This includes the area‘s capacity to meet the business‘s logistical and infrastructural needs, as well as the regional markets, culture, and economy. Thus, a company has an ethical obligation to acquire that knowledge. And the company has a similar duty to know the country‘s political situation. Those politics can affect business, which impacts a company‘s stakeholders—its owners, employees, suppliers, and customers—and others—its competitors, the larger community of which the business is a part, and global buyers, sellers, and distributors of its products. Relevant ethical standards can include company policies, which undoubtedly cover remaining profitable and might mention a duty to ―do good.‖ The next step of the approach is a Discussion that touches on actions that address the issue. Factors include the strengths and weaknesses of the actions, including the consequences and the effects on stakeholders. The simplest course to become familiar with a country‘s political situation is to research it. Read about it, talk to experts, and review the country‘s media. The weakness of this action might be the time and expense it adds to the costs of doing business. The strengths might include the confidence that being forewarned can bring to any business setting. If the politics are too untenable, a company might wisely stay out of the local market. The IDDR approach suggests for its next step a Decision and the reasons. To the question in this problem, the decision seems clear—the political situation in another country should be investigated before business is done there. And the reasons set out above are as convincing as the decision is clear. Finally, the approach posits a Review to estimate the success or failure of the action to resolve the issue, and satisfy the stakeholders. If a company doing business in another country is successful in that nation, its numerous stakeholders should be satisfied. If, to realize that success, the company first divined the nation‘s politics, its ethical obligation to those stakeholders is likewise met.

284

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Critical Thinking and Writing Assignments 10. Time-Limited Group Assignment—Globalization. Assume that you are manufacturing tablet accessories and that your business is becoming more successful. You are now considering expanding operations into another country. (See Doing Business Internationally.) 1.

One group will explore the costs and benefits of advertising internationally on the Internet.

Solution Factors to consider when expanding operations into another country by advertising online include (1) business costs such as website design and maintenance; (2) marketing considerations such as which business model to use; (3) security concerns such as the safety of company and customer information; (4) practical elements such as inventory storage and product shipping; and (5) cultural characteristics such as language and customs. The benefits of Internet advertising include that it is relatively inexpensive to reach a vast market, compared to the cost of traditional marketing. And because the operation can be digitized, ―testing the waters‖ of a potential market, as well as tracking consumers and accumulating market data, can be easier and less costly. 1.

Another group will consider whether to take in a partner from a foreign nation and examine the benefits and risks of doing so.

Solution A partnership in another country typically requires local participation—nationals of the other country must own a specific share of the business. Of course, if the partnership dissolves, the firm‘s technology and other expertise may fall into in the hands of a foreign competitor. The domestic firm that initiated the partnership may have little recourse in the foreign country against their former partner‘s use of this expertise. Thus, to take in a partner in a foreign nation, a domestic business firm should define each party‘s duties and risks in a written contract, including the object or subject of the partnership, the assets that each party contributes to the firm, what is expected of each party with respect to the firm‘s intellectual property, and the sharing of profits and losses. Important provisions would also cover forum selection, choice of law, choice of language, and the resolution of disputes, as well as remedies and the division of assets on the firm‘s dissolution.

2. A third group will discuss what problems may arise if you want to manufacture in a foreign location. Solution Problems that may arise when a domestic business company decides to manufacture its products in a foreign location include the costs and other considerations in obtaining and using foreign labor, shipping, and raw materials. There may also be different cultural, economic, legal, political, and social conditions to take into account.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

285

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 286 Adapting the Law to the Online Environment ................................................................................ 286 Critical Thinking Questions in Cases ................................................................................................................... 287 Case 24.1 ............................................................................................................................................... 287 Case 24.2 ............................................................................................................................................... 287 Case 24.3 ............................................................................................................................................... 288 Chapter Review ........................................................................................................................................................... 289 Practice and Review .............................................................................................................................. 289 Practice and Review: Debate This ......................................................................................................... 290 Issue Spotters ........................................................................................................................................ 290 Business Scenarios and Case Problems ................................................................................................. 291 Critical Thinking and Writing Assignments ............................................................................................ 297

Critical Thinking Questions in Features Adapting the Law to the Online Environment 436. Why is consumer consent so important to the open banking model? Solution Obviously, open banking is untenable if banks and fintech companies take advantage of it to share consumer financial data without the consumer‘s consent. As with any business transaction in which one party has access to and, on some level, control over another party‘s money, trust is key. Without their customers‘ trust, banks could not survive. In open banking, customers need not only to trust that financial data are not stolen or lost, but also that such data will only be used for purposes that customers consent to. Suppose, for instance, that a small business wants to open a line of credit. With open banking, that business could provide consent for a bank to access its accounting records, which, combined with its bank accounts, would give lenders a sense of its credit worthiness, At the same time, if any of this information ―leaked‖ to other sources, the trust between the small business and its bank would be severely damaged. The value of this trust is even higher in the United States, where banking regulators seem uninterested in dictating open banking rules and strategies, at least for now. Consequently, the weight of earning and keeping consumer trust falls squarely on the shoulders of fintech companies who want to offer these services.

286

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Critical Thinking Questions in Cases Case 24.1 437. Suppose that West Bank‘s Deposit Account Agreement had not included ―an obligation to Depositor to exercise good faith and ordinary care in connection with each account.‖ How might the result have been different? Solution It is not likely that the result would have been different in this case if West Bank‘s Deposit Account Agreement had excluded ―an obligation to Depositor to exercise good faith and ordinary care in connection with each account.‖ Here, the courts‘ regard for the decisions of other courts in cases with similar facts leads to an inference that the courts would have found a duty to act in good faith even without an express contractual provision in the bank‘s account agreement. As the state supreme court stated, ―The Leggs could reasonably argue that the change in sequencing of bank card transactions, coupled with the lack of notification, violated the reasonable expectations of customers that the bank act in good faith when exercising its discretion to sequence transactions.‖

Case 24.2 438. Horton claimed that she had not agreed to the conversion of the account or to the withdrawal of the funds. These contentions did not affect the court‘s decision. Why not? Solution The court did not need to consider these assertions. Even assuming they were true, the judgment in the bank‘s favor was proper because Horton did not comply with the terms of the account agreement. In the case, Horton opened an individual checking account with Chase Bank. The terms of the account required Horton to notify Chase in writing of any unauthorized item within thirty days of when a statement showing the item was mailed or made available. A failure to provide the notice would preclude a claim based on the item. Later, Chase received a purported request by Horton and Kimberly Stovall, a representative of Horton‘s employer, to convert the account to a joint account. Still later, Stovall terminated Horton‘s employment and withdrew all of the funds in the account. Almost two years after the final withdrawal, Horton filed a suit in a Texas state court against Chase, alleging breach of contract. This was the first notice to Chase in writing of a challenge to the withdrawal. Chase filed a motion for summary judgment, which the court granted. A state intermediate appellate court upheld the judgment. 439. Why does the UCC ―absolutely‖ limit the time that a customer has to report an altered check or unauthorized signature?

287

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Solution A limit on the period of time that a customer has to report an altered check or unauthorized signature is reasonable. The purposes underlying the limit include stopping fraudulent acts, minimizing losses, and encouraging customers to carefully monitor their bank accounts. Article 4 of the Uniform Commercial Code (UCC) establishes the rights and duties of banks and their customers regarding deposits and collections. UCC 4–401 provides that a bank can only charge a customer‘s account for ―an item that is properly payable.‖ To qualify, an item must be ―authorized by the customer‖ and in accord with any agreement between the customer and the bank. A bank is liable if it charges a customer‘s account for an item that is not ―properly payable.‖ Under UCC 4–406, if a bank sends or makes available to the customer an account statement that reasonably identifies the items paid, the customer must examine the statement and promptly notify the bank of any unauthorized alterations or signatures. A customer‘s claim with respect to such an item is ―absolutely‖ barred if the notice is not provided within one year. (These obligations and this time period may be varied by agreement.)

Case 24.3 440. On what fact might a court base a decision that the EFTA does not apply in Binns‘s situation? Solution A court might base a decision that the Electronic Fund Transfer Act, or EFTA, does not apply to the situation in the Binns case on the fact that the unauthorized transactions for which Binns sought to recover involved a commercial, or business, account. The EFTA governs ―any transfer of funds, other than a transaction originated by check, draft, or similar paper instrument, which is initiated through an electronic terminal, telephonic instrument, or computer or magnetic tape so as to order, instruct, or authorize a financial institution to debit or credit an account.‖ The transactions at issue in the Binns case involved electronic transfers, effected through the unauthorized use of the account and routing numbers. For electronic consumer payments, the EFTA, rather than other federal or state law, governs. But the account from which the unauthorized transfers were made was not a consumer account but a commercial corporate account. Thus, it would not be subject to the EFTA, which states that its primary objective is to provide ―individual consumer rights‖ and defines an ―account‖ as a ―demand deposit, savings deposit, or other asset account * * * established primarily for personal, family, or household purposes.‖ Under the EFTA, corporations and other business entities are not consumers. If, however, a defendant bank in a suit involving a commercial account does not object to the application of the EFTA, a court might allow a claim based on it to go forward. 441. Suppose that Binns had charged the bank with violations of Article 3 of the UCC, which governs negotiable instruments, defined as signed writings that order or promise payments of money. Article 3 allocates loss from a forged signature or alteration on an instrument according to the exercise of ordinary care by a bank and its customer. Would the result have been different? Explain.

288

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Solution No, the result would not have been different if Binns had asserted that Truist had violated Article 3 of the UCC. Article 3 governs negotiable instruments, of course. A negotiable instrument is defined as a signed writing that orders or promises a payment of money. Here, the transfers at issue took place through electronic transactions with the use of routing and account numbers without the use of signatures, not signed writings. Because the withdrawals were not signed writings, Article 3 would not have applied. It might be added that Article 4, which governs bank deposits and collections, would likewise not have applied to the circumstances in the Binns case. Article 4 does not cover, or make any reference to, electronic transactions—like Article 3, it applies only to traditional written instruments. It is possible that Article 4A, which applies to wire transfers, if they are credit transfers, might apply to electronic transactions such as those at issue here. But Article 4A permits parties to alter its terms by contract. This interpretation would have taken the dispute in the Binns case out of the application of the UCC and subjected it the terms of the Customer Agreements. And under those terms, Binns‘s claims were barred.

Chapter Review Practice and Review RPM Pizza, Inc., issued a check for $96,000 to Systems Marketing for an advertising campaign. A few days later, RPM decided not to go through with the deal and placed a written stop-payment order on the check. RPM and Systems had no further contact for many months. Three weeks after the stoppayment order expired, however, Toby Rierson, an employee at Systems, cashed the check. Bank One Cambridge, RPM‘s bank, paid the check with funds from RPM‘s account. Because the check was more than six months old, it was stale. Thus, according to standard banking procedures as well as Bank One‘s own policies, the signature on the check should have been specially verified, but it was not. RPM filed a suit in a federal district court against Bank One to recover the amount of the check. Using the information presented in the chapter, answer the following questions. 442. How long is a written stop-payment order effective? What else could RPM have done to prevent this check from being cashed? Solution A written stop-payment order (or an oral order confirmed in writing) is effective for six months, when it may be renewed in writing, under UCC 4–403(b). To prevent the cashing of the check, RPM might have asked Systems Marketing to return it. 443. What would have happened if RPM had not had a legitimate reason for stopping payment on the check? Solution

289

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

A customer-drawer must have a valid legal ground for issuing a stop-payment order on a check or a holder can sue the drawer for payment. A person who wrongfully stops payment on a check is liable to the payee for the amount of the check and can also be liable for consequential damages. 444.

What are a bank‘s obligations with respect to stale checks?

Solution Under UCC 4–404, a bank is not obligated to pay a stale check, although the bank has that option. If a bank pays a stale check in good faith, the bank has the right to charge the customer‘s account for the amount even without consulting the customer. 445. Would a court be likely to hold the bank liable for the amount of the check because it failed to verify the signature on the check? Why or why not? Solution The failure to verify the signature will result in Bank One‘s loss of the amount of the check. A bank that pays a customer‘s check bearing a forged indorsement must recredit the customer‘s account or be liable to the customer-drawer for breach of contract, under UCC 4–401(a). The reasoning is because the bank failed to pay the check in accord with the customer‘s ―order to pay.‖ Banks today normally verify signatures only on checks that exceed a certain threshold, such as $1,000, $2,500, or some higher amount, but in line with standard practices and Bank One‘s own policies, RPM‘s check falls well outside such a limit. Assuming that Rierson‘s signature was a forgery, Bank One‘s failure to recognize it could also subject the bank to liability for a failure to exercise ordinary care. If Rierson altered the check to cash it, and RPM is also considered to have been negligent, the liability for the amount of the check may be apportioned between the bank and its customer.

Practice and Review: Debate This 446. To reduce fraud, checks that utilize mechanical or electronic signature systems should not be honored. Solution If businesses were forced to always have physical person sign each check, then fraud would be reduced. Banks and businesses would be involved in fewer lawsuits over who is responsible for such fraud. The use of mechanical or electronic signatures systems for checks allows businesses to more cheaply carry out their operations. Any attempt at eliminating such systems would cause businesses to use more employees. Costs and therefore prices would rise as a result.

Issue Spotters 447. Lyn writes a check for $900 to Mac, who indorses the check in blank and transfers it to Jan. She then presents the check to Omega Bank, the drawee bank, for payment. Omega does not honor the check. Is Lyn liable to Jan? Could Lyn be subject to criminal prosecution? Why or why not? Solution

290

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Yes, to both questions. In a civil suit, a drawer (Lyn) is liable to a payee (Jan) or to a holder of a check that is not honored. If intent to defraud can be proved, the drawer (Lyn) can also be subject to criminal prosecution for writing a bad check. 448. Herb steals a check from Kay‘s checkbook, forges Kay‘s signature, and transfers the check to Will for value. Unaware that the signature is not Kay‘s, Will presents the check to First State Bank, the drawee. The bank cashes the check. Kay discovers the forgery and insists that the bank recredit her account. Can the bank refuse to recredit Kay‘s account? If not, can the bank recover the amount paid to Will? Why or why not? Solution The general rule is that the bank must recredit a customer‘s account when it pays on a forged signature. The bank has no right to recover from a holder who, without knowledge, cashes a check bearing a forged drawer‘s signature. Thus, the bank in this problem can collect from neither its customer nor the party who cashed the check. The bank‘s recourse is to look for the thief.

Business Scenarios and Case Problems 449. Forged Checks. Roy Supply, Inc., and R. M. R. Drywall, Inc., had checking accounts at Wells Fargo Bank. Both accounts required all checks to carry two signatures—that of Edward Roy and that of Twila June Moore, both of whom were executive officers of both companies. Between January 2018 and March 2019, the bank honored hundreds of checks on which Roy‘s signature was forged by Moore. On January 31, 2020, Roy and the two corporations notified the bank of the forgeries and then filed a suit in a California state court against the bank, alleging negligence. Who is liable for the amounts of the forged checks? Why? (See The Bank’s Duty to Honor Checks.) Solution The UCC requires customers to discover and report forgeries to their banks within one year of the time the checks and a statement of account showing payment of the checks are made available to the customer [UCC 4-406(d)]. Thus, Roy and the two corporations can only be held liable for the amounts of any forged checks that were reported less than one year after the bank statement showing payment of the checks. The critical dates are (1) the date that the bank statement showing the checks were paid was sent or made available to the customer, and (2) the date that the customer discovered and reported the forgery. The date on the face of the check and the date that the check was paid by the bank are irrelevant. 450. Customer Negligence. Gary goes grocery shopping and carelessly leaves his checkbook in his shopping cart. His checkbook, with two blank checks remaining, is stolen by Dolores. On May 5, Dolores forges Gary‘s name on a check for $100 and cashes the check at Gary‘s bank, Citizens Bank of Middletown. Gary has not reported the loss of his blank checks to his bank. On June 1, Gary receives his monthly bank statement from Citizens Bank, which includes the forged check, but he does not notice the item, nor does he examine his bank statement. On June 20, Dolores forges Gary‘s last check. This check is for $1,000 and is cashed at Eastern City Bank, a bank with which Dolores has previously done business. Eastern City Bank puts the check through the collection process, and Citizens Bank honors it. On July 1, on receipt of his bank statement and canceled checks covering June transactions, Gary discovers both forgeries and immediately notifies Citizens Bank. Dolores cannot be found. Gary claims that Citizens Bank must recredit his account for both checks, as his signature was forged. Discuss fully Gary‘s claim. (See The Bank’s Duty to Honor Checks.)

291

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Solution Citizens Bank will not have to recredit Gary‘s account for the $1,000 check and probably will not have to recredit his account for the first forged check for $100. Generally, a drawee bank is responsible for determining whether the signature of its customer is genuine, and when it pays on a forged customer‘s signature, the bank must recredit the customer‘s account [UCC 3–401, 4– 406]. There are, however, exceptions to this general rule. The first exception is when a customer‘s negligence substantially contributes to the making of an unauthorized signature (including a forgery), the drawee bank that pays the instrument in good faith will not be obligated to recredit the customer‘s account for the full amount of the check [UCC 3–406]. In addition, when a drawee bank sends to its customer a statement of account and canceled checks, the customer has a duty to exercise reasonable care and promptness in examining the statement to discover any forgeries and report them to the drawee bank. Failure of the customer to do so relieves the drawee from liability to the customer to the extent that the drawee bank suffers a loss [UCC 4–406(c)]. Therefore, Gary‘s negligence in allowing his checkbook to be stolen and his failure to report the theft or examine his May statement will preclude his recovery on the $100 check from the Citizens Bank. Under UCC 3–406(b) and 4–406(e), however, the bank could be liable to the extent that its negligence substantially contributes to the loss. The second exception is when a series of forgeries is committed by the same wrongdoer, the customer must discover and report the initial forgery within fourteen calendar days from the date that the statement of account and canceled checks (containing the initial forged check) are made available to the customer [UCC 4–406(d)(2)]. Failure to discover and report a forged check releases the drawee bank from liability for all additional forged checks in the series written after the thirty-day period. Therefore, Gary‘s failure to discover the May forged check by June 30 relieves the bank from liability for the June 20 check of $1,000. 451. Forged Indorsements. Adley Abdulwahab (Wahab) opened an account on behalf of W Financial Group, LLC, with Wells Fargo Bank. Wahab was one of three authorized signers on the account. Five months later, Wahab withdrew $1,701,250 from W Financial‘s account to buy a cashier‘s check payable to Lubna Lateef. Wahab visited a different Wells Fargo branch and deposited the check into the account of CA Houston Investment Center, LLC. Wahab was the only authorized signer on this account. Lateef never received or indorsed the check. W Financial filed a suit to recover the amount. Applying the rules for payment on a forged indorsement, who is liable? [Jones v. Wells Fargo Bank, 666 F.3d 955 (5th Cir. 2012)] (See The Bank’s Duty to Honor Checks.) Solution Wells Fargo is liable to W Financial for the amount of the check. A bank that pays a customer‘s check bearing a forged indorsement must recredit the customer‘s account or be liable to the customer-drawer for breach of contract. The bank must recredit the account because it failed to carry out the drawer‘s order to pay to the order of the named party. Eventually, the loss falls on the first party to take the instrument bearing the forged indorsement because a forged indorsement does not transfer title. Thus, whoever takes an instrument with a forged indorsement cannot become a holder. Under these rules, Wells Fargo is liable to W Financial for the amount of the check. The bank had an obligation to ensure that the check was properly indorsed. The bank did not pay the check to the order of Lateef, the named payee, but accepted the check for deposit into the account of CA

292

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Houston without Lateef‘s indorsement. The bank did not obtain title to the instrument and could not become a holder, nor was it entitled to enforce the instrument on behalf of any other party who was entitled to enforce it. In the actual case on which this problem is based, the court held the bank liable to pay the amount of the check to W Financial. 452. Business Case Problem with Sample Answer— Consumer Fund Transfers. Stephen Patterson held an account with Suntrust Bank in Alcoa, Tennessee. Juanita Wehrman—with whom Patterson was briefly involved in a romantic relationship—stole his debit card and used it for sixteen months (well beyond the length of their relationship) to make unauthorized purchases in excess of $30,000. When Patterson learned what was happening, he closed his account. The bank refused to reimburse him more than $677.46—the amount of unauthorized transactions that had occurred within sixty days of the transmittal of the bank statement that revealed the first unauthorized transaction. Is the bank‘s refusal justifiable? Explain. [Patterson v. Suntrust Bank, 2013 WL 139315 (Tenn.App. 2013)] (See Electronic Fund Transfers.) Solution Yes. The bank‘s refusal to reimburse Patterson more than $677.46 was justified. Under the Electronic Fund Transfer Act (EFTA), if a customer‘s debit card is lost or stolen and used without permission, the customer does not have to pay more than $50. But for this limit to apply, the customer must notify the bank of the loss or theft within two days of learning about it. Otherwise, the liability increases to $500. The customer may be liable for more than $500 if the unauthorized use is not reported within sixty days after it appears on the customer‘s statement. In this problem, Stephen Patterson held an account with Suntrust Bank. He was briefly involved in a romantic relationship with Juanita Wehrman, who stole his debit card and used it for sixteen months (well beyond the length of their relationship), spending more than $30,000. When Patterson learned what was happening, he closed his account. But of course, sixteen months is much more than sixty days, and the bank refused to reimburse him more than $677.46. This was the amount of unauthorized transactions that occurred within sixty days of the transmittal of the bank statement that revealed the first unauthorized transaction. In the actual case on which this problem is based, in Patterson‘s suit in a Tennessee state court against the bank to recover the rest of the spent funds, the court upheld the bank‘s refusal. A state intermediate appellate court affirmed. 453. Forged Drawers’ Signatures. Victor Nacim had a checking account at Compass Bank. The ―Deposit Agreement‖ required him to report an unauthorized transaction within thirty days of his receipt of the statement on which it appeared to obtain a recredit. When Nacim moved to a new residence, he asked the bank to update the address on his account. Compass continued to mail his statements to his previous address, however, and Nacim did not receive them. In the meantime, Compass officer David Peterson made an unauthorized withdrawal of $34,000 from Nacim‘s account. A month later, Peterson told Nacim what he had done. The next month, Nacim asked the bank for a recredit. Compass refused on the ground that he reported the withdrawal more than thirty days after the bank mailed the statement on which it appeared—a statement that Nacim never received. Is Nacim entitled to a recredit? Explain. [Compass Bank v. Nacim, 459 S.W.3d 95 (Tex. App.—El Paso 2015)] (See The Bank’s Duty to Honor Checks.)

293

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Solution Yes. Nacim is entitled to a recredit of his account for the amount of Peterson‘s unauthorized withdrawal. A forged signature on a check—or other means of effecting an unauthorized withdrawal from a customer‘s account—has no legal effect as the signature or authorization of a customer-drawer. When a bank pays a check in this situation, generally the bank is liable. The contract between the bank and its customer may shift the loss to the customer in some circumstances. For example, a bank may send a monthly statement that shows the activity in the customer‘s account. The customer has a duty to promptly examine the statement and report any unauthorized transactions. ―Promptly‖ may have a specific time limit, such as thirty days, depending on the terms of the account agreement between the bank and its customer. In this problem, Nacim had a checking account at Compass Bank. When he moved to a new residence, he asked the bank to update the address on his account. But Compass continued to mail his statements to his previous address, and Nacim did not receive them. Peterson made an unauthorized withdrawal from Nacim‘s account. Nacim learned what Peterson had done and asked the bank for a recredit. Compass refused on the ground that the notice was more than thirty days after it had mailed the relevant bank statement to Nacim. Under the bank‘s ―Deposit Agreement,‖ however, the duty to report an unauthorized transaction did not begin to run until the customer received the mailed statement. Nacim did not receive the statement because Compass failed to change his address in its system. Thus, Nacim is entitled to a recredit. In the actual case on which this problem is based, Nacim filed a suit in a Texas state court against the bank. The court issued a judgment in Nacim‘s favor. A state intermediate appellate court affirmed the judgment for the reason stated above. 454. Checks Bearing Forged Indorsements. The law firm of Levy Baldante Finney & Rubenstein, P.C., had a checking account at TD Bank, N.A. The account agreement required notice to the bank of ―any problem with a check‖ within thirty days from when a statement showing the item was mailed. Jack Cohen, a partner at the law firm, stole more than three hundred thousand dollars from the account by fraudulently indorsing twenty-nine checks that had been made payable to clients and other third parties. More than two years after the first item appeared in an account statement, Susan Huffington, the firm‘s bookkeeper, discovered one of the fraudulently indorsed checks. She reviewed previous statements with images of the back of each check, compiled a list of fraudulently indorsed items, and notified the bank to recredit the account. Is the bank obligated to honor this request? Why or why not? [Levy Baldante Finney & Rubenstein, P.C. v. Wells Fargo Bank, N.A., __ A.3d __, 2018 WL 847756 (Pa.Super. 2018)] (See The Bank’s Duty to Honor Checks.) Solution No. TD Bank is not obligated to honor the customer‘s request to credit its account for the amounts of the fraudulently indorsed items. A bank that pays a customer‘s check bearing a forged indorsement is obligated to credit the customer‘s account for the amount of the item (or risk being held liable for breach of the contract between the customer and the bank). But the customer has a duty to report such items promptly. Under the UCC, failure to report such an item within three years after it appears on a statement made available to the customer relieves the bank of liability. These terms can be altered by agreement. In this problem, the bank‘s customer was a law firm. A partner at the firm stole over $300,000 from its checking account by fraudulently indorsing checks that had been made payable to third

294

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

parties. More than two years after the first item appeared in an account statement, the firm‘s bookkeeper discovered one of the checks, reviewed previous statements, compiled a list of fraudulently indorsed items, and notified the bank to credit the account. The account agreement required notice to the bank of ―any problem with a check‖ within thirty days from when a statement showing the item was mailed. Because the firm‘s notice was more than two years after this period had run, the bank had no obligation to credit the firm‘s account. In the actual case on which this problem is based, the firm filed a suit in a Pennsylvania state court against the bank to recover the amounts of the checks. The court granted a summary judgment in the bank‘s favor. A state intermediate appellate court affirmed. In regard to the agreement‘s thirty-day limit, the court concluded, ―Such time limits are not unreasonable.‖ 455. A Question of Ethics—The IDDR Approach and Unauthorized Items. While working as an executive assistant to David Ducote, Michelle Freytag fraudulently obtained a credit card in Ducote‘s name from Whitney National Bank in New Orleans, Louisiana. Freytag told Whitney to pay the credit card balances with funds from Ducote‘s bank account. The bank included a ―debit memo‖ of each payment with the monthly account statements sent to Ducote. But Ducote never contacted the bank about any unauthorized items. Freytag‘s scheme was not discovered until, more than five years later, the bank contacted Ducote to ask about some of the charges to the credit card. [Ducote v. Whitney National Bank, 212 So.3d 729 (La.App. 5 Cir. 2017)] (See The Bank’s Duty to Honor Checks.) 1. Do bank customers in Ducote‘s position have an ethical duty to examine their account statements? Discuss.

295

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

Solution Yes. A bank customer has an ethical duty to examine account statements and notify the bank if her or she wants to obtain a recredit for unauthorized items. A customer must examine monthly account statements and report any forged or unauthorized items. Otherwise, the customer is liable for the loss of the funds debited from the account to pay the item. To obtain a recredit, the customer must report the item within one year from the date the statement was available. If there is a series of such items, the customer has only thirty days to report the first one, or the bank will be discharged of liability for paying all similar items before it is notified. If the customer can prove that the bank was negligent, the bank can also be held liable. These same principles and standards apply to any unauthorized payment from a customer‘s bank account. Here, Michelle Freytag, executive assistant to David Ducote, fraudulently obtained a credit card in Ducote‘s name from Whitney National Bank. Freytag told Whitney to pay the card balances with funds from Ducote‘s account. The monthly account statements sent to Ducote clearly showed the payments, but he never contacted the bank about the unauthorized items. Ducote‘s ethical duty to examine the statements and notify the bank arises from his legal duty to do so and the practicality of the circumstances. Who has the legal duty to examine the statements? Who is most likely to know whether items reflected in the statement were authorized? Whose interest in avoiding payment for such items is paramount? Who is in the best position to thwart fraud in this situation? The customer, of course. Stakeholders who would suffer from the customer‘s choice not to act on this duty include those connected with Ducote‘s business—owners, employees, customers, and suppliers—and, to a lesser extent, those who do business with the bank. Ducote‘s career could be affected, which could impact his family. 2.

Is the bank ethically obligated to recredit Ducote‘s account? Explain.

Solution A bank customer may have an ethical duty to examine monthly account statements and notify the bank if that individual wants to obtain a re-credit for unauthorized items. But a bank does not have an ethical duty to re-credit the customer‘s account. As stated in the answer to the previous question, a customer must examine account statements and report any forged or unauthorized items. Otherwise, the customer is liable for the loss of the funds debited from the account to pay the item. To obtain a re-credit, the customer must report the item within one year from the date the statement was available. If there is a series of such items, the customer has only thirty days to report the first one, or the bank will be discharged of liability for paying all similar items before it is notified. If the customer can prove that the bank was negligent, the bank will be comparatively liable. These principles and standards apply to any unauthorized payment from a customer‘s bank account. A customer‘s ethical duty to examine the statements and notify the bank arises from the legal duty to do so, which makes practical sense. The customer has the legal duty to examine the

296

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 24: Banking

statements. The customer is most likely to know whether items reflected in the statement were authorized. The customer‘s interest in avoiding payment for such items is paramount. And the customer is in the best position to avoid the fraud in the first place and stop it if it occurs. For the same reasons, a bank does not have an ethical duty to re-credit a customer‘s account. In the actual case on which this problem is based, Ducote filed a suit in a Louisiana state court against Whitney. The court issued a summary judgment in the bank‘s favor. A state intermediate appellate court affirmed. Freytag was convicted of wire fraud, sentenced to prison, and ordered to pay restitution.

Critical Thinking and Writing Assignments 456. Critical Legal Thinking. Under the revised Article 4, a bank is no longer required to include the customer‘s canceled checks when it sends monthly statements to the customer. A bank may simply itemize the checks (by number, date, and amount). It may provide photocopies of the checks as well but is not required to do so. What implications do these rules have for bank customers in terms of liability for unauthorized signatures and indorsements? (See The Bank’s Duty to Honor Checks.) Solution UCC Article 4 was revised, and Check 21 was enacted, to reflect new technology and business practices. These rules reflect a policy decision in favor of reducing the costs of check collection and payment. Many customers do not keep track of every check or may be unable to identify a check based on the information in a bank statement or even by viewing an electronic copy. Without seeing an original copy, some customers may be unable to determine whether an item includes an unauthorized signature. To date, however, evidence indicates that the procedures authorized in the revised UCC 4–406(a) and under Check 21 reduce costs, speed collection and payment, and have other practical advantages, but produce no significant increase in losses to customers. It might also be noted that the time period within which a customer has to report a forgery or alteration under the revised UCC 4–406(a) has been increased from fourteen to thirty days. 457. Time-Limited Group Assignment—Death of a Customer. On January 5, Brian drafts a check for $3,000 drawn on Southern Marine Bank and payable to his assistant, Shanta. Brian puts last year‘s date on the check by mistake. On January 7, before Shanta has had a chance to go to the bank, Brian is killed in an automobile accident. Southern Marine Bank is aware of Brian‘s death. On January 10, Shanta presents the check to the bank, and the bank honors the check by payment to Shanta. Later, Brian‘s widow, Joyce, claims that because the bank knew of Brian‘s death and also because the check was by date over one year old, the bank acted wrongfully when it paid Shanta. Joyce, as executor of Brian‘s estate and sole heir by his will, demands that Southern Marine Bank recredit Brian‘s estate for the check paid to Shanta. (See The Bank’s Duty to Honor Checks.) 1.

The first group will determine whether the bank acted wrongfully by honoring Brian‘s check and paying Shanta.

Solution Southern Marine Bank did not act wrongfully by honoring Brian‘s check and paying Shanta. The UCC provides that the death of a customer does not revoke a payor bank‘s authority to pay a check drawn by the customer and that even with knowledge of the customer‘s death, the bank

297

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

may for ten days after the date of death pay checks drawn before death [UCC 4–405]. Therefore, Southern Marine Bank‘s payment on January 10, three days after Brian‘s death, is a proper payment. 1.

The second group will assess whether Joyce has a valid claim against Southern Marine Bank for the amount of the check paid to Shanta.

Solution Joyce‘s claim that Brian‘s death and Southern Marine Bank‘s knowledge of it revoked Southern Marine Bank‘s authority to pay is incorrect. As noted in the answer to the previous question, the UCC provides that the death of a customer does not revoke a payor bank‘s authority to pay a check drawn by the customer and that even with knowledge of the customer‘s death, the bank may for ten days after the date of death pay checks drawn before death [UCC 4–405]. Joyce‘s claim that the bank must not pay a check presented more than six months after its date is also incorrect. A check whose date and presentment are more than six months apart is a ―stale check.‖ Although a bank is under no obligation to honor such a check, it may in good faith honor the check without liability. Normally, a bank will consult its depositor, but this is a time of year during which many drawers mistakenly still use last year‘s date. Thus, consultation is not required and because payment in good faith is permitted, Southern Marine Bank is not liable [UCC 4–404]. 2.

The third group will assume that the check Brian drafted was on his business account rather than on his personal account and that he had two partners in the business. Would a business partner be in a better position to force Southern Marine Bank to recredit Brian‘s account than his widow? Why or why not?

Solution A business partner might be in a better position to force Southern Marine Bank to recredit Brian‘s account than his widow. The death of a bank‘s customer does not revoke the bank‘s authority to pay a check drawn by the customer. Even with knowledge of the death, the bank may for ten days after the date of death pay checks drawn before death. There is an exception, however—the bank cannot pay a check, and is liable to recredit the customer‘s account, if a proper stop-payment order has been issued by a person claiming an interest in the account [UCC 4–405]. Therefore, if a business partner had issued a stop-payment order on the check drawn on the business‘s account, Southern Marine Bank‘s payment on January 10, three days after Brian‘s death, would not be a proper payment.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors’ Rights

298

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Case 25.2 ............................................................................................................................................... 299 Case 25.3 ............................................................................................................................................... 300 Chapter Review ........................................................................................................................................................... 302 Practice and Review .............................................................................................................................. 302 Practice and Review: Debate This ......................................................................................................... 303 Issue Spotters ........................................................................................................................................ 303 Business Scenarios and Case Problems ................................................................................................. 304 Critical Thinking and Writing Assignments ............................................................................................ 310

Critical Thinking Questions in Features Adapting the Law to the Online Environment 458.

How could online escrow services reduce Internet fraud?

Solution As more individuals demand to use an escrow company for purchases on the Internet, fewer fraudulent transactions will occur. Those who wish to engage in Internet fraud will find that they have a declining audience of potential victims.

Critical Thinking Questions in Cases Case 25.1 459. Under the circumstances, is it ethical for GRB to enforce its security interest in the ring to recover the unpaid amount of the price? Discuss. Solution Yes. It is ethical for GRB to enforce its security interest in the ring to recover the unpaid amount of the price. Steven granted a valid security interest in the ring to Royal and the ring had not been fully paid for. With his consent, Royal assigned the security interest to GRB. Therefore, GRB had a valid and enforceable security interest in the ring. Presumably, the creditor has employees, investors, or others to whom it must account for its practices. It would be unethical for the company to forego collecting debts and risk failing to meet its obligations to its stakeholders. No, it is not ethical for GRB to enforce its security interest in the ring to recover the unpaid amount of the price. GRB may have a valid and enforceable security interest in the ring, but the value of the ring to Sheila may have been greater than its economic worth. Given Steven‘s death before their promised marriage, the ring may have had considerable sentimental value. GRB might have been able to recapture its investment in the security interest by negotiating repayment terms with Steven‘s estate.

Case 25.2 460.

What might Lewis have done to avoid the result in this case? Discuss.

Solution

299

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

To avoid the result in the Lewis case, Lewis might have obtained a security interest in the vehicles bought with his funds and perfected it. Or he could have refused Carbine‘s offer to provide those funds in exchange for a share of the profit on the sale of the vehicles. Of course, Whitney had a perfected security interest in all of Carbine‘s property, including the dealership‘s funds and inventory consisting of the vehicles in its possession. On the dealership‘s default, Whitney and Lewis both sought to recover from the same property. The rule pertaining to conflicting perfected security interests would have given priority to the bank‘s interest, which had been filed first. But Lewis might have been able to take advantage of an exception to the first-in-time rule by obtaining a purchase-money security interest (PMSI) in Carbine‘s inventory (the vehicles bought with Lewis‘s funds). A perfected PMSI takes priority over a conflicting security interest in the same collateral if the holder of the PMSI notifies the secured party with the conflicting interest on or before the debtor acquires, or otherwise takes possession, of the inventory. And Lewis could have avoided the dispute, and the result in this case, altogether by refusing Carbine‘s offer to provide the dealership with funds to buy vehicles. 461. Suppose that instead of seeking to be paid for the cost of the vehicles sold with funds he provided to Carbine, Lewis had already been reimbursed, and Whitney sought to obtain the funds from Lewis as part of the bank‘s recovery for Carbine‘s default on its loan. Would the result have been different? Explain. Solution No, the result in the Lewis case would not likely have been different if the facts had been as stated in the question. The court would probably have ruled that Whitney‘s perfected security interest took priority even if Lewis had already been paid for the cost of the vehicles sold. A security interest in collateral gives the secured party a security interest in the proceeds acquired from a sale of the collateral. An interest in the proceeds remains perfected automatically for twenty days after the debtor receives the proceeds and can extend longer if provided in the security agreement. This is common when collateral is likely to be sold, such as the vehicles in Carbine‘s possession. A security interest in identifiable cash proceeds also remains perfected beyond twenty days. Thus, Whitney‘s perfected security interest in Carbine‘s inventory, which took priority over Lewis‘s asserted interest in the result of the Lewis case, would have extended to the proceeds from the sale of that inventory. This covered the vehicles bought with Lewis‘s funds, and would have extended to the proceeds from their sale.

Case 25.3 462. Is a low price sufficient to establish that a sale of collateral was not made in a commercially reasonable manner? Explain. Solution No. A low price is insufficient to establish that a sale of collateral was not made in a commercially reasonable manner. Of course, every aspect of a disposition of collateral, including the method, manner, time, place, and other terms must be commercially reasonable. Some of the factors that determine commercial reasonableness are set out in the SunTrust case.

300

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Price is one of the terms of a sale, and its amount is one of the factors. A low price suggests that all aspects of a disposition should be scrutinized carefully to ensure that each aspect was commercially reasonable. That is, all of the factors should be weighed in the balance. The fact that a higher price could have been obtained—for example, at a different time or by a different method—is not alone sufficient to show that a disposition was not commercially reasonable. 463. A jury has broad discretion to identify the value of collateral in a commercially reasonable transaction. What evidence might provide a rational basis for this determination? Solution In exercising discretion to identify the value of collateral in a commercially reasonable transaction, a jury should review any evidence presented at trial. This might include the collateral‘s original cost, the parties‘ qualified opinions of its value, and other reasonably relevant facts. Mathematical precision may not be possible, but a figure can be arrived at with reasonable certainty. In the SunTrust case, the creditor and debtor proffered a range of prices—from $115,000 to $175,000—for the jury to consider in deciding the value of the collateral. This range would provide a rational basis for a number fitting squarely between the lowest and highest figures— about $145,000, for example. A court would most likely uphold this figure as supported by legally sufficient evidence.

301

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Chapter Review Practice and Review Paul Barton owned a small property-management company, doing business as Brighton Homes. In October, Barton went on a spending spree. First, he bought a Bose surround-sound system for his home from KDM Electronics. The next day, he purchased a Wilderness Systems kayak from Outdoor Outfitters, and the day after that he bought a new Toyota 4-Runner financed through Bridgeport Auto. Two weeks later, Barton purchased six new iMac computers for his office, also from KDM Electronics. Barton bought all of these items under installment sales contracts. Six months later, Barton‘s property-management business was failing. He could not make the payments due on any of these purchases and thus defaulted on the loans. Using the information presented in the chapter, answer the following questions. 464. For which of Barton‘s purchases (the surround-sound system, the kayak, the 4-Runner, and the six iMacs) would the creditor need to file a financing statement to perfect its security interest? Solution To perfect a security interest in the computers would require the filing of a financing statement because the computers would be classified as equipment (goods bought for use primarily in a business). With respect to the sound system, the kayak, and the vehicle, the text explains that when a seller of consumer goods extends credit for the purchase to a person buying for household purposes, a purchase-money security interest, or PMSI, is created and attaches automatically, without the filing of a financing statement. (Motor vehicles often fall under other state laws concerning such details as their use as collateral and encumbrances on their titles, but these laws are not discussed in the chapter.) 465. Suppose that Barton‘s contract for the office computers mentioned only the name Brighton Homes. What would be the consequences if KDM Electronics filed a financing statement that listed only Brighton Homes as the debtor‘s name? Solution Using only the business‘s name would likely not be sufficient to perfect the lender‘s interest in the goods. 466.

Which of these purchases would qualify as a PMSI in consumer goods?

Solution The sound system, the kayak, and possibly the vehicle would qualify for purchase-money security interests, or PMSIs. 467. Suppose that after KDM Electronics repossesses the surround-sound system, it decides to keep the system rather than sell it. Can KDM do this under Article 9? Why or why not? Solution A secured party can retain repossessed collateral unless it consists of consumer goods on which the debtor has paid 60 percent or more of the purchase price in a PMSI, in which case, the secured party must sell or otherwise dispose of the repossessed collateral within ninety days. Failure to comply could subject the secured party to an action for conversion or other liability.

302

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Practice and Review: Debate This 468. A financing statement that does not have the debtor‘s exact name should still be effective because creditors should always be protected when debtors default. Solution What is important in secured transactions is that creditors should be able to attempt to be made whole when debtors stop making payments on a loan or do not pay back the loan with the agreed-upon interest. Creditors should be able to take possession of collateral in which the creditors have created a security interest. Just because a creditor might have made an error in naming the debtor should not prevent the creditor from obtain the collateral in case of default. Those creditors who engage in secured transactions have very specific requirements to follow for them to be able to have priority over collateral in case debtor defaults. If we allowed creditors to become less accurate with respect to who are the named debtors in filing statements, then the courts would be overwhelmed with supposedly secured creditors who would claim that they had perfected security interests even if the named debtors were not correctly listed in financing statements.

Issue Spotters 469. Liberty Bank loans Michelle $5,000 to buy a car, which is used as collateral to secure the loan. After repaying less than 50 percent of the loan, Michelle defaults. Liberty could repossess and keep the car, but the bank does not want it. What are the alternatives? Solution When collateral consists of consumer goods, and the debtor has paid less than 60 percent of the debt or the purchase price, the creditor has the option of disposing of the collateral in a commercially reasonable manner. This generally requires notice to the debtor of the place, time, and manner of sale. A debtor can waive the right to notice, but only after default. Before the disposal, a debtor can redeem the collateral by tendering performance of all of the obligations secured by the collateral and by paying the creditor‘s reasonable expenses in retaking and maintaining the collateral. 470. Jorge contracts with Midwest Roofing to fix his roof. Jorge pays half of the contract price in advance. Midwest completes the job, but Jorge refuses to pay the rest of the price. What can Midwest do? Solution The creditor (Midwest) can place a mechanic‘s lien on the debtor‘s property. If the debtor does not pay what is owed, the property can be sold to satisfy the debt. The only requirements are that the lien be filed within a specific time from the time of the work, depending on the state statute, and that notice of the foreclosure and sale be given to the debtor in advance.

303

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Business Scenarios and Case Problems 471. Priority Disputes. Redford is a seller of electric generators. He purchases a large quantity of generators from a manufacturer, Mallon Corp., by making a down payment and signing an agreement to pay the balance over a period of time. The agreement gives Mallon Corp. a security interest in the generators and the proceeds. Mallon Corp. properly files a financing statement on its security interest. Redford receives the generators and immediately sells one of them to Garfield on an installment contract with payment to be made in twelve equal installments. At the time of the sale, Garfield knows of Mallon‘s security interest. Two months later, Redford goes into default on his payments to Mallon. Discuss Mallon‘s rights against purchaser Garfield in this situation. (See Priorities, Rights, and Duties.) Solution A perfected secured party prevails over most third parties having claims to the same collateral of the debtor. An exception, however, is a buyer who, in the ordinary course of business, ―takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence.‖ Garfield purchased a generator from Redford, a seller who deals in goods of that kind. Thus, Garfield is a buyer in the ordinary course of business. Mallon‘s perfection of its security interest in the generators sold to Redford as inventory is not effective against Garfield, even if Garfield knows of Mallon‘s perfection or security interest. Therefore, Mallon has no rights at all in the generator possessed by Garfield. Mallon is entitled to proceeds (the payments Garfield is making to Redford), however. Proceeds include whatever is received when the collateral subject to the security interest is sold. The right to proceeds is automatic on Mallon‘s perfection of its security interest in the inventory sold and remains perfected up to twenty-one days after Redford (the debtor) receives the proceeds (Garfield‘s payment). To extend this period, Mallon would have had to provide for such an extension in the original perfection or perfect such separately within the twenty-one days [UCC 9–315]. 472. Perfection. Marsh has a prize horse named Arabian Knight. In need of working capital, Marsh borrows $5,000 from Mendez, who takes possession of Arabian Knight as security for the loan. No written agreement is signed. Discuss whether, in the absence of a written agreement, Mendez has a security interest in Arabian Knight. If Mendez does have a security interest, is it a perfected security interest? Explain. (See Creating and Perfecting a Security Interest.) Solution Mendez has both a security interest in Arabian Knight and is a perfected secured party. He has met all the necessary criteria listed under UCC 9–203 to be a secured creditor. Mendez has given value of $5,000 and has taken possession of the collateral, Arabian Knight, owned by Marsh (who has rights in the collateral). Thus, Mendez has a security interest even though Marsh did not sign a security agreement. Once a security interest attaches, a transfer of possession of the collateral to the secured party can perfect the party‘s security interest without a filing [UCC 9–310(b)(6); 9– 313]. Thus, a security interest was created and perfected at the time Marsh transferred Arabian Knight to Mendez as security for the loan.

304

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

473. Guaranty. Timothy Martinez, owner of Koenig & Vits, Inc. (K&V), guaranteed K&V‘s debt to Community Bank & Trust. The guaranty stated that the bank was not required to seek payment of the debt from any other source before enforcing the guaranty. K&V defaulted. Through a Wisconsin state court, the bank sought payment of $536,739.40, plus interest at the contract rate of 7.5 percent, from Martinez. Martinez argued that the bank could not enforce his guaranty while other funds were available to satisfy K&V‘s debt. For instance, the debt might be paid out of the proceeds of a sale of corporate assets. Is this an effective defense to a guaranty? Why or why not? [Community Bank & Trust v. Koenig & Vits, Inc., 346 Wis.2d 279 (Wis.App. 2013)] (See Other Laws Assisting Creditors.) Solution No. Martinez‘s argument that the bank could not enforce his guaranty while other funds were available to satisfy K&V's debt—for example, that the debt might be paid out of the proceeds of a sale of corporate assets—is not an effective defense to the guaranty in the Community case. The guaranty contract terms determine the extent and time of the guarantor‘s liability. Thus, a defense such as Martinez asserted might be defeated by the language of the guaranty—for example, it might state or indicate that payment is ―unconditionally guaranteed‖ or that the creditor ―is not required to seek payment of the principal‘s debt from any other source to enforce the guaranty.‖ In this problem, Timothy Martinez, owner of Koenig & Vits, Inc. (K&V), guaranteed the firm‘s debt to Community Bank & Trust. When K&V defaulted, the bank sought payment of the debt from Martinez. Martinez made the argument stated above. But the guaranty expressly stated that the bank was not required to seek payment of the debt from any other source before enforcing the guaranty. This language is sufficient to support the rejection of Martinez‘s argument. In the actual case on which this problem is based, in the bank‘s suit in a Wisconsin state court against Martinez to recover the amount of the debt, the court ruled in the bank‘s favor. A state intermediate appellate court affirmed. ―The terms of the guaranty compel us to reject all permutations of this argument. . . . It is no defense to the guaranty that other funds may be available [now or] in the future to be applied to the bank's debt.‖ 474. Liens. Daniel and Katherine Balk asked Jirak Construction, LLC, to remodel their farmhouse in Lawler, Iowa. Jirak provided the Balks with an initial estimate of $45,975 for the cost. Over the course of the work, the Balks made significant changes to the plan. Jirak agreed to the changes and regularly advised the Balks about the increasing costs. In mid-project, Jirak provided an itemized breakdown at their request. The Balks paid Jirak $67,000 but refused to pay more. Jirak claimed that they still owed $55,000 in labor and materials. Jirak filed a suit in an Iowa state court against the Balks to collect. Which of the liens discussed in this chapter would be most useful to Jirak in its attempt to collect? How does that type of lien work? Is the court likely to enforce it in this case? Explain. [Jirak Construction, LLC v. Balk, 863 N.W.2d 35 (lowa App. 2015)] (See Other Laws Assisting Creditors.) Solution Among the liens discussed in this chapter, a mechanic‘s lien would likely be most effective to Jirak in its attempt to collect the unpaid cost of its work for the Balks. A creditor can place a mechanic‘s lien on the real property of a debtor who has contracted for improvements to the property and has not paid the price. When a creditor obtains a mechanic‘s lien, the debtor‘s real estate becomes security for the debt. If the debtor does not pay, the creditor can foreclose on the property and sell it to collect the amount due.

305

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

In this problem, the Balks contracted with Jirak for the remodel of their farmhouse. Due to the Balks‘ changes to the project during the course of the work, the costs exceeded the amount of Jirak‘s original estimate. Although Jirak regularly advised the Balks about the increasing costs and provided an itemized breakdown at their request, they refused to pay the price. Jirak can make most effective use of a mechanic‘s lien to collect the unpaid amount. In the actual case on which this problem is based, Jirak filed a suit in an Iowa state court against the Balks to foreclose on their property by way of a mechanic‘s lien and collect the unpaid amount. The court entered a judgment in Jirak‘s favor and enforced the lien. A state intermediate appellate court affirmed the judgment. 475. Business Case Problem with Sample Answer—Perfection of a Security Interest. G&K Farms, a North Dakota partnership, operated a farm in Texas. G&K was insured under the Supplemental Revenue Assistance Payments Program (SURE), through which the federal government provides financial assistance for crop losses caused by natural disasters. PHI Financial Services, Inc., loaned G&K $6.6 million. PHI filed a financing statement that described the collateral as the debtor‘s interest in ―Government Payments.‖ The document did not refer to the farm‘s crops. G&K defaulted on the loan. Later, G&K received a SURE payment for crop losses and transferred some of the funds to its law firm, Johnston Law Office, P.C., in payment for services. PHI brought an action against Johnston to recover those funds as partial payment on its loan to G&K. Johnston argued that PHI did not have a perfected security interest in the SURE payment because the financing statement did not identify the crops. Was the description of the collateral in the financing statement sufficient? Why or why not? [PHI Financial Services, Inc. v. Johnston Law Office, P.C., 2016 ND 20, 874 N.W.2d 910 (2016)] (See Creating and Perfecting a Security Interest.) —For a sample answer to Problem 21–5, go to Appendix E. Solution Yes. The description in PHI‘s financing statement was sufficient to perfect the creditor‘s security interest in the SURE payment. A financing statement must describe the collateral in which a secured party has a security interest in order to provide public notice of the fact that certain property of the debtor is subject to a security interest. The UCC permits broad, general descriptions in a financing statement, such as ―all assets.‖ In this problem, G&K Farms ran a farm. G&K was insured under the federal Supplemental Revenue Assistance Payments Program (SURE), which provides financial assistance for crop losses caused by natural disasters. PHI loaned G&K $6.6 million, and filed a financing statement that described the collateral as G&K‘s interest in ―Government Payments.‖ The statement did not refer specifically to the farm‘s crops. G&K defaulted on the loan. But when G&K received a SURE payment for crop losses and transferred some of the funds to its law firm, Johnston Law Office, PHI sought to recover the funds as a partial payment on its loan. Johnston argued that PHI did not have a perfected security interest in the SURE payment because PHI‘s financing statement did not identify the farm‘s crops. Johnston‘s argument is faulty because the debtor‘s crops were not the collateral at issue. The government‘s SURE payment was the disputed collateral, and PHI‘s financing statement sufficiently described it by its general reference to ―Government Payments.‖ PHI‘s security interest was perfected.

306

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

In the actual case on which this problem is based, PHI filed its suit against Johnston in a North Dakota state court, which entered a judgment in the creditor‘s favor. The North Dakota Supreme Court affirmed on the issue highlighted in this problem, based on the reasoning stated here. 476. Laws Assisting Creditors. Grand Harbour Condominium Owners Association, Inc., obtained a judgment in an Ohio state court against Gene and Nancy Grogg for $45,458.86. To satisfy the judgment, Grand Harbour filed a notice of garnishment with the court, seeking funds held by the Groggs in various banks. The Groggs disputed Grand Harbour‘s right to garnish the funds. They claimed that the funds were exempt Social Security and pension proceeds, but they offered no proof of this claim. The banks responded by depositing $23,911.97 with the court. These funds were delivered to Grand Harbour. Later, the Groggs filed a petition for bankruptcy in a federal bankruptcy court. After they were granted a discharge, they filed a ―motion to return funds to debtors‖ but provided no evidence that their debt to Grand Harbour had been included in the discharge. What is Grand Harbour‘s best argument in response to the Groggs‘ motion? [Grand Harbour Condominium Owners Association, Inc. v. Grogg, 2016 -Ohio- 1386 (Ohio Ct.App. 2016)] (See Other Laws Assisting Creditors.) Solution In response to the Groggs‘ motion, Grand Harbour can successfully argue any or all of the following. 1.

2. 3.

The Groggs did not provide any evidence to support their claim that the funds garnished from their bank accounts and delivered to Grand Harbour represented exempt Social Security and pension proceeds. The funds in those accounts were attached before the Groggs filed for bankruptcy. There is no evidence that the discharge in the Groggs‘ bankruptcy included Grand Harbour‘s judgment.

Grand Harbour might also assert that under the circumstances only the bankruptcy trustee (a party who has authority over a debtor‘s assets during a bankruptcy proceeding) could avoid the transfer of the funds from the banks. In any case, with garnishment, a creditor can obtain a debtor‘s funds or other property in the possession of a third party. A proceeding for garnishment of property, other than personal earnings, may be commenced. After a creditor obtains a judgment on a debt, that individual can commence a garnishment proceeding by filing written notice with the appropriate court. The debtor is then given an opportunity for a hearing at which the right to garnish can be disputed. If the debtor does not respond, waives the hearing, or does not appear, the right to garnish can be upheld. The garnishee is notified and the garnishment can proceed. These steps occurred in this case. Grand Harbour was the creditor, the Groggs were the debtors, an Ohio state court was the appropriate court for the garnishment notice, the Groggs‘ banks were garnishees, and the garnishment proceeded. The result was a disbursement of the debtors‘ funds to the creditor. The Groggs later filed for bankruptcy in a federal court, giving rise to the events set out in the facts of the problem. In the actual case on which this problem is based, the court in which the Groggs filed their ―motion for return of funds to debtors‖ denied the motion. A state intermediate appellate court

307

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

affirmed, based on the arguments noted here. In addition, the Groggs cited no authority to support their claim for a return of the funds. 477. Disposition of Collateral. Dustin Mosely financed the purchase of two cars with a loan from Show-Me Credit Union (SMCU). When Mosely stopped making payments on the loan, SMCU notified him that it intended to repossess the cars and dispose of them at a ―private or public‖ sale. After the sale, the creditor filed a suit in a Missouri state court to recover the difference between the sale price and the outstanding debt. Mosely counterclaimed that SMCU had failed to give proper notice before repossessing the vehicles. Public and private sales of collateral are significantly different methods of disposition. Did SMCU‘s failure to specify the type of sale, either public or private, at which the creditor would dispose of the collateral violate the UCC‘s notice requirement? Explain. [Show-Me Credit Union v. Mosely, 541 S.W.3d 28 (Mo.App.E.D. 2018)] (See Default.) Solution Yes. SMCU‘s failure to specify the type of sale, either public or private, at which the creditor would dispose of the collateral violated Article 9‘s notice requirement. The UCC requires that every aspect of a creditor‘s disposition of collateral after repossession must be commercially reasonable. This includes the method, manner, time, and place. And the creditor must inform the debtor and other specified parties in writing ahead of time about the disposition. In this problem, Mosely bought two cars with a loan from Show-Me Credit Union (SMCU). When Mosely stopped paying on the loan, SMCU repossessed the vehicles. The creditor informed Mosely that it intended to dispose of the cars at a ―private or public‖ sale. After the sale, SMCU sought to recover the deficiency between the sale price and the rest of the debt. Mosely claimed that SMCU had failed to give proper notice before repossessing the vehicles. As stated in the facts, public and private sales are significantly different methods of disposition of collateral. These differences mean that a failure to specify the type of sale in notices to debtors leaves them without an adequate ability to protect their interests. In other words, such a failure violates the UCC‘s notice requirement. In the actual case on which this problem is based, the court dismissed Moseley‘s counterclaim. A state intermediate appellate court reversed and remanded, according to the reasoning stated above. 478. A Question of Ethics—The IDDR Approach and Defenses of the Guarantor. Woodsmill Park Limited Partnership borrowed $6.2 million secured by real property in Chicago, Illinois. Bill and Brian Bruce and Matthew O‘Malley signed guaranties to meet Woodsmill‘s obligation on the loan. Woodsmill defaulted on the payments. Northbrook Bank & Trust Company filed an action in an Illinois state court against Woodsmill and the Bruces to foreclose on the property. The defendants agreed to resolve the claim in exchange for a deed in lieu of foreclosure and a promise to pay the difference between the value of the property and the unpaid amount of the loan. The parties stipulated, ―Nothing in this Agreement shall release or reduce O‘Malley‘s obligations under O‘Malley‘s Guaranty.‖ [Northbrook Bank & Trust Co. v. Matthew O’Malley, 2017 IL App (1st) 160438-U (2017)] (See Other Laws Assisting Creditors.) 479. What is the effect on O‘Malley‘s guaranty of the agreement between Northbrook, Woodsmill, and the Bruces? Explain.

308

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

Solution The effect of the agreement between Northbrook, Woodsmill, and the Bruces on O‘Malley‘s guaranty is to relieve O‘Malley of liability. Any material change made in the terms of the original contract between the principal debtor and the creditor, including the awarding of a binding extension of time for making payment without first obtaining the consent of the surety or guarantor will discharge the surety or guarantor either completely or to the extent that the surety or guarantor suffers a loss. In this problem, Woodsmill (a partnership) took out a loan secured by certain real property. Bill and Brian Bruce, and Matthew O‘Malley signed guaranties on the loan. When the partnership defaulted. Northbrook Bank & Trust filed an action against the debtor and the Bruces to foreclose on the property. The defendants agreed to resolve the claim in exchange for a deed and a promise to pay the deficiency. These parties stipulated, ―Nothing in this Agreement shall release or reduce O‘Malley‘s obligations.‖ But there is no indication in the facts that this stipulation was agreed to with O‘Malley‘s consent or knowledge. Thus, the principles stated above apply to relieve O‘Malley of his obligation on the guaranty. In the actual case on which this problem is based, the court issued a summary judgment in favor of O‘Malley, relieving him of liability on the guaranty. A state intermediate appellate court affirmed. 480. Using the IDDR approach, evaluate the ethics of Northbrook, Woodsmill, and the Bruces in agreeing to the stipulation concerning O‘Malley. Solution For O‘Malley, it was not ethical for the other parties to the loan to agree to change its terms without his consent. The law also recognizes this conclusion by permitting guarantors to assert the modification of loan contracts without their to discharge them. The IDDR approach opens with an Inquiry stating the issue, the stakeholders, and the ethical standards. The issue is framed in the question: Was it ethical of Northbrook, Woodsmill, and the Bruces to agree to resolve their dispute over Woodsmill‘s debt in part by continuing O‘Malley‘s obligation for the debt according to his previously-signed guaranty? This was accomplished without O‘Malley‘s consent. The principal stakeholders are the parties to the deal that created the debt, any third parties who stand to benefit from a resolution of these parties‘ dispute, and potential borrowers and investors aware of it. Ethical standards include a duty to contract honestly and in good faith. The IDDR approach next involves a Discussion of actions to address the issue. The strengths and weaknesses of these actions, and any consequences and effects on the stakeholders, are also considered. Here, possible actions include informing O‘Malley of the agreement before its conclusion—the stipulation of his continuing liability could then be included or excluded, depending on his response. Or the parties might have finalized an agreement that did not contain the stipulation. If the other facts in the case remained the same, taking either of these actions might result in a loss to the lender. But the parties would meet the obligation to act honestly and in good faith—their consciences with respect to O‘Malley could be clear.

309

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

The IDDR approach also requires a Decision with a statement of the reasons. The decision here would be to take either of the actions suggested above. The chief reason for taking these actions is to satisfy the parties‘ ethical duty. A more practical result might be to avoid further litigation in this case, and provide a basis for avoiding disputes in similar circumstances. The IDDR approach has a final step—a Review of the success or failure of the actions to resolve the issue, and satisfy the stakeholders. From the perspective of the Bruces and Northbrook, it likely made sense to resolve their dispute in exchange for a deed and a promise to pay the difference between the value of the deeded property and the amount of the loan. The agreement efficiently disposed of Northbrook‘s suit, which would have cost every party additional time and money. The agreement also provided an opportunity to renegotiate the loan. For O‘Malley, however, it was not ethical for the other parties to the loan to agree to change its terms without his consent. Taking either of the actions suggested above would meet this duty, and thereby satisfy all of the stakeholders, by acting honestly and in good faith with O‘Malley while preserving the resolution of the dispute.

Critical Thinking and Writing Assignments 481. Business Law Writing. Write a few sentences describing the circumstances in which a creditor would resort to each of the following remedies when trying to collect on debt. (See Other Laws Assisting Creditors.) 482.

Mechanic‘s lien

Solution A creditor can place a mechanic‘s lien on real property when a person contracts for labor, services, or material to be furnished for the purpose of making improvements on the property but does not immediately pay for the improvements.

310

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 25: Security Interests and Creditors‘ Rights

483.

Artisan‘s lien

Solution With an artisan‘s lien, a creditor can recover payment from a debtor for labor and materials furnished in the repair of personal property. The lienholder must have possession of the property and have agreed to provide the services on a cash, not a credit, basis. The lien terminates once possession is surrendered—unless the surrender is temporary, in which case there must be an agreement that the property will be returned to the lienholder. If a third party obtains rights in the property while it is out of the possession of the lienholder, the lien is lost. The only way that a lienholder can protect a lien and surrender possession at the same time is to record notice of the lien. 484.

Writ of attachment

Solution Attachment is a court-ordered seizure and taking into custody of property for a past-due debt before the securing of a judgment (either at the time of or immediately after the commencement of a lawsuit and before the entry of a final judgment). To use attachment as a remedy, the creditor must have an enforceable right to payment and must follow certain procedures. 2.

Time-Limited Group Assignment—Validity of a Security Interest. Nick Sabol, doing business in the recording industry as Sound Farm Productions, applied to Morton Community Bank for a $58,000 loan to expand his business. Besides the loan application, Sabol signed a promissory note that referred to the bank‘s rights in ―any collateral.‖ Sabol also signed a letter authorizing Morton Community Bank to execute, file, and record all financing statements, amendments, and other documents required by Article 9 to establish a security interest. Sabol did not sign any other documents, including the financing statement, which contained a description of the collateral. Two years later, without having repaid the loan, Sabol filed for bankruptcy. The bank claimed a security interest in Sabol‘s sound equipment. (See Creating and Perfecting a Security Interest.) 3.

The first group will list all the requirements of an enforceable security interest and explain why each of these elements is necessary. Solution The requirements that must be met for a creditor to have an enforceable security interest are (1) the collateral must either (a) be in the possession of the secured party pursuant to an agreement, or (b) there must be a written security agreement describing the collateral and signed by the debtor; (2) the secured party must give value; and (3) the debtor must have rights in the collateral. The first requirement is necessary to provide proof of the security agreement. The second requirement (value) can consist of any consideration that supports a contract (as well as an antecedent obligation or a binding commitment to extend credit). It is a necessary element to the formation of any contract. The third requirement protects property owners from others‘ use of the property to secure interests in which the owners have no part.

The second group will determine if Morton Community Bank had a valid security interest. Solution

311

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

A security interest is not enforceable unless it attaches to the collateral. For attachment to occur, under UCC 9–203 the debtor must have rights in the collateral, the secured party must give something of value to the debtor, and the creditor must either possess the collateral or there must be a security agreement that contains a description of the collateral and that has been signed or otherwise authenticated by the debtor. There must be some language reflecting the debtor's intent to grant a security interest—a financing statement that does not contain any such language, and only identifies the collateral, is not a security agreement. Here, there does not appear to be language conveying a security interest. The financing statement, which contains the only description of collateral, was not signed by the debtor. There is only the reference in the note to the bank‘s rights in ―any collateral.‖ Without a description of the collateral in a signed or authenticated document or in a separate document incorporated by reference into a signed or authenticated document, no security interest can be recognized. 5.

The third group will discuss whether a bank should be able to execute financing statements on a debtor‘s behalf without the debtor being present or signing them. Are there are any drawbacks to this practice? Solution As noted in the answer to the previous question, the debtor did not sign the financing statement. Under the UCC, without a description of the collateral in a signed or authenticated document or in a separate document incorporated by reference into a signed or authenticated document, no security interest can exist.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 313 Case 26.1 ............................................................................................................................................... 313 Case 26.2 ............................................................................................................................................... 313 Case 26.3 ............................................................................................................................................... 314 Chapter Review ........................................................................................................................................................... 316 Practice and Review .............................................................................................................................. 316 Practice and Review: Debate This ......................................................................................................... 316 Issue Spotters ........................................................................................................................................ 317 Business Scenarios and Case Problems ................................................................................................. 317 Critical Thinking and Writing Assignments ............................................................................................ 325

312

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

Critical Thinking Questions in Cases Case 26.1 6.

Why, as a general rule, should a court apply the law that is in effect at the time the court renders its decision? Solution The answer to this question seems obvious. A rule that courts should apply the law in effect when they render their decisions has the advantage of being clear and easy to administer. Without such a rule, a given case might continue almost infinitely, as parties argue for the application of any law in existence at any time related to the case. That rule is especially important in the context of bankruptcy proceedings. Bankruptcy trustees are charged with making complex and difficult determinations and calculations, sometimes quickly, in circumstances in which competing interests must be balanced and reconciled. To advance the trustee‘s swift and efficient administration of the debtor‘s estate, there is a public policy interest in reducing the number of ancillary suits that can be brought. Requiring a bankruptcy trustee to distinguish between, and apply, different versions of the Bankruptcy Code, which may have been in effect at different times in the chronology of events leading up to, and occurring during, bankruptcy proceedings, would complicate the process, requiring more discovery and analysis. The result would be a delay in administration of the estate. There might also be a greater potential of liability for a trustee, who could be subject to a claim for improper distribution of the debtor‘s assets.

If Anderson had filed his initial bankruptcy petition under Chapter 7, not under Chapter 11, the result would have been different—Stubbs would have been able to subordinate the IRS claim. Is this fair? Solution Chapter 7 debtors typically are seeking a discharge of debts, whereas Chapter 11 debtors are seeking to reorganize their debts. Therefore, it is fair to treat these types of debtors differently. Congress changed this particular law for a good reason. The statutory prior scheme had been criticized on the ground that it created perverse incentives. It encouraged Chapter 11 debtors and their representatives to incur administrative expenses, even where there was no real hope for a successful reorganization. This likely was the situation here—there was no real chance of Anderson reorganizing his debt under Chapter 11. Therefore, his attorney (Stubbs) should not be entitled to a higher priority in the distribution of assets than the IRS‘s tax lien.

Case 26.2 8.

In determining whether a debtor‘s failure to keep adequate records was justified, the Bankruptcy Code requires a determination based on all the circumstances of the case. What factors might a court weigh in making this determination? Solution To determine whether a debtor‘s record keeping is adequate and therefore justified, to support a discharge in bankruptcy, the Bankruptcy Code requires the court to make a determination based on ―all the circumstances of the case.‖ Factors that the court might weigh in making this determination include, in particular, the debtor‘s education, experience, and sophistication. Of

313

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

course, the number and complexity of the transactions, and their relation to the debtor‘s financial situation, are paramount considerations. The court should also decide what records someone in the debtor‘s circumstances would keep. In the Dykes‘s bankruptcy proceeding, for example, the debtors did not have the same duty to create, preserve, and provide records of their financial transactions as a debtor operating a business. But Dykes was, in the court‘s estimation, ―a well-educated and sophisticated collector of highly valuable watches and jewelry.‖ And even in the circumstance of a consumer bankruptcy, a debtor has a duty to keep records of ―a sudden and large dissipation of assets.‖ 9.

How might the Dykes have established, or at least indicated, the fair market value of the watches and jewelry at the time of their return in order to avoid the result in this case? Explain. Solution Under the Bankruptcy Code, the test of the adequacy of financial records to avoid denial of discharge is whether the documentation is sufficient to determine the debtor‘s financial condition. The records should cover a debtor‘s business and other transactions for a reasonable period. The debtor should take such steps as fair dealing and common sense would suggest. In addition to the court, creditors should also be able to learn what has taken place. In the Dykes‘ case, the debtors could have matched each watch and piece of jewelry with an invoice in their possession, they could have noted the purchase price of each item charged by the jeweler, and they could have insisted that the jeweler further document the amount each returned item reduced their debt. These records might have provided the court with sufficient information to assess the debtors‘ situation and prevent denial of discharge on the ground that the records were inadequate. The information would also have allowed the debtors to challenge the jeweler‘s claim against their estate, if necessary. Of course, the Dykes did not provide such records, leaving serious, unanswered questions as to their financial condition, as well as the legitimacy of the jeweler‘s claim.

Case 26.3 10. Maryland law arguably does not include postsecondary education expenses in the definition of ―child support.‖ Should this state law have governed the court‘s conclusion in the Chamberlain case? Why or why not? Solution No. Maryland state law should not have determined the court‘s conclusion in the Chamberlain case. The Bankruptcy Code is federal law. In the context of a bankruptcy proceeding, the characterization of an obligation to pay for children‘s college education, or any other debt ascribed at the time of a divorce, as a ―domestic-support obligation‖ would be a question of federal law. In other words, a debt may qualify as ―support‖ for the purpose of a federal bankruptcy proceeding even if that obligation does not fit the definition of ―support‖ under state law. 11. Suppose that the marital settlement agreement had obligated Stephen to assume the mortgage debt on the family home. If all other facts were the same, would the result have been different? Solution

314

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

No. The result in the Chamberlain case would not likely have been different if the marital settlement agreement had obligated Stephen to take on the mortgage debt of the family home Assuming all of the other facts were the same—particularly the couple‘s relative financial circumstances—the reasons that led the court to conclude the obligation to pay the children‘s college education was ―in the nature of support‖ would have contributed to the same conclusion about a promise to pay the mortgage debt. Most likely, the couple would have viewed a home as a significant part of their children‘s upbringing, they would have intended to provide such a home, and Stephen would have been the parent most able to assume the debt to pay for it.

315

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

Chapter Review Practice and Review Three months ago, Janet Hart‘s husband of twenty years died of cancer. Although he had medical insurance, he left Janet with outstanding medical bills of more than $50,000. Janet has worked at the local library for the past ten years, earning $1,500 per month. Since her husband‘s death, Janet also has received $1,500 in Social Security benefits and $1,100 in life insurance proceeds every month, giving her a monthly income of $4,100. After she pays the mortgage payment of $1,500 and the amounts due on other debts each month, Janet barely has enough left over to buy groceries for her family (she has two teenage daughters at home). She decides to file for Chapter 7 bankruptcy, hoping for a fresh start. Using the information provided in the chapter, answer the following questions. 12. Under the current Bankruptcy Code, what must Janet do before filing a petition for relief under Chapter 7? Solution Janet must receive credit counseling from an approved nonprofit agency. Under the BAPCPA, all debtors must receive credit counseling from an approved nonprofit agency within the 180-day period preceding the date of filing a petition in bankruptcy. Therefore, before Janet can file her petition, she needs to attend either an individual or group briefing from an approved creditcounseling agency. 13. How much time does Janet have after filing the bankruptcy petition to submit the required schedules? What happens if Janet does not meet the deadline? Solution Janet has forty-five days unless she is granted an extension of up to forty-five additional days. If she misses the deadline, her case will be dismissed. 14. Assume that Janet files a petition under Chapter 7. Further assume that the median family income in the state in which Janet lives is $49,300. What steps would a court take to determine whether Janet‘s petition is presumed to be substantial abuse under the means test? Solution To determine whether Janet‘s petition is presumed to be ―substantial abuse,‖ the court would calculate Janet‘s average monthly income for the last six months (less certain allowed expenses) and multiply it by twelve to establish her yearly income. If Janet‘s yearly income exceeds the state‘s median family income by $6,000 or more, then abuse is presumed. 15. Suppose the court determines that no presumption of substantial abuse applies in Janet‘s case. Nevertheless, the court finds that Janet does have the ability to pay at least a portion of the medical bills out of her disposable income. What would the court likely order in that situation? Solution If a court found that Janet had an ability to pay a portion of her deceased husband‘s medical bills, a court would convert her bankruptcy case to a Chapter 13, individual repayment plan.

Practice and Review: Debate This 16. Rather than being allowed to file Chapter 7 bankruptcy petitions, individuals and couples should always be forced to make an effort to pay off their debts through Chapter 13.

316

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

Solution Every time consumers deprive creditors of repayment by successfully obtaining Chapter 7 protection, the creditors‘ costs rise. Consequently, all business that extend credit must raise the interest rates they charge to all borrowers to cover these increased costs. Therefore, allowing consumers to simply walk away from bone fide debts imposes extra burdens on all other borrowers. Not all borrowers default on their debt repayments just because they borrowed ―too‖ much. Sometimes, unplanned events occur, such as illness, infirmity, and protracted unemployment. It would not only be unfair, but unrealistic to think that everyone could repay even part of what was owned through use of a Chapter 13 plan. No one wants Chapter 7 to be abused, but means testing at least partially takes care of the problem of abuse in filing Chapter 7 plans.

Issue Spotters 17. After graduating from college, Tina works briefly as a salesperson and then files for bankruptcy. As part of her petition, Tina reveals her only debts are student loans, taxes accruing within the last year, and a claim against her based on her misuse of funds during her employment. Are these debts dischargeable in bankruptcy? Explain. Solution No. Besides the claims listed in this problem, the debts that cannot be discharged in bankruptcy include amounts borrowed to pay back taxes, goods obtained by fraud, debts that were not listed in the petition, domestic-support obligations, certain cash advances, and others. 18. Ogden is a vice president of Plumbing Service, Inc. (PSI). On May 1, Ogden loans PSI $10,000. On June 1, the firm repays the loan. On July 1, PSI files for bankruptcy. Quentin is appointed trustee. Can Quentin recover the $10,000 paid to Ogden on June 1? Why or why not? Solution Yes. A debtor‘s payment to a creditor made for a preexisting debt, within ninety days (one year in the case of an insider or fraud) of a bankruptcy filing, can be recovered if it gives a creditor more than would have been received in the bankruptcy proceedings. Trustees can recover these preferences using their specific avoidance powers.

Business Scenarios and Case Problems 19. Voluntary versus Involuntary Bankruptcy. Burke has been a rancher all her life, raising cattle and crops. Her ranch is valued at $500,000, almost all of which is exempt under state law. Burke has eight creditors and a total indebtedness of $70,000. Two of her largest creditors are Oman ($30,000 owed) and Sneed ($25,000 owed). The other six creditors have claims of less than $5,000 each. A drought has ruined all of Burke‘s crops and forced her to sell many of her cattle at a loss. She cannot pay off her creditors. (See Chapter 7—Liquidation.) 20. Under the Bankruptcy Code, can Burke, with a $500,000 ranch, voluntarily petition herself into bankruptcy? Explain. Solution Any person, including a rancher or farmer, can voluntarily petition himself or herself into bankruptcy. The person has only to be a debtor. This includes partnerships and corporations that are liable on a claim held by a creditor, as well as individuals. The debtor does not have to be insolvent to file a petition. Under the Code, a debtor is presumed to be insolvent when

317

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

that individual‘s debts exceed the fair market value of nonexempt assets. Thus, even though Burke owns a $500,000 ranch and has debts of only $70,000, she can voluntarily petition herself into bankruptcy. 21. Could either Oman or Sneed force Burke into involuntary bankruptcy? Explain. Solution Neither Oman nor Sneed—nor any combination of Burke‘s creditors—can involuntarily petition Burke into bankruptcy. The Code provides that involuntary bankruptcy proceedings cannot be commenced against a farmer. The definition of a farmer includes individuals who receive 50 percent of their gross income from farming operations, such as tilling the soil, ranching, or the production or raising of crops or livestock. Because Burke obviously fits the definition of a farmer, no creditor can force her into bankruptcy. 22. Distribution of Property. Montoro petitioned himself into voluntary bankruptcy. There were three major claims against his estate. One was made by Carlton, a friend who held Montoro‘s negotiable promissory note for $2,500. Another was made by Elmer, Montoro‘s employee, who claimed that Montoro owed him three months‘ back wages of $4,500. The last major claim was made by the United Bank of the Rockies on an unsecured loan of $5,000. In addition, Dietrich, an accountant retained by the trustee, was owed $500, and property taxes of $1,000 were owed to Rock County. Montoro‘s nonexempt property was liquidated, with proceeds of $5,000. Discuss fully what amount each party will receive, and why. (See Chapter 7—Liquidation.) Solution The Bankruptcy Code establishes a payment priority of claims from the debtor‘s estate. Each class of debt in this priority list must be fully paid before the next class in priority is entitled to any of the proceeds. If insufficient funds remain to pay an entire class, the proceeds are distributed on a pro rata basis to each creditor within that class. The order of priority for claims listed in this problem is as follows: 23. $ 500—Administrative bankruptcy costs (Dietrich). 24. $ 2,000—Claims for back wages (Elmer), limited to $2,000 per claimant, provided the wages were earned within ninety days of the petition. 25. $ 1,000—Taxes and penalties due and owing (Rock County).

318

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

26. $10,000—General creditors: Carlton $ 2,500 Elmer $ 2,500 (balance of wages owed) United Bank $ 5,000 $10,000 Because the amount remaining is only $1,500, these creditors share on a pro rata basis. For example, for United Bank it is: 5,000  $1,500  $750 10,000 27. Discharge in Bankruptcy. Like many students, Barbara Hann financed her education partially through loans. These loans included three federally insured Stafford Loans of $7,500 each ($22,500 in total). Hann believed that she had repaid the loans, but later, when she filed a Chapter 13 petition, Educational Credit Management Corp. (ECMC) filed an unsecured proof of claim based on the loans. Hann objected. At a hearing at which ECMC failed to appear, Hann submitted correspondence from the lender that indicated the loans had been paid. The court entered an order sustaining Hann‘s objection. Despite the order, can ECMC resume its effort to collect on Hann‘s loans? Explain. [In re Hann, 711 F.3d 235 (1st Cir. 2013)] (See Bankruptcy Relief under Chapter 13 and Chapter 12.) Solution No. ECMC cannot now resume its effort to collect on Hann‘s loans. After the debtor has completed all payments, the court grants a discharge of all debts provided for by the repayment plan. All debts generally are dischargeable, especially those for which the court either declared that there was no obligation or disallowed on the ground that the underlying debt was satisfied. In this problem, Hann financed her education partially through loans. When she filed a Chapter 13 petition, Educational Credit Management Corp. (ECMC) filed an unsecured proof of claim based on the loans. Hann believed that she had repaid the loans in full and objected. The court held a hearing at which ECMC failed to appear, and Hann submitted correspondence from the lender indicating the loans had been paid. The court then entered an order sustaining Hann's objection to ECMC‘s claim, in effect declaring that there was no obligation and the underlying debt was satisfied. By later attempting to renew efforts to collect on the loans, ECMC would violate the court‘s order. In the actual case on which this problem is based, ECMC resumed collection efforts after the bankruptcy. Hann reopened her case and filed a complaint against ECMC, alleging that it had violated the order sustaining her objection. The court ruled in Hann‘s favor, and sanctioned ECMC for attempting to collect on the debt. On ECMC‘s appeal, the U.S. Court of Appeals for the First Circuit affirmed.

319

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

28. Business Case Problem with Sample Answer—Discharge. Michael and Dianne Shankle divorced. An Arkansas state court ordered Michael to pay Dianne alimony and child support, as well as half of the $184,000 in their investment accounts. Instead, Michael withdrew more than half of the investment funds and spent them. Over the next several years, the court repeatedly held Michael in contempt for failing to pay Dianne. Six years later, Michael filed for Chapter 7 bankruptcy, including in the petition‘s schedule the debt to Dianne of unpaid alimony, child support, and investment funds. Is Michael entitled to a discharge of this debt? Explain. [In re Shankle, 554 Fed.Appx. 264 (5th Cir. 2014)] (See Chapter 7—Liquidation.) —For a sample answer to Problem 22–4, go to Appendix E. Solution No. Michael is not entitled to a discharge of the debt to Dianne of half of the amount in the investment accounts or the unpaid alimony and child support. The debt qualifies as an exception to discharge. As far as a debtor is concerned, the primary purpose of a liquidation proceeding is to obtain a fresh start through a discharge of debts. But certain debts are not dischargeable in bankruptcy. Claims that are not dischargeable in bankruptcy include domestic-support obligations and property settlements provided for in a divorce decree and claims based on willful or malicious conduct by the debtor toward another. In this problem, on Michael and Dianne‘s divorce, a court ordered Michael to pay alimony and child support and to tender half of the couple‘s $184,000 in their investment accounts to Dianne. Michael did not comply with this order, but withdrew half of the investment funds and spent them on himself. Meanwhile, the court repeatedly held him in contempt for failing to pay Dianne alimony, child support, and half of the investment funds. These items are nondischargeable because they are domestic-support obligations and part of the property settlement provided for in the parties‘ divorce decree. The unpaid investment funds also constitute a claim based on Michael‘s willful and malicious conduct towards Dianne. Michael deliberately defied multiple contempt orders to leave Dianne uncompensated, thereby certain to inflict harm on her. In the actual case on which this problem is based, the court concluded that Michael's conduct was willful and malicious and that therefore the debt to Dianne listed in the petition‘s schedule was nondischargeable. On Michael‘s appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed. 29. Discharge under Chapter 13. James Thomas and Jennifer Clark married and had two children. They bought a home in Ironton, Ohio, with a loan secured by a mortgage. Later, they took out a second mortgage. On their divorce, the court gave Clark custody of the children and required Clark to pay the first mortgage. The divorce decree also required Thomas and Clark to make equal payments on the second mortgage and provided that Clark would receive all proceeds on the sale of the home. Thomas failed to make any payments, and Clark sold the home. At that point, she learned that Auto Now had a lien on the home because Thomas had not made payments on his car. Clark used all the sale proceeds to pay off the lien and the mortgages. When Thomas filed a petition for a Chapter 13 bankruptcy in a federal bankruptcy court, Clark filed a proof of claim for the mortgage and lien debts. Clark claimed that Thomas should not be able to discharge these debts because they were part of his domestic-support obligations. Are these debts dischargeable? Explain. [In re Thomas, 591 Fed.Appx. 443 (6th Cir. 2015)] (See Bankruptcy Relief under Chapter 13 and Chapter 12.) Solution

320

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

No. Thomas‘s mortgage and lien debts are not dischargeable in a Chapter 13 bankruptcy case. Domestic-support obligations, such as child support and alimony, are exempted from the automatic stay provision and from discharge under most, if not all, circumstances on a bankruptcy petition, including one filed under Chapter 13. And claims for domestic-support obligations have the highest priority among unsecured claims, so these debts must be paid first. Here, when Clark and Thomas divorced, the decree gave Clark custody of their children, required Clark to pay their first mortgage, required Thomas and Clark to make equal payments on a second mortgage, and provided that Clark would receive all proceeds on the sale of the home. Thomas failed to make any payments, and Clark sold the home. She then learned that Auto Now had a lien on the home because Thomas had not made payments on his car. Clark used all the sale proceeds to pay off the lien and the mortgages. When Thomas filed a petition for a Chapter 13 bankruptcy, Clark filed a proof of claim to collect on the mortgage and lien debts. These debts could be construed as non-dischargeable domestic-support obligations. At the time of the divorce, the parties and the court most likely intended the mortgage debt to serve as a support obligation and in fact the debt actually provided support. In the actual case on which this problem is based, Thomas filed a petition for a Chapter 13 bankruptcy in a federal bankruptcy court. Clark filed a proof of claim for the mortgage and lien debts. Over Thomas‘s objection, the court ruled that the debts were non-dischargeable domesticsupport obligations. The U.S. Court of Appeals for the Sixth Circuit affirmed this ruling. 30. Liquidation Proceedings. Jeffrey Krueger and Michael Torres, shareholders of Cru Energy, Inc., were embroiled in litigation in a Texas state court. Both claimed to act on Cru‘s behalf, and each charged the other with attempting to obtain control of Cru through fraud and other misconduct. Temporarily prohibited from participating in Cru‘s business, Krueger formed Kru, a company with the same business plan and many of the same shareholders as Cru. Meanwhile, to delay state court proceedings, Krueger filed a petition for a Chapter 7 liquidation in a federal bankruptcy court. He did not reveal his interest in Kru to the bankruptcy court. Ownership of Krueger‘s Cru shares passed to the bankruptcy trustee, but Krueger ignored this. He called a meeting of Cru‘s shareholders—except Torres—and voted those shares to remove Torres from the board and elect himself chairman, president, chief executive officer, and treasurer. The Cru board then dismissed all of Cru‘s claims against Krueger in his suit with Torres. Are there sufficient grounds for the bankruptcy court to dismiss Krueger‘s bankruptcy petition? Discuss. [In re Krueger, 812 F.3d 365 (5th Cir. 2016)] (See Chapter 7—Liquidation.) Solution Yes. There are sufficient grounds for the bankruptcy court to dismiss Krueger‘s petition for a Chapter 7 liquidation, Bad faith conduct is the basis for the court to dismiss the petition. Good faith is implicitly required for the commencement, prosecution, and confirmation of bankruptcy proceedings—a prerequisite for an honest debtor to obtain a fresh start. Acting in bad faith can serve as a ground for a bankruptcy court to dismiss a case, after notice and a hearing, for cause. In this problem, Krueger and Torres, shareholders of Cru Energy, were suing each other in a state court, both claiming to act on Cru‘s behalf and charging each other with fraud and other misconduct. Ordered not to participate in Cru‘s business, Krueger formed Kru, with the same business plan and many of the same shareholders as Cru. Meanwhile, he filed a petition for a Chapter 7 liquidation in a federal bankruptcy court to delay the state court proceedings. He did not tell the court of his interest in Kru. Although ownership of his Cru shares had passed to the bankruptcy trustee, he called a meeting of Cru‘s shareholders—except Torres—and voted those

321

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

shares to remove Torres from the board and elect himself chairman, president, chief executive officer, and treasurer. The Cru board then dismissed all of Cru‘s claims against Krueger in his suit with Torres. Here, Krueger misled the courts and filed his bankruptcy petition for an illegitimate purpose. He sought to use the bankruptcy process as a shield against the state court‘s actions to restrain his behavior and as a sword to take control of Cru. His primary reason for filing the bankruptcy petition was not to obtain a fresh start, as an honest debtor, but to delay the state court proceedings in his litigation with Torres over control of Cru. Furthermore, he failed to inform the bankruptcy court of his interest in Kru, the formation of which was likely a violation of the state court‘s order to stay out of Cru‘s business. He violated the automatic stay imposed through his bankruptcy petition when he voted his Cru shares at the meeting of its shareholders. In the actual case on which this problem is based, the bankruptcy court dismissed Krueger‘s case, on Torres‘s motion, for all of the reasons stated above, and more. The U.S. Court of Appeals for the Fifth Circuit affirmed this action. 31. The Reorganization Plan. Under the ―plain language‖ of the Bankruptcy Code, at least one class of creditors must accept a Chapter 11 plan for it to be confirmed. Transwest Resort Properties, Inc., and four related companies filed a petition for bankruptcy under Chapter 11. The five debtors filed a joint reorganization plan. Several classes of their creditors approved the plan. Grasslawn Lodging, LLC, filed a claim based on its loan to two of the companies, and objected to the plan. Grasslawn further asserted that the Code‘s confirmation requirement applied on a ―per debtor,‖ not a ―per plan,‖ basis, and because Grasslawn was the only class member for two of the debtors, the plan in this case did not meet the test. Can the court order a ―cram-down‖? Why or why not? [In the Matter of Transwest Resort Properties, Inc., 881 F.3d 724 (9th Cir. 2018)] (See Chapter 11— Reorganization.) Solution Yes. The court in the Transwest case can order a cramdown. Under the Bankruptcy Code‘s cramdown provision, a bankruptcy court can confirm a Chapter 11 plan over the objections of one or more of the creditors if at least one class of creditors has accepted the plan. This is possible if it is demonstrated that the plan is fair and equitable. In this problem, five related companies filed for bankruptcy under Chapter 11. The five debtors filed a joint reorganization plan. Some of their creditors approved the plan. Grasslawn Lodging was the only creditor of two of the companies. Grasslawn argued that the Code‘s confirmation requirement applied on a ―per debtor,‖ not a ―per plan,‖ basis. This plan did not meet the test, because Grasslawn was the only class member for two of the debtors, and it objected to the plan. According to the stated facts, the Code does make a distinction concerning the creditors of different debtors under the plan, nor does it distinguish between single-debtor and multi-debtor plans. Under the ―plain language‖ of the statute, once a single class of creditors accepts a plan, the requirement for its confirmation is met. In the actual case on which this problem is based, the court approved the plan despite Grasslawn‘s objection. The U.S. Court of Appeals for the Ninth Circuit affirmed. ―The plain language of the statute contemplates a ‗per plan‘ approach.‖

322

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

32. A Question of Ethics—The IDDR Approach and Reorganization. Jevic Transportation Corporation filed a petition in a federal bankruptcy court for a Chapter 11 reorganization. A group of former Jevic truck drivers filed a suit and won a judgment against the firm for unpaid wages. This judgment entitled the workers to payment from Jevic‘s estate ahead of its unsecured creditors. Later, some of Jevic‘s unsecured creditors filed a suit against some of its other unsecured creditors. The plaintiffs won a judgment on the ground that the firm‘s payments to the defendants constituted fraudulent transfers and preferences. These parties then negotiated, without the truck drivers‘ consent, a settlement agreement that called for the workers to receive nothing on their claims while the creditors were to be paid proportionately. [Czyzewski v Jevic Holding Corp, 580 U.S. ___, 137 S.Ct. 973, 197 L.Ed.2d 398 (2017)] (See Chapter 11— Reorganization.) 33. Was it ethical of the truck drivers to obtain a judgment entitling them to payment ahead of the unsecured creditors? Why or why not? Solution As part of a Chapter 11 reorganization, an order concerning the debtor‘s estate cannot generally be entered without the consent of a committee of creditors. Sometimes, their lack of consent can be avoided—for instance, by a court order. The Bankruptcy Code, however, establishes basic priority rules for determining the order in which a court can distribute an estate‘s assets. A Chapter 11 reorganization cannot give effect to a distribution that does not follow these priorities without the affected creditors‘ consent. In this problem, Jevic Transportation Corp. sought a Chapter 11 reorganization. A group of former employees obtained a judgment against the firm for unpaid wages. This judgment entitled the workers to payment from Jevic‘s estate ahead of its unsecured creditors. There is no dispute that this result was legal—the drivers‘ claims were otherwise entitled to priority over most others. The issue was whether this result was ethical. The stakeholders include primarily the drivers and Jevic‘s other creditors whose priority to payment falls below that of the unpaid employees. Other stakeholders include the employees‘ families, their creditors, and their future employers (who might find themselves driving hard bargains with mistrusting workers). The ethical standards arise chiefly from the employees‘ duty to meet their own obligations. But as noted above, the Code establishes rules that dictate a certain priority for a distribution of a bankruptcy estate. These rules provide a legal guideline for an ethical dilemma. The drivers‘ decision to pursue their claims was an affirmative attempt to meet their obligations. The judgment in their case followed the Code‘s distribution rules. The creditors whose claim to payment fell below the employees, according to the Code‘s rules, were likely not as happy as they would have been if the drivers‘ claims had been refused. But the other stakeholders were probably as satisfied as could be expected in the circumstances of the bankruptcy. Thus, the drivers‘ actions were ethical. 34. Was it ethical of the unsecured creditors to agree that the workers would receive nothing on their claims? Use the IDDR approach to decide. Solution

323

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

The Bankruptcy Code establishes priority rules for the order in which a court can distribute an estate‘s assets. With the creditors‘ consent, however, a reorganization can affect a distribution that does not follow these priorities. Here, Jevic Transportation Corp. sought a Chapter 11 reorganization. A group of former employees obtained a judgment against the firm for unpaid wages. This entitled the workers to payment from Jevic‘s estate ahead of its unsecured creditors. Later, some of these unsecured creditors won a judgment against other unsecured creditors on the basis of fraudulent transfers and preferences. These parties negotiated a settlement, without the employees‘ consent, that called for the workers to receive nothing on their claims while the creditors were paid. This agreement violated the Bankruptcy Code‘s distribution priority. Was it ethical? That is the question. The principal stakeholders include all of Jevic‘s creditors, including the truck drivers, and unrelated parties for whose claims under Chapter 11 the outcome in this case might serve as a precedent. The standards here derive from general principles of fairness, the Code‘s priorities, and the parties‘ circumstances. The unsecured creditors might have elected to acknowledge in their agreement the drivers‘ claims. This would have had the merit of fairly recognizing the claims, following the Code‘s strict rules, and distributing the assets to satisfy at least part of every debt. But the creditors chose not to do this.

324

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 26: Bankruptcy

In making this choice, the creditors did not give sufficient weight to the Code‘s obligation to distribute the assets in a certain order. Instead, they appear to have selfishly attempted to satisfy their own claims while ignoring the claims of the employees, whose payment took priority. If the estate contained only a few assets, the agreement bypassing the workers‘ claim would still be unethical. A possibly paltry payment does not eliminate the value of the claim or the legitimacy of the workers‘ injury. They are entitled to a chance to obtain redress and a respect of their priority. Of course, the creditors‘ choice satisfied none of the stakeholders, not even the creditors themselves, who are likely to face a costly challenge to their agreement, which is also likely to be rejected. In the actual case on which this problem is based, a federal bankruptcy court approved the settlement. The U.S. Court of Appeals for the Third Circuit affirmed the approval. The United States Supreme Court reversed the ruling, however, and remanded the case. ―We cannot alter the balance struck by the statute.‖

Critical Thinking and Writing Assignments 35. Time-Limited Group Assignment—Student Loan Debt. Cathy Coleman took out loans to complete her college education. After graduation, Coleman was irregularly employed as a teacher. Eventually, she filed a petition in a federal bankruptcy court under Chapter 13. The court confirmed a five-year plan under which Coleman was required to commit all of her disposable income to paying the student loans. Less than a year later, when Coleman was laid off, she still owed more than $100,000 to Educational Credit Management Corp. Coleman asked the court to discharge the debt on the ground that it would be an undue hardship for her to pay it. (See Bankruptcy Relief under Chapter 13 and Chapter 12.) 36. The first group will explain when a debtor normally is entitled to a discharge under Chapter 13. Solution Debtors who seek Chapter 13 relief commit to a three-to five-year period of repayment, after which their remaining debts are discharged. Unlike Chapter 7 debtors, who are entitled to a discharge of debt as soon as their estate is liquidated and distributed, Chapter 13 debtors are not entitled to a discharge of debts unless and until they complete payments to creditors under the repayment plan. 37. The second group will discuss whether student loans are dischargeable and when ―undue hardship‖ is a legitimate ground for an exception. Solution Student loans are exempted from discharge unless the debtor can show ―undue hardship.‖

325

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

38. The third group will outline the goals of bankruptcy law and make an argument, based on these facts and principles, in support of Coleman‘s request. Solution A fundamental goal of bankruptcy is to protect debtors by giving them fresh starts free from debt. It could be argued that a debtor who is burdened by student loans will not emerge from bankruptcy with a ―fresh start‖ if the debt is not discharged. According to the facts in the question, Coleman is less than one year into a five-year plan. She would not normally be entitled to a discharge of any of her debts until she completed the plan and of course would not be entitled to discharge her student loans unless she could show ―undue hardship.‖ Here, the hardship to Coleman arguably consists of the commitment of five years of disposable income to payments without any guarantee that the student loans will be discharged at the end of the period. This suggests that the court might at least agree to a discharge of the student loan debt on the completion of the plan.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 326 Case 27.1 ............................................................................................................................................... 326 Case 27.2 ............................................................................................................................................... 327 Case 27.3 ............................................................................................................................................... 328 Chapter Review ........................................................................................................................................................... 329 Practice and Review .............................................................................................................................. 329 Practice and Review: Debate This ......................................................................................................... 330 Issue Spotters ........................................................................................................................................ 330 Business Scenarios and Case Problems ................................................................................................. 330 Critical Thinking and Writing Assignments ............................................................................................ 338

Critical Thinking Questions in Cases Case 27.1 39. Did Ward breach any duties owed to his employer in addition to his alleged breach of the duty of loyalty? Discuss. Solution In the Taser case, if Taser can prove its case, Ward was in breach of the agent‘s duty of loyalty. Taser might also allege that Ward breached the agent‘s duty of notification. Under the duty of loyalty, an agent has the duty to act solely for the benefit of the principal. Under the duty of notification, an agent is required to notify the principal of all matters that come to the agent‘s attention concerning the subject matter of the agency. ―Assuming Taser was engaged in the research and development of a

326

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

recording device during Ward's employment, assuming Ward knew or should have known of those efforts, and assuming Taser's device would compete with Ward's concept, substantial design and development efforts by Ward during his employment‖ without informing Taser would constitute a violation of the duty of notification. Under the duty of obedience, when acting on behalf of the principal, an agent has a duty to follow all lawful and clearly stated instructions of the principal. Any deviation from such instructions is a violation of the duty. Depending on the scope of Ward‘s employment—what he was instructed to do—he might also have violated this duty. And under the duty of accounting, an agent has a duty to keep and make available to the principal an account of all property and funds received and paid out on behalf of the principal. If Ward expended any of Taser‘s resources on research and development of his own projects, he might also have violated this duty. 40. Suppose that Ward‘s pre-termination activities focused on a product that was not designed to compete with Taser‘s products. Would these efforts have breached his duty of loyalty? Why or why not? Solution In these circumstances, assuming that Ward‘s activities did not involve the improper use any of Taser‘s resources (including Ward‘s work time), there would be no basis for concluding that Ward had breached his duty of loyalty to his employer by planning a new and noncompetitive business venture.

Case 27.2 41. Normally, modification of the Association‘s bylaws requires the approval of two-thirds of the unit owners. Could Makki have successfully argued that the actions of the board members who violated the bylaws modified them in accord with the freedom to contract? Explain. Solution No, Makki could not have successfully argued that the actions of the board members who violated the bylaws effectively modified those restrictions in accord with the freedom to contract. In asserting this contention, Makki might have posited that the bylaws are a contract, that parties are free to contract, and that the actions of the parties, in light of their oral or written representations, amounted to a waiver of the leasing restrictions. Of course, contracting parties are free to modify the terms of their deal. But in the Makki case, the parties to the bylaws are all of the Association‘s members, not just the members who violated the leasing restrictions in the bylaws. By buying a unit in the project, an owner agrees to follow the bylaws. This confines the parties‘ freedom to contract within the parameters established by those bylaws. Unit owners are free to modify the bylaws, but only in accord with the prescribed procedures for modification, including the approval of two-thirds of the owners. The improper conduct of some of the board members would not effectively modify the bylaws. 42. Why might a condominium complex‘s bylaws impose restrictions on individual owners‘ leasing of their units? Why might some of those owners opt to violate the restrictions? Discuss. Solution

327

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

The most likely and obvious answer to this question is provided by its heading. A condominium complex‘s bylaws might impose restrictions on individual owners‘ leasing of their units, and some of those owners might opt to violate the restrictions, for economic reasons. When a unit is bought, payments must be made on the mortgage loan that financed its purchase. And an owner might buy more than one unit for investment purposes—that is, to sell once the market price has increased. In the meantime, a vacant unit could prove less costly, and even profitable, by leasing it. These circumstances could motivate an owner to violate any leasing restrictions in the complex‘s bylaws. The complex might have imposed those restrictions to avoid the habitation of the units by parties who had little or no interest in maintaining or contributing to the value of the property.

Case 27.3 43. If the appellate court had upheld the trial court‘s finding that Doughty was an independent contractor, would he have been liable to Simon? Explain. Solution Yes, Doughty would most likely have been liable to Simon if the appellate court had affirmed the trial court‘s finding that Doughty was an independent contractor. The term independent contractor connotes a freedom of action and choice with respect to the work or other performance on a job and a legal responsibility on the part of the contractor for discrepancies and deviations. A principal is not generally liable for the negligence of an independent contractor. Like an employee, an independent contractor may be engaged in an activity for the benefit of an employer, but it is the latter‘s freedom from control that relieves the employer of liability. 44. Suppose that the accident in this case had happened during Doughty‘s drive home after he had dropped off the supplies. Would the result have been different? Discuss. Solution Yes, if Doughty had been involved in the accident during his drive home after he had dropped of the supplies, the result in the Simon case would likely have been different. In that circumstance, Doughty would not have been at work at the time but on a commute, or a personal pursuit. The key to determining liability for an agent or employee‘s negligence, or other tort, is whether the act is committed within the scope or course of employment. Factors that affect this determination include the time of the act, the extent of the involvement of the worker‘s private interests, and whether the employer provided the means by which the tort was committed. The time that an employee spends commuting to or from work is normally considered outside the scope of employment. In the facts of the question, Doughty‘s commute would have been outside the time of employment. He was driving home. Furthermore, he was using his own vehicle to make the trip.

328

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

Chapter Review Practice and Review Lynne Meyer, on her way to a business meeting and in a hurry, stopped by a Buy-Mart store for a new car charger for her smartphone. There was a long line at one of the checkout counters, but a cashier, Valerie Watts, opened another counter and began loading the cash drawer. Meyer told Watts that she was in a hurry and asked Watts to work faster. Watts, however, only slowed her pace. At this point, Meyer hit Watts. It is not clear whether Meyer hit Watts intentionally or, in an attempt to retrieve the car charger, hit her inadvertently. In response, Watts grabbed Meyer by the hair and hit her repeatedly in the back of the head, while Meyer screamed for help. Management personnel separated the two women and questioned them about the incident. Watts was immediately fired for violating the store‘s no-fighting policy. Meyer subsequently sued Buy-Mart, alleging that the store was liable for the tort (assault and battery) committed by its employee. Using the information presented in the chapter, answer the following questions. 45. Under what doctrine discussed in this chapter might Buy-Mart be held liable for the tort committed by Watts? Solution The doctrine of respondeat superior, under which employers may be held liable for the actions of their agents or employees, may apply in this situation. The concept of respondeat superior is based on the assumption that employers are usually in a better position to absorb the costs that may result from agents‘ or employees‘ torts. 46. What is the key factor in determining whether Buy-Mart is liable under this doctrine? Solution Under the doctrine of respondeat superior, an employer is responsible for torts committed by agents or employees in the course and scope of their employment. 47. Did Watts‘s behavior constitute an intentional tort or a tort of negligence? How would this difference affect Buy-Mart‘s potential liability? Solution It seems clear that Watt‘s behavior constituted an intentional tort. In any event, because Watts‘ actions took place in the scope of employment, the employer in this problem may be liable in either situation under the doctrine of respondeat superior. 48. Suppose that when Watts applied for the job at Buy-Mart, she disclosed in her application that she had previously been convicted of felony assault and battery. Nevertheless, Buy-Mart hired Watts as a cashier. How might this fact affect Buy-Mart‘s liability for Watts‘s actions? Solution This circumstance would support an assessment of liability on the employer under the theory that the employee acted with the employer‘s knowledge of a propensity for tortious behavior.

329

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

Practice and Review: Debate This 49. The doctrine of respondeat superior should be modified to make agents solely liable for some of their tortious (wrongful) acts. Solution Because of the doctrine of respondeat superior, some agents may act more recklessly because they know that the principal will pay all damages for their irresponsible behavior. If all agents knew that they would be financially liable for at least some of the damages their tortious conduct caused, they would behave in a more responsible manner. Business owners and other principals take out sufficient insurance to cover damages owed due to their agents‘ tortious acts. It would be unfair to impose any liability on agents, who, in general, are not in a financial position to pay for any part of a damage award as a result of their tortious acts.

Issue Spotters 50. Dimka Corporation wants to build a new mall on a specific tract of land. Dimka contracts with Nadine to act as its agent in buying the property. When Nadine learns of the difference between the price that Dimka is willing to pay and the price at which the owner is willing to sell, she wants to buy the land and sell it to Dimka herself. Can she do this? Discuss. Solution No. Nadine, as an agent, is prohibited from taking advantage of the agency relationship to obtain property that the principal (Dimka Corporation) wants to purchase. This is the duty of loyalty that arises with every agency relationship. 51. Davis contracts with Estee to buy a certain horse on her behalf. Estee asks Davis not to reveal her identity. Davis makes a deal with Farmland Stables, the owner of the horse, and makes a down payment. Estee does not pay the rest of the price. Farmland Stables sues Davis for breach of contract. Can Davis hold Estee liable for whatever damages he has to pay? Why or why not? Solution Yes. A principal has a duty to indemnify (reimburse) an agent for liabilities incurred because of authorized and lawful acts and transactions and for losses suffered because of the principal‘s failure to perform any duties.

Business Scenarios and Case Problems 52. Ratification by Principal. Springer, who was running for Congress, instructed his campaign staff not to purchase any campaign materials without his explicit authorization. In spite of these instructions, one of his campaign workers contracted with Dubychek Printing Co. to print some promotional materials for Springer‘s campaign. When the printed materials arrived, Springer did not return them but instead used them during his campaign. When Springer failed to pay for the materials, Dubychek sued for recovery of the price. Springer contended that he was not liable on the sales contract because he had not authorized his agent to purchase the printing services. Dubychek argued that the campaign worker was Springer‘s agent and that the worker had authority to make the printing contract. Additionally, Dubychek claimed that even if the purchase was unauthorized, Springer‘s use of the materials constituted ratification of his agent‘s unauthorized purchase. Is Dubychek correct? Explain. (See Formation of an Agency.)

330

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

Solution Dubychek may very well be correct in his claim. Implied ratification by a principal of an agent‘s unauthorized action occurs when a principal accepts the benefits of the unauthorized transaction and/or does not object to or repudiate the action within a reasonable time. It is essential, however, that the principal be aware of all material facts; otherwise, the ratification will not be effective. If Springer knew that the printed materials had been ordered by his campaign workers without his authorization and used the materials in spite of this knowledge, such use would constitute ratification of the unauthorized purchase agreement. In such a case, Dubychek could successfully sue to recover the purchase price of the campaign materials. If Springer were unaware that the materials had been purchased without his authorization, his use of the materials would not constitute ratification. A good point for discussion is whether the campaign worker was impliedly authorized or had apparent authority to contract for the printing of the promotional material. There is no question that there was no express authorization. Springer‘s prohibition, unknown to Dubychek, may not relieve Springer of liability, however. If the campaign worker is one who is placed in a position of a person who usually orders campaign printing, or if this campaign worker had previously ordered campaign materials from Dubychek, Dubychek can claim that the campaign worker had either implied authority to act or that previous conduct led Dubychek to believe that the worker had (apparent) authority to contract for the printing. If either is applicable, ratification is not necessary, as the worker‘s contract is authorized, and the principal, Springer, is liable. 53. Employee versus Independent Contractor. Stephen Hemmerling was a driver for the Happy Cab Co. Hemmerling paid certain fixed expenses and abided by a variety of rules relating to the use of the cab, the hours that could be worked, and the solicitation of fares, among other things. Rates were set by the state. Happy Cab did not withhold taxes from Hemmerling‘s pay. While driving the cab, Hemmerling was injured in an accident and filed a claim against Happy Cab in a Nebraska state court for workers‘ compensation benefits. Such benefits are not available to independent contractors. On what basis might the court hold that Hemmerling is an employee? Explain. (See Agency Law.) Solution A court might hold that Hemmerling and Happy Cab have an employment relationship primarily on the basis of control. Happy Cab clearly has the right to control the methods or means used by Hemmerling in the course of operating the taxicab by virtue of its exclusive control over the taxicab. Happy Cab exercises its control by establishing and enforcing a variety of rules relating to the use of the cab, solicitation of fares, and so on. Other factors supporting the existence of an employment relationship include that Hemmerling was not engaged in a distinct occupation or business from that of Happy Cab, and the type of work is that which can be done by employees rather than specially skilled independent contractors. Also, Happy Cab supplied the instrumentality of the trade (the cab), and given that the rates were set by the state, Hemmerling‘s ability to control his profit was limited. The only factor that supports an independent contractor relationship is that Happy Cab did not withhold taxes. 54. Liability for Contracts. Thomas Huskin and his wife entered into a contract to have their home remodeled by House Medic Handyman Service. Todd Hall signed the contract as an authorized representative of House Medic. It turned out that House Medic was a fictitious name for Hall Hauling, Ltd. The contract did not indicate this, however, and Hall did not inform the Huskins

331

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

about Hall Hauling. When a contract dispute later arose, the Huskins sued Todd Hall personally for breach of contract. Can Hall be held personally liable? Why or why not? [Huskin v. Hall, 2012 Ohio- 653 (Ohio Ct.App. 2012)] (See Liability in Agency Relationships.) Solution Hall may be held personally liable. Hall could not be an agent for House Medic because it was a fictitious name and not a real entity. Moreover, when the contract was formed, Hall did not disclose his true principal, which was Hall Hauling, Ltd. Thus, Hall may be held personally liable as a party to the contract. 55. Agent’s Authority. Basic Research, LLC, advertised its products on television networks owned by Rainbow Media Holdings, Inc., through an ad agency, Icebox Advertising, Inc. As Basic‘s agent, Icebox had the express authority to buy ads from Rainbow on Basic‘s behalf, but the authority was limited to buying ads with cash in advance. Despite this limit, Rainbow sold ads to Basic through Icebox on credit. Basic paid Icebox for the ads, but Icebox did not pass all of the payments on to Rainbow. Icebox filed for bankruptcy. Can Rainbow recoup the unpaid amounts from Basic? Explain. [American Movie Classics v. Rainbow Media Holdings, 508 Fed.Appx. 826 (10th Cir. 2013)] (See Agent’s Authority.) Solution No. Rainbow cannot recoup the unpaid amounts from Basic. Express authority is authority declared in clear, direct, and definite terms. Express authority can be given orally or in writing. In most states, if the contract being executed is or must be in writing, then the agent‘s authority must also be in writing. Otherwise, the contract may be avoided (or ratified) by the principal. If it is ratified, the ratification must be in writing. An agent has the implied authority to do what is reasonably necessary to carry out express authority. For example, authority to manage a business implies authority to do what is reasonably required to operate the business. But an agent‘s implied authority cannot contradict that agent‘s express authority. Thus, if a principal has limited an agent‘s express authority, then the fact that the agent customarily would have such authority is irrelevant. In this problem, Basic Research advertised its products on television networks owned by Rainbow Media Holdings through an ad agency, Icebox Advertising. Basic paid Icebox for the ads, but Icebox did not make all of the payments to Rainbow. Icebox filed for bankruptcy. Rainbow cannot recover what it was owed from Basic. As Basic's agent, Icebox had the express authority to buy ads from Rainbow on Basic's behalf, but that authority was limited to purchasing ads with cash in advance. Thus, Icebox did not have the authority—express or implied—to buy ads on Basic's credit. And Basic did not ratify the contracts that represented purchases on credit. In the actual case on which this problem is based, on Basic‘s appeal from a judgment in Rainbow‘s favor, the U.S. Court of Appeals for the Tenth Circuit reversed that judgment and ruled in Basic‘s favor. 56. Business Case Problem with Sample Answer—Determining Employee Status. Nelson Ovalles worked as a cable installer for Cox Rhode Island Telecom, LLC, under an agreement with a third party, M&M Communications, Inc. The agreement stated that no employer-employee relationship existed between Cox and M&M‘s technicians, including Ovalles. Ovalles was required to designate his affiliation with Cox on his work van, clothing, and identification badge, but Cox had minimal contact with him and limited power to control the manner in which he performed his duties. Cox

332

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

supplied cable wire and similar items, but the equipment was delivered to M&M, not to Ovalles. On a workday, while Ovalles was fulfilling a work order, his van rear-ended a car driven by Barbara Cayer. Is Cox liable to Cayer? Explain. [Cayer v. Cox Rhode Island Telecom, LLC, 85 A.3d 1140 (R.I. 2014)] (See Agency Law.) —For a sample answer to Problem 27–5, go to Appendix E. Solution No. Cox is not liable to Cayer for the injuries or damage that she sustained in the accident with Ovalles. Generally, an employer is not liable for physical harm caused to a third person by the negligent act of an independent contractor in the performance of a contract. This is be cause the employer does not have the right to control the details of the performance. In determining whether a worker has the status of an independent contractor, how much control the employer can exercise over the details of the work is the most important factor weighed by the courts. In this problem, Ovalles worked as a cable installer for Cox under an agreement with M&M. The agreement disavowed any employer-employee relationship between Cox and M&M‘s installers. Ovalles was required to designate his affiliation with Cox on his van, clothing, and an ID badge. But Cox had minimal contact with Ovalles and limited power to control the manner in which he performed his work. Cox supplied cable wire and other equipment, but these items were delivered to M&M, not Ovalles. These facts indicate that Ovalles was an independent contractor, not an employee. Thus, Cox was not liable to Cayer for the harm caused to her by Ovalles when his van rear-ended Cayer‘s car. In the actual case on which this problem is based, the court issued a judgment in Cox's favor. The Rhode Island Supreme Court affirmed, applying the principles stated above to arrive at the same conclusion.

57. Agent’s Authority. Terry Holden‘s stepmother, Rosie, was diagnosed with amyotrophic lateral sclerosis (ALS), and Terry‘s wife, Susan, became Rosie‘s primary caregiver. Rosie executed a durable power of attorney appointing Susan as her agent. Susan opened a joint bank account with Rosie at Bank of America, depositing $9,643.62 of Rosie‘s funds. Susan used some of the money to pay for ―household expenses to keep us going while we were taking care of her.‖ Rosie died three months later. Terry‘s father, Charles, as executor of Rosie‘s estate, filed a petition in a Texas state court against Susan for an accounting. What general duty did Susan owe Rosie as her agent? What does an agent‘s duty of accounting require? Did Susan breach either of these duties? Explain. [Holden v. Holden, 456 S.W.3d 642 (Tex.App.—Tyler 2015)] (See Agent’s Authority.) Solution As Rosie‘s agent, Susan owed her a fiduciary duty to act in the utmost good faith on Rosie‘s behalf and in her best interest. An agent‘s duty of accounting requires an agent to keep and make available to the principal an account of all property and funds received and paid out on the principal‘s behalf. The agent has a duty to maintain separate accounts for the principal‘s funds and for the agent‘s personal funds, and the agent must not intermingle these accounts. Susan violated both of these duties. In this problem, Rosie executed a durable power of attorney appointing Susan as her agent. Susan opened a joint bank account with Rosie at Bank of America and deposited Rosie‘s funds into the account. Susan used some of the money to pay for ―household expenses.‖ The facts indicate that

333

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

Susan did not account to Rosie for this use of her funds. After Rosie‘s death, Charles, the executor of Rosie‘s estate, filed a suit against Susan for an accounting. Susan breached her fiduciary duty to Rosie by spending Rosie‘s funds for Susan‘s own expenses. Susan breached the agent‘s duty to account to the principal by not informing Rosie of the transactions involving her funds. In the actual case on which this problem is based, in Charles‘s suit against Susan for an accounting, the court ordered Susan to provide bank account summaries and transaction information. After review, the court ordered Susan to return all of Rosie‘s funds deposited into their joint account to Rosie‘s estate. A state intermediate appellate court affirmed the order. 58. Agency Relationships. Standard Oil of Connecticut, Inc., sells home heating, cooling, and security systems. Standard schedules installation and service appointments with its customers and then contracts with installers and technicians to do the work. The company requires an installer or technician to complete a project by a certain time but to otherwise ―exercise independent judgment and control in the execution of any work.‖ The installers and technicians are licensed and certified by the state. Standard does not train them, provide instruction manuals, supervise them at customers‘ homes, or inspect their work. The installers and technicians use their own equipment and tools, and they can choose which days they work. Standard pays a set rate per project. According to criteria used by the courts, are these installers and technicians independent contractors or employees? Why? [Standard Oil of Connecticut, Inc. v. Administrator, Unemployment Compensation Act, 320 Conn. 611, 134 A.3d 581 (2016)] (See Agency Law.) Solution According to criteria used by the courts, the installers and technicians who contract with Standard to install and service the company‘s products in its customers‘ homes are classified as independent contractors. In deciding whether a worker is an employee or an independent contractor, courts consider a number of factors, including the following. 1. 2.

The degree of control that the employer exercises over the work. Whether the worker is engaged in an occupation distinct from the business of the employer. 3. The amount of supervision that the employer imposes. 4. Who supplies the tools. 5. The duration of employment. 6. The timeframe of payment for the work (periodically or per-project). 7. The degree of skill required of the work. The degree of control is the most important factor. Standard sold home heating, cooling, and security systems, scheduled appointments with its customers for installation and service, and contracted with installers and technicians to do the work. The company required an installer or technician to finish by a certain time, but otherwise encouraged each individual to ―exercise independent judgment and control in the execution of any work.‖ The installers and technicians were licensed and certified by the state. Standard did not provide training, instruction manuals, supervision at customers‘ homes, or inspection of the work. The workers used their own equipment and tools, and chose which days to work (if at all—they were free to accept or reject any assignment). Standard paid a set rate per project. These facts indicate

334

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

that the installers and technicians should be categorized as independent contractors, not employees. In the actual case on which this problem is based, Standard classified the workers as independent contractors. The state ruled that they should have been classified as employees, and assessed $41,501.38 in unpaid unemployment contribution taxes, plus interest. From adverse state agency and court decisions, Standard appealed. The Connecticut Supreme Court reversed and remanded. On proof of the facts in this case set out above, Standard ―satisfied its burden of showing that the installers/technicians were free from its control and direction.‖ 59. Scope of Agent’s Authority. Kindred Nursing Centers East, LLC, owns and operates Whitesburg Gardens, a long-term care and rehabilitation facility in Huntsville, Alabama. Lorene Jones was admitted to the facility following knee-replacement surgery. Jones‘s daughter, Yvonne Barbour, signed the admission forms required by Whitesburg Gardens as her mother‘s representative in her presence. Jones did not object. The forms included an ―Alternative Dispute Resolution Agreement,‖ which provided for binding arbitration in the event of a dispute between ―the Resident‖ (Jones) and ―the Facility‖ (Whitesburg Gardens). Six days later, Jones was transferred to a different facility. After recovering from the surgery, she filed a suit in an Alabama state court against Kindred, alleging substandard care on a claim of negligence. Can Jones be compelled to submit her claim to arbitration? Explain. [Kindred Nursing Centers East, LLC v. Jones, 201 So.3d 1146 (Ala. 2016)] (See Agent’s Authority.) Solution Yes. Jones can be compelled to submit her claim against Kindred (Whitesburg Gardens) to arbitration. The liability of a principal to third parties with whom an agent contracted depends on whether the agent had the authority to enter into a legally binding contract on the principal‘s behalf. This authority can be actual (express or implied) or apparent. Apparent authority arises when a principal causes a third party reasonably to believe that an agent has the authority to act. In this problem, Kindred operates Whitesburg Gardens, a rehabilitation facility to which Jones was admitted following knee-replacement surgery. Jones‘s daughter Yvonne Barbour signed the admission forms as her mother‘s representative in her presence and without objection by Jones. The forms included an ―Alternative Dispute Resolution Agreement‖ (ADR Agreement), which provided for binding arbitration in the event of a dispute between Jones and Whitesburg Gardens. Later, Jones filed a suit against Kindred claiming negligence. The question is whether, under the ADR Agreement, this dispute could be submitted to binding arbitration.

335

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

The answer depends on whether Barbour had the apparent authority to sign the admission forms, including the ADR Agreement with its arbitration provision, on Jones‘s behalf. According to the facts, she did. Barbour signed the forms in Jones‘s presence, with no objection by Jones. By her passive acquiescence, Jones caused Whitesburg Gardens reasonably to believe that Barbour had the authority to act on Jones‘s behalf. In the actual case on which this problem is based, the court denied Kindred‘s motion to compel arbitration. The Alabama Supreme Court reversed. The decision turned in part on whether Jones was mentally competent at the time of her admission to Whitesburg Gardens—the court concluded that she was—and, as in this problem, whether Barbour had the apparent authority to sign the admission forms on Jones‘s behalf. The court concluded that she did. ―Jones passively permitted Barbour to act on her behalf in signing the admission forms.‖ 60. Agency Relationships. Jane Westmas was killed when a tree branch cut by Creekside Tree Service, Inc., fell on her while she was walking on a public path through the private property of Conference Point Center on the shore of Lake Geneva in Wisconsin. Conference Point had contracted with Creekside to trim and remove trees from its property, but the owner had no control of (and no right to control) the details of Creekside‘s work. Jane‘s husband, John, and her son, Jason, filed a suit in a Wisconsin state court against Creekside, alleging that the service‘s negligence caused her death. Creekside contended it was immune from the suit under a state statute that provides ―no . . . agent of an owner is liable for the death of . . . a person engaging in a recreational activity on the owner‘s property.‖ Could Creekside be held liable for Jane‘s death? Why or why not? [Westmas v. Creekside Tree Service, Inc., 2018 WI 12, 379 Wis.2d 471, 907 N.W.2d 68 (2018)] (See Agency Law.) Solution Yes. Creekside could be held liable for Jane‘s death. An employer normally is not responsible for the actions of an independent contractor because the employer does not control the independent contractor‘s work. Whether an independent contractor is the employer‘s agent can affect the employer‘s liability. The most important factor in determining whether an independent contractor is also an agent is the employer‘s degree of control over the details of the work. If an employer exercises considerable control over the work, the contractor is more likely to be construed as an agent. In this problem, Conference Point contracted with Creekside to trim and remove trees from Conference Point‘s property, but the employer had no control over, nor the right to control, the details of the contractor‘s work. Jane Westmas was killed when a tree branch cut by Creekside fell on her while she was walking on a public path on the property. In response to a suit alleging that the service‘s negligence caused her death, Creekside cited a state statute that provides ―no . . . agent of an owner is liable for the death of . . . a person engaging in a recreational activity on the owner‘s property.‖ Because Conference Point had no control of, nor the right to control, the details of Creekside‘s work, the contractor would not qualify as the employer‘s agent. Thus, Creekside would not be immune from liability for Jane‘s death under the state statute. 61. A Question of Ethics—The IDDR Approach and Agent’s Authority. Devin Fink was the manager of Precision Tune Auto Care in Charlotte, North Carolina. Randall Stywall brought her car to the shop to replace the rear shocks. Fink filled out the service order with an estimate of the cost. Later, Stywall returned to pick up her car, and Fink collected payment for the work. When Stywall started to drive away, however, the car bounced as if the shocks had not been replaced. A

336

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

complaint to Precision‘s corporate office resulted in the discovery that in fact the work had not been done and Fink had kept the payment. He was charged with larceny against his employer. He argued that he had not committed this crime because the victim was Stywall, not Precision. [State of North Carolina v. Fink, 798 S.E.2d 537 (N.C.App. 2017)] (See Agent’s Authority.) 62. Which agency principles support the charge against Fink? Explain. Solution An agent may have the authority to enter into contracts on the principal‘s behalf. An agent‘s authority may be actual or apparent. Express authority is embodied in what the principal engages the agent to do. An agent has the implied authority to do what is reasonably necessary to carry out the express authority. Authority can also be inferred from the agent‘s position. These principles support the charges against Fink. He was the manager of an auto repair shop to which Stywall brought her car to have the shocks replaced. Fink‘s authority to manage the shop implied the authority to do what was reasonably required to operate the business. As his employer‘s agent, it is reasonable to imply that he had the authority to collect Stywall‘s payment for the work on her car. At that point, the funds became the property of Fink‘s principal, his employer. By keeping those funds for himself, Fink committed the crime of larceny against his employer. 63. Using the IDDR approach, determine whether Fink had an ethical duty to offer a defense to the crime with which he was charged. What does Fink‘s stated defense suggest about his ethics? Solution Fink may have had an ethical duty to offer a defense to the crime with which he was charged. But such a defense should be as ethical as the duty. Here it is not, making it likewise unethical to offer it. The first step of the IDDR approach is an Inquiry to state the issue, the stakeholders, and the ethical standards. The issue is whether Fink had an ethical duty to offer a defense to the crime with which he was charged. Stakeholders would include those who depend on Fink to avoid criminal penalties—his immediate family, for instance, who might need his income to maintain their living standard, his presence to remain stable (a parent‘s imprisonment can emotionally affect a child, for example), and his freedom to live their own lives more fully. His co-workers and his employer‘s customers might feel justified in their having trusted Fink in other circumstances. Other criminal defendants familiar with Fink‘s case might gain confidence to plead their defenses. The second step of the IDDR approach is a Discussion of actions to address the issue, the strengths and weaknesses of the actions, and consequences and effects on the stakeholders. Offering a legitimate, truthful defense to the charge would meet the duty. The other chief strength of this action could be a finding of no liability to the charges. This conclusion would obviously satisfy all of the identified stakeholders.

337

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 27: Agency Relationships in Business

The third step of the IDDR approach is a Decision on the action and a statement of its reasons. The decision on the issue seems clear, given the potentially positive outcome. Without offering a defense, Fink is not likely to avoid being found guilty as charged. The negative effects of this result on the stakeholders only add to the reasons to plead. The fourth and final step of the IDDR approach is a Review of the success or failure of the actions to resolve the issue, and satisfy the stakeholders. Success in these circumstances can only occur if a defense is pleaded, but if the defense is successful, the stakeholders will be satisfied. In Fink‘s case, he argued that he had not committed the charged crime because the victim was the customer, not the employer. This defense suggests both ethical honesty and deceit. Honesty is suggested by Fink‘s appearance to face the charge and offer a defense, and by his confession to keeping the funds. Deceit is suggested by the false impression of sincerity created by the offered defense in the face of clear agency principles to the contrary. The sum of these impressions betrays a general lack of ethics. In the actual case on which this problem is based, Fink was convicted of the larceny charge in a North Carolina state court. A state intermediate appellate court affirmed the conviction.

Critical Thinking and Writing Assignments 64. Critical Legal Thinking. What policy is served by the law that employers do not own the copyrights for works created by independent contractors (unless there is a written ―work for hire‖ agreement)? (See Agency Law.) Solution The Copyright Act of 1976 provides that copyright ownership ―vests initially in the author or authors of the work.‖ As a general rule, the author is the party who actually creates the work. This statute follows Congress‘s declared policy of enhancing the predictability and certainty of copyright ownership. Vesting the rights to works in the parties who create them—parties who include independent contractors—also supports such policies as the ―work ethic.‖ Individuals who reap the benefits of the ―fruits of their labor‖ (the products of their effort) are arguably more likely to work harder and produce better products than individuals who receive no ownership of, or at least no benefit from, what they produce. Vesting the rights to works in the parties who create them also preserves the ―independence‖ of the independent contractor and the ―independence‖ of an employer, in the case of a work for hire, who can retain freedom from some types of potential liability by hiring independent contractors rather than employees. 65. Time-Limited Group Assignment—Liability for Independent Contractor’s Torts. Dean Brothers Corp. owns and operates a steel-drum manufacturing plant. Lowell Wyden, the plant superintendent, hired Best Security Patrol, Inc. (BSP), a security company, to guard the property and ―deter thieves and vandals.‖ Some BSP security guards, as Wyden knew, carried firearms. Pete Sidell, a BSP security guard, was not certified as an armed guard but nevertheless took his gun to work. While working at the Dean plant on October 31, Sidell fired his gun at Tyrone Gaines, in the belief that Gaines was an intruder. The bullet struck and killed Gaines. Gaines‘s mother filed a

338

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

lawsuit claiming that her son‘s death was the result of BSP‘s negligence, for which Dean was responsible. (See Liability in Agency Relationships.) 66. The first group will determine what the plaintiff‘s best argument is to establish that Dean is responsible for BSP‘s actions. Solution The plaintiff‘s best argument that Dean is responsible for BSP‘s actions may be that work such as BSP was hired to perform creates a peculiar risk of harm to others. When armed guards are hired to deter vandals and thieves it is foreseeable that someone might be injured by the inappropriate use of a weapon if proper precautions are not taken. Thus, in this case, such an injury is one that might have been anticipated as a direct or probable consequence of the performance of the work contracted for, if reasonable care had not been taken in its performance. Also, the risk created is not a normal, routine matter of customary human activity, such as driving an automobile, but is instead a special danger arising out of the particular situation created and calling for special precautions. Under this reasoning, the plaintiff would argue that Dean could be liable even though the guard responsible was an employee of an independent contractor. 67. The second group will discuss Dean‘s best defense and formulate arguments in support of it. Solution To the plaintiff‘s best argument set out in the previous answer, Dean might respond that hiring armed guards to protect property does not create a peculiar risk of harm to others and, therefore, is not inherently dangerous work. On this conclusion, even if Gaines‘s death were the result of BSP‘s negligence, Dean would not be liable because BSP was an independent contractor and an employer is not generally liable for the negligent acts of its independent contractor. 68. The third group will consider slightly different facts. Suppose that Dean Brothers had an express policy that prohibited all security guards from carrying firearms on its property, which Wyden had conveyed to BSP. Despite knowing about this policy, Sidell had brought his weapon to work, and then fired it, killing Gaines. Could Dean be held responsible for negligence in that situation? Explain. Solution No. Most likely, Dean could not be held liable for negligence under the slightly different facts provided in this question. The reason and conclusion are similar to the reason and conclusion in the answer to the previous question—Dean would not be liable because BSP was an independent contractor whose employee was clearly acting outside the scope of employment. In the circumstances of the different facts in this question, BSP or its employee might arguably be negligent, but their employer Dean would not be generally liable for their negligent acts.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

339

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 340 Adapting the Law to the Online Environment ....................................................................................... 340 Managerial Strategy .............................................................................................................................. 340 Critical Thinking Questions in Cases ................................................................................................................... 341 Case 28.1 ............................................................................................................................................... 341 Case 28.2 ............................................................................................................................................... 342 Case 28.3 ............................................................................................................................................... 343 Chapter Review ........................................................................................................................................................... 344 Practice and Review .............................................................................................................................. 344 Practice and Review: Debate This ......................................................................................................... 346 Issue Spotters ........................................................................................................................................ 346 Business Scenarios and Case Problems ................................................................................................. 346 Critical Thinking and Writing Assignments ............................................................................................ 353

Critical Thinking Questions in Features Adapting the Law to the Online Environment 69. What problems might arise if data from an internal social media system are stored on third party servers? Solution Some corporations have internal rules that prohibit storing any company information outside a company‘s firewall. Additionally, if the third party servers are hacked, confidential company information could be compromised. Intellectual property rights could be inadvertently shared with others. Private information about individual employees might be transmitted throughout the Internet.

Managerial Strategy 70. Employees meeting around the water cooler or coffee machine have always had the right to discuss work-related matters. Is an employer-provided e-mail system or social media outlet simply a digital water cooler? Why or why not? Solution Many businesspersons argue that the analogy is false. An actual water-cooler or coffee-machine discussion only involves a few individual employees. Social media sites, in contrast, are accessible by all employees, all suppliers, and perhaps more importantly, by all actual or potential customers. 71. Why might the nondiscrimination component of the NLRB‘s latest ruling make a ban on unionrelated e-mails difficult for managers to enforce? Solution

340

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

In theory, if a manager wants to prohibit union-related e-mails on the company‘s computer system, the NLRB ruling requires the manager to ban all e-mails that are not strictly work-related. Otherwise, employees or union representatives could argue that the policy wrongly discriminates again union organizing via e-mail. This means, to stay within the bounds of the NLRB guidelines, the manager would have to prohibit non-work-related e-mails about a wide variety of subjects such as ―What time to do you want to get together for lunch?‖ and ―Who is in for the softball game on Saturday?‖ etc. Frankly, this would take more time and effort than most managers are willing to expend on the subject. As one observer asks, ―How do you enforce a policy like that in a non-discriminatory way?‖

Critical Thinking Questions in Cases Case 28.1 72. The salesmen, mechanics, and partsmen identified in the FLSA exemption work irregular hours, sometimes away from their principal work site. Service advisors typically work ordinary, fixed schedules on-site. Should the Court have considered these attributes in making its decision in the Encino case? Discuss. Solution Common features of the three jobs enumerated in the FLSA exemption from the overtime-pay requirement—salesmen, mechanics, and partsmen—that make them unsuitable for overtime pay include that those who fill them work irregular hours, including nights and weekends. This renders their time more difficult to track. It could also be noted that the FLSA overtime rules encourage employers to hire more individuals who work forty-hour weeks rather than to maintain a staff of fewer employees who consistently work longer hours. If a position‘s working hours ebb and flow, it does not make sense to encourage employers to hire more workers for that position—hence, salesmen, mechanics, and partsmen are exempt from the overtime-pay requirement. Some of these workers‘ tasks may be done away from the principal work site. Salesmen, for example, often put in unusual hours, sometimes off site, trying to earn commissions. Similarly, mechanics may put in irregular hours, particularly in rural areas. The job of partsman, too, can involve off-site searching for and delivering parts. This feature can complicate the difficulty of tracking these workers‘ time. Furthermore, for all of these occupations, business can vary substantially from season to season. This is because the exemption extends to salesmen, mechanics, and partsmen at dealerships selling farm implements and trucks, not just autos. In the farm equipment business, for example, farmers, during planting, cultivating and harvesting seasons, may call on their dealers for parts at any time during the day or evening and on weekends. The Court, of course, can consider and weigh a variety of factors in making its decisions. In the Encino case, the Court relied primarily on a simple, though somewhat extended definition, of the job of service advisors to place those workers within the FLSA exemption. Had the Court considered more fully the features noted above the result might have been otherwise. 73. Suppose that the FLSA exemption covered ―any salesman or mechanic primarily engaged in selling or servicing automobiles‖ but not ―any partsman.‖ Would the result have been different? Explain.

341

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Solution Yes. The result in the Encino case would likely have been different if the FLSA exemption covered ―any salesman or mechanic primarily engaged in selling or servicing automobiles‖ but not ―any partsman.‖ The Court stated that ―service advisors are also primarily engaged in . . . servicing automobiles.‖ Partsmen, too, are ―primarily engaged in . . . servicing automobiles.‖ And like service advisors, partsmen did not spend most of their time under the hoods of cars. Instead, these employees obtain vehicle parts and provide them to the mechanics. Thus, reasoned the Court, the phrase ―primarily engaged in . . . servicing automobiles‖ must include some individuals who do not repair vehicles but who are integrally involved in the ―servicing process.‖ ―That description applies to partsmen and service advisors alike.‖ Without the inclusion of ―partsmen‖ in the FLSA, the Court could not have supported its decision with this reasoning. Under the more limited occupational coverage suggested in the question, service advisors would clearly fit within the exemption. Only a ―salesman‖ primarily engaged in ―selling‖ automobiles and a ―mechanic‖ primarily engaged in ―servicing‖ them would fall outside the exemption. Service advisors, whom the Court defined as ―salesmen primarily engaged in the selling of services,‖ would not fit in either category.

Case 28.2 74. As a defense to the citation for an OSHA violation, Packers argued that the injured employee violated the proximity rule. Was this defense relevant to the question before the court? Discuss. Explain. Solution No, Packers‘ argument in defense to the citation for the OSHA violation that the employee violated the two-foot rule, in effect attempting to blame the employee for the injury, was not relevant to the issue before the court in this case. The departure from OSHA standards, not the worker‘s injury, was the violation. The relevant inquiry, on a contention shifting responsibility to an employee, would have been whether the employee caused the violation, not whether the employee could have avoided injury despite the employer‘s violation. To be relevant, the defense would assert that the employee caused the violation. In the circumstances of this case, to establish as a defense that the employee‘s violation of a workplace rule caused the OSHA violation, Packers would have had to show that it had rules designed to prevent the violation, communicated those rules to the employees, took steps to discover violations of the rules, and enforced the rules when violations occurred. For example, an assertion of employee misconduct might have been a successful defense here if Packers had shown that it imposed a rule requiring the use of machine guards to clean a quill puller, told the employees about the rule, directed a supervisor to check the puller before each cleaning to be sure the guards were in use, and employees had been disciplined for violating the rule. 75. Suppose that in this case, no accident had taken place. Instead, the employee had refused to clean the unguarded quill puller, and Packers had discharged him. Would the result have been different? Explain. Solution

342

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

No, the result would not have been different in this case if the employee had refused to clean the unguarded quill puller, and Packers had discharged him, before the accident took place. Packers would have been cited for a different OSHA violation, but it is not likely that any defense the employer asserted against that citation would have succeeded. Under OSHA, an employer cannot discharge an employee who, in good faith, refuses to work in a high-risk area if bodily harm, or death, might occur as a consequence. Terminating the employee in that circumstance would of course be a violation of the act, and prompt an OSHA investigation, a workplace inspection, and a citation.

Case 28.3 76. What might the dealership have asserted in defense to the charge that its actions violated its employees‘ rights? Solution The primary defense of the dealership to the charge that its actions violated its employees‘ rights to organize under the National Labor Relations Act would have been a denial supported by testimony regarding the managers‘ intent and evidence that its actions did not have a chilling effect on its employees or their union. For example, with respect to the exchanges between Grobler and Cazoria, the employer might have asserted that at the time its employees and their union activities were not under surveillance, the dealership was not aware such activities were occurring, Grobler‘s comments were innocuous and misconstrued by Cazoria, and that despite what Cazoria might have inferred, he attended the meeting and later voted for the union, which won the election. The employer‘s chief obstacle to success with such a contention is the fact that it is the employer. Thus, in the circumstances of Berryhill‘s purported ―coercive interrogation‖ of employees in the presence of the service director, when Berryhill called each employee individually into his office to ask about union activity, the administrative law judge found that ―the setting of the meetings in Berryhill‘s office, Berryhill‘s and the director‘s positions of authority, and the fact that each technician was alone and outnumbered by managers all support the finding of coercion.‖ There would seem to be almost no argument that could overcome this finding. Similarly, once a vice president of AutoNation, the employer‘s owner, visited the dealership and began to question employees individually about union support, and the dealership began to hold group meetings to announce that positive changes in employment conditions were forthcoming, a finding of unfair labor practices would seem nearly inevitable. The employer‘s conduct might have been far more egregious, as has happened in many cases, but that would not have excused the conduct that occurred in the Contemporary Cars case. 77. Suppose that the dealership had taken no steps to change any of the terms or conditions of employment until well after the union election. Would the result have been different in this case? Explain. Solution Yes. If the dealership had taken no steps to change any of the terms or conditions of employment until well after the union election, the result would have been different. The NLRB, and the court, would have had nothing on which

343

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

to base its conclusion of unfair labor practices in violation of the National Labor Relations Act (NLRA). Thus, what the employer in the Contemporary Cars case could have done to avoid the charge of committing unfair labor practices in violation of its employees‘ rights under the NLRA would have been to refrain from engaging in the conduct on which the administrative law judge based his findings and conclusions that such violations occurred. In other words, the dealership could have avoided the charge by not ―coercively creating an impression of surveillance of union activity, interrogating employees about union activity, and soliciting and promising to remedy employee grievances.‖ During the time leading up to the union election, the employer might have refrained from the following actions: 1. Berryhill, Davis, Grobler, and other managers‘ commenting to the employees—the technicians and all others on the dealership‘s staff—about the union. 2. The managers‘ questioning of the technicians about union activities and support. 3. Calling individual and group meetings to ostensibly address employment terms and conditions. 4. Promising changes to remedy grievances and solve workplace problems. 5. Promulgating a policy to prohibit any solicitation on any AutoNation property at any time. 6. Firing Roberts.

Chapter Review Practice and Review Rick Saldona began working as a traveling salesperson for Aimer Winery in 2009. Sales constituted 90 percent of Saldona‘s work time. Saldona worked an average of fifty hours per week but received no overtime pay. In June 2019, Saldona‘s new supervisor, Caesar Braxton, claimed that Saldona had been inflating his reported sales calls and required Saldona to submit to a polygraph test. Saldona reported Braxton to the U.S. Department of Labor, which prohibited Aimer from requiring Saldona to take a polygraph test for this purpose. In August 2019, Saldona‘s wife, Venita, fell from a ladder and sustained a head injury while employed as a full-time agricultural harvester. Saldona delivered to Aimer‘s human resources department a letter from his wife‘s physician indicating that she would need daily care for several months, and Saldona took leave until December 2019. Aimer had sixty-three employees at that time. When Saldona returned to Aimer, he was informed that his position had been eliminated because his sales territory had been combined with an adjacent territory. Using the information presented in the chapter, answer the following questions. 78. Would Saldona have been legally entitled to receive overtime pay at a higher rate? Why or why not? Solution No, because he is exempt from the overtime rules. Over 90 percent of Saldona‘s time was spent on sales. As an outside salesperson, Saldona is exempt from the overtime rules established by the Fair Labor Standards Act. 79. What is the maximum length of time Saldona would have been allowed to take leave to care for his injured spouse? Solution

344

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

The Family and Medical Leave Act (FMLA) applied to Saldona‘s employer, Aimer Winery, because Aimer had over fifty employees. Under the FMLA, Saldona would have been entitled to up to twelve weeks of unpaid medical leave to care for his injured wife. 80. Under what circumstances would Aimer have been allowed to require an employee to take a liedetector test? Solution The Employee Polygraph Protection Act generally prohibits employers from requiring applicants or employees to take lie-detector tests. The only time employers are permitted to use polygraph tests under the act, is when investigating losses attributable to theft, including embezzlement or theft of trade secrets. Therefore, if Aimer had suffered losses due to theft, such as embezzlement or theft of trade secrets, and was attempting to investigate such losses, it could use polygraphs as part of its investigation. 81. Would Aimer likely be able to avoid reinstating Saldona under the key employee exception? Why or why not? Solution An important exception to the FMLA allows an employer to avoid reinstating a key employee— defined as an employee whose pay falls within the top 10 percent of the firm‘s workforce. Thus, if Saldona falls within that group of Aimer‘s employees, Aimer could avoid reinstating him.

345

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Practice and Review: Debate This 82. The U.S. labor market is highly competitive, so state and federal laws that require overtime pay are unnecessary and should be abolished. Solution In a competitive market, arrangements for overtime pay would be dictated by the forces of supply and demand for labor. There is no need for the government to step in to regulate this market. Most employees have little bargaining power in the labor market. Consequently, without government regulations with respect to overtime pay, employers would exploit the weakest employees, the ones that cannot seek alternative employment.

Issue Spotters 83. Erin, an employee of Fine Print Shop, is injured on the job. For Erin to obtain workers‘ compensation, does her injury have to have been caused by Fine Print‘s negligence? Does it matter whether the action causing the injury was intentional? Explain. Solution Workers‘ compensation laws establish a procedure for compensating workers who are injured on the job. Instead of suing to collect benefits, an injured worker notifies the employer of an injury and files a claim with the appropriate state agency. The right to recover is normally determined without regard to negligence or fault, but intentionally inflicted injuries are not covered. Unlike the potential for recovery in a lawsuit based on negligence or fault, recovery under a workers‘ compensation statute is limited to the specific amount designated in the statute for the employee‘s injury. 84. Onyx applies for work with Precision Design Company, which tells her that it requires union membership as a condition of employment. She applies for work with Quality Engineering, Inc., which does not require union membership as a condition of employment but requires employees to join a union after six months on the job. Are these conditions legal? Why or why not? Solution No. A closed shop (a company that requires union membership as a condition of employment) is illegal. A union shop (a company that does not require union membership as a condition of employment but requires workers to join the union after a certain time on the job) is illegal in a state with a right-to-work law, which makes it illegal to require union membership for continued employment.

Business Scenarios and Case Problems 85. Unfair Labor Practices. Consolidated Stores is undergoing a unionization campaign. Prior to the union election, management states that the union is unnecessary to protect workers. Management also provides bonuses and wage increases to the workers during this period. The employees reject the union. Union organizers protest that the wage increases during the election campaign unfairly prejudiced the vote. Should these wage increases be regarded as an unfair labor practice? Discuss. (See Labor Law.)

346

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Solution The NLRB has consistently been suspicious of companies that grant added benefits during election campaigns. These benefits will be considered as an unfair labor practice that biases elections, unless the employer can demonstrate that the benefits were unrelated to the unionization. 86. Wrongful Discharge. Denton and Carlo were employed at an appliance plant. Their job required them to do occasional maintenance work while standing on a wire mesh twenty feet above the plant floor. Other employees had fallen through the mesh, and one was killed by the fall. When Denton and Carlo were asked by their supervisor to do work that would likely require them to walk on the mesh, they refused due to their fear of bodily harm or death. Because of their refusal to do the requested work, the two employees were fired. Was their discharge wrongful? If so, under what federal employment law? To what federal agency or department should they turn for assistance? (See Employment at Will.) Solution The Occupational Safety and Health Act requires employers to provide safe working conditions for employees. The act prohibits employers from discharging or discriminating against any employee who refuses to work when the employee believes in good faith that undertaking the employment activity will bring about a risk of death or great bodily harm. Denton and Carlo had sufficient reason to believe that the maintenance job required of them by their employer involved great risk. Therefore, under the act, their discharge was wrongful. Denton and Carlo can turn to the Occupational Safety and Health Administration, which is part of the U.S. Department of Labor, for assistance. 87. Exceptions to the Employment-at-Will Doctrine. Li Li worked for Packard Bioscience, and Mark Schmeizl was her supervisor. In March 2000, Schmeizl told Li Li to call Packard‘s competitors, pretend to be a potential customer, and request ―pricing information and literature.‖ Li Li refused to perform the assignment. She told Schmeizl that she thought the work was illegal and recommended that he contact Packard‘s legal department. Although a lawyer recommended against the practice, Schmeizl insisted that Li Li perform the calls. Moreover, he later wrote negative performance reviews because she was unable to get the requested information when she called competitors and identified herself as a Packard employee. On June 1, 2000, Li Li was terminated on Schmeizl‘s recommendation. Can Li Li bring a claim for wrongful discharge? Why or why not? [Li Li v. Canberra Industries, 134 Conn.App. 448, 39 A.3d 789 (2012)] (See Employment at Will.) Solution Li can bring a wrongful discharge claim. Ordinarily, an employer may terminate an employment relationship at will. Courts provide an exception, however, when an employer‘s conduct violates public policy. In this case, Li has evidence that Packard retaliated against her because she refused to deceive Packard‘s competitors. Li also arguably engaged in whistleblowing by recommending that her supervisor contact the company‘s legal department.

347

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

88. Collective Bargaining. SDBC Holdings, Inc., acquired Stella D‘oro Biscuit Co., a bakery in New York City. At the time, a collective bargaining agreement existed between Stella D‘oro and Local 50 of the Bakery, Confectionary, Tobacco Workers and Grain Millers International Union. During negotiations to renew the agreement, Stella D‘oro allowed Local 50 to examine and take notes on the company‘s financial statement but would not give Local 50 a copy of the statement. Did Stella D‘oro engage in an unfair labor practice? Discuss. [SDBC Holdings, Inc. v. National Labor Relations Board, 711 F.3d 281 (2d Cir. 2013)] (See Labor Law.) Solution No. Stella D'oro did not engage in an unfair labor practice. In collective bargaining, both the employer and the union must negotiate in good faith and make a reasonable effort to come to an agreement. Good faith is a matter of subjective intent, but a party‘s actions can be used to evaluate the party‘s good or bad faith. Excessive delaying tactics may be proof of bad faith, as is insistence on obviously unreasonable contract terms. Other factors include rejecting a proposal without offering a counterproposal, engaging in a campaign among workers to undermine the union, unilaterally changing wages or terms and conditions of employment during the bargaining process, constantly shifting positions on disputed contract terms, and sending bargainers who lack authority to commit the company to a contract. An employer or a union that refuses to bargain in good faith without justification commits an unfair labor practice. In this problem, Stella D'oro Biscuit Co., a bakery in New York City, entered into collective bargaining with Local 50, Bakery, Confectionary, Tobacco Workers and Grain Millers International Union. During negotiations, Stella D'oro allowed Local 50 to examine and take notes on the company‘s financial statement and offered the union an opportunity to make its own copy, but Stella D'oro would not give Local 50 a copy. The employer‘s refusal to give the union a copy of its financial statement was not an unfair labor practice in light of the opportunity the union had to examine the statement and make its own copy. None of the factors listed above existed here. In the actual case on which this problem is based, the National Labor Relations Board concluded that Stella D'oro committed an unfair labor practice by declining to permit the union to keep a copy of the statement. On the employer‘s appeal, the U.S. Court of Appeals for the Second Circuit reversed. The court held that the employer was not required to permit the union to retain a copy of the company's audited financial statement, and that the employer satisfied any obligation it did have by affording the union many opportunities to examine the statement, or even to make its own copy. 89. Business Case Problem with Sample Answer— Unemployment Compensation. Fior Ramirez worked as a housekeeper for Remington Lodging & Hospitality, a hotel in Atlantic Beach, Florida. After her father in the Dominican Republic suffered a stroke, she asked her employer for time off to be with him. Ramirez‘s manager, Katie Berkowski, refused the request. Two days later, Berkowski received a call from Ramirez to say that she was with her father. He died about a week later, and Ramirez returned to work, but Berkowski told her that she had abandoned her position. Ramirez applied for unemployment compensation. Under the applicable state statute, ―an employee is disqualified from receiving benefits if he or she voluntarily left work without good cause.‖ Does Ramirez qualify for benefits? Explain. [Ramirez v. Reemployment Assistance Appeals Commission, 135 So.3d 408 (Fla.App. 1 Dist. 2014)] (See Health, Safety, Income Security, and Privacy.) —For a sample answer to Problem 28–5, go to Appendix E.

348

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Solution Yes. Ramirez qualifies for unemployment compensation. Generally, to be eligible for unemployment compensation, a worker must be willing and able to work. Workers who have been fired for misconduct or who have voluntarily left their jobs are not eligible for benefits. In the facts of this problem, the applicable state statute disqualifies an employee from receiving benefits if that employee voluntarily leaves work without ―good cause.‖ The issue is whether Ramirez left her job for ―good cause.‖ When her father in the Dominican Republic had a stroke, she asked her employer for time off to be with him. Her employer refused the request. But Ramirez left to be with her father and called to inform her employer. It seems likely that this family emergency would constitute ―good cause,‖ and Ramirez‘s call and return to work after her father‘s death indicated that she did not disregard her employer‘s interests. In the actual case on which this problem is based, the state of Florida denied Ramirez unemployment compensation. On Ramirez‘s appeal, a state intermediate appellate court reversed, on the reasoning stated above. 90. Labor Unions. Carol Garcia and Pedro Salgado, bus drivers for Latino Express, Inc., a transportation company, began soliciting signatures from other drivers to certify the Teamsters Local Union No. 777 as the official representative of the employees. Latino Express fired Garcia and Salgado. The two drivers filed a claim with the National Labor Relations Board (NLRB) alleging that the employer had committed an unfair labor practice. Which employer practice defined by the National Labor Relations Act did the plaintiffs most likely charge Latino Express with committing? Is the employer‘s discharge of Garcia and Salgado likely to be construed as a legitimate act in opposition to union solicitation? If a violation is found, what can the NLRB do? Discuss. [Ohr v. Latino Express, Inc., 776 F.3d 469 (7th Cir. 2015)] (See Labor Law.) Solution The National Labor Relations Act (NLRA) defines a number of employer practices as unfair to labor. Most likely to be charged by the plaintiffs in this case is the ban on an employer‘s Interference with the efforts of employees to form, join, or assist labor organizations. Garcia and Salgado, who were bus drivers for Latino Express, had begun soliciting signatures from other drivers to certify a Teamsters local union as the employees‘ official representative. Latino Express fired Garcia and Salgado. The employer‘s discharge of Garcia and Salgado is not likely to be construed as a legitimate act in opposition to union solicitation. Generally, an employer has control over unionizing activities that take place on company property during working hours. An employer can limit the campaign activities of union supporters for a legitimate business reason. An employer can also reasonably limit the times and places that union solicitation takes place. An employer can campaign among its workers against the union. But an employer cannot issue threats or engage in other coercive conduct. Discharging union supporters is likely to be perceived as coercive. If a violation is found in these circumstances, the NLRB can issue a cease-and-desist order compelling the employer to stop engaging in the unfair practice. A U.S. court of appeals can enforce the order. In the actual case on which this problem is based, Peter Ohr, regional director of the NLRB, asked a federal district court to enjoin Latino Express from engaging in specific acts prohibited by the NLRA and to reinstate the terminated drivers. The court issued the injunction. Latino Express did

349

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

not comply. The court held the employer in contempt. The U.S. Court of Appeals for the Seventh Circuit affirmed. 91. Income Security. Jefferson Partners LP entered into a collective bargaining agreement (CBA) with the Amalgamated Transit Union. Under the CBA, drivers had to either join the union or pay a fair share—85 percent—of union dues, which were used to pay for administrative costs incurred by the union. An employee who refused to pay was subject to discharge. Jefferson hired Tiffany Thompson to work as a bus driver. When told of the CBA requirement, she said that she thought it was unfair. She asserted that it was illegal to compel her to join the union and that it would be illegal to discharge her for not complying. She refused either to join the union or to pay the dues. More than two years later, she was fired on the ground that her continued refusal constituted misconduct. Is Thompson eligible for unemployment compensation? Explain. [Thompson v. Jefferson Partners LP, 2016 WL 953038 (Minn. App. 2016)] (See Health, Safety, Income Security, and Privacy.) Solution No. Thompson is not eligible for unemployment compensation. Under the Federal Unemployment Tax Act, a state-administered system provides unemployment compensation to eligible individuals who have lost their jobs. To be eligible for unemployment compensation, a worker must be willing and able to work. Workers are not eligible for benefits if they voluntarily left their jobs or were fired for misconduct. Here, Jefferson hired Thompson to work as a bus driver. Thompson was informed of the CBA provision that stipulated a non-union employee‘s payment of 85 percent of the amount of union dues paid by an employee who is a member of the union. She was also told of the possible consequence for non-compliance of a termination of employment. She complained that this requirement was unfair. She argued that she thought it was illegal to compel her to join the union and it would be illegal to discharge her for not complying with the CBA. At any rate, she refused to join the union or to pay the dues. Two years later, Jefferson terminated her on the ground that her continued refusal constituted misconduct. This ―misconduct‖ serves as a basis for the state‘s denial of unemployment benefits. In the actual case on which this problem is based, the Minnesota Department of Employment and Economic Development denied Thompson‘s claim for benefits. Thompson appealed to a Minnesota state intermediate appellate court. The court defined employment misconduct to include ―a serious violation of the standards of behavior the employer has the right to reasonably expect of the employee.‖ The court held that Thompson‘s failure to comply with the CBA was ―a significant violation of Jefferson‘s reasonable policy. Accordingly, Thompson committed employment misconduct and she is ineligible to receive unemployment benefits.‖ 92. Family and Medical Leave. To qualify for leave under the Family and Medical Leave Act (FMLA), an employee must comply with the employer‘s usual and customary notice requirements, including call-in policies. Robert Stein, an employee of Atlas Industries, Inc., suffered a knee injury at work. Stein took medical leave to have surgery on the knee. Ten weeks into his recovery, Stein‘s doctor notified Atlas that Stein could return to work with light-duty restrictions in two days. Stein, however, thought he was on leave for several more weeks. Atlas company policy provided that employees who missed three workdays without notification were subject to automatic termination. Stein did not return to work or call in as Atlas expected. Four days later, he was fired.

350

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Did Stein‘s discharge violate the FMLA? Discuss. [Stein v. Atlas Industries, Inc., 730 Fed.Appx. 313, (6th Cir. 2018)] (See Wages, Hours, and Leave.) Solution No. Atlas‘s discharge of Stein did not violate the Family and Medical Leave Act (FMLA). The FMLA requires employers with fifty or more employees to provide them with up to twelve weeks of unpaid family or medical leave during any twelve-month period. Legitimate reasons for the leave include a serious health condition that renders the employee unable to perform the essential functions of his or he job. But the FMLA does not grant an unconditional right to leave. As stated at the beginning of the problem, to qualify for leave, an employee must comply with his employer‘s notice requirements, including any call-in policies. When an employee fails to do so, the employer is within its rights to terminate him—even if the days the employee failed to call in were otherwise FMLA-protected. Here, Stein, an Atlas employee, took medical leave from his job to have surgery. Ten weeks into recovery, Stein‘s doctor notified Atlas that Stein could return to work in two days. Stein, however, thought he was on leave for several more weeks. Atlas company policy provided that employees who missed three workdays without notice were subject to automatic termination. Stein did not return to work or call in as Atlas expected. Four days later, he was fired. Atlas was fully within its rights as an employer in the circumstances to take this step. In the actual case on which this problem is based, the court issued a judgment in Atlas‘s favor. The U.S. Court of Appeals for the Sixth Circuit affirmed, based on the reasoning set out here. 93. A Question of Ethics—The IDDR Approach and Immigration Law. Split Rail Fence Company sells and installs fencing materials in Colorado. U.S. Immigration and Customs Enforcement (ICE) sent Split Rail a list of the company‘s employees whose documentation did not satisfy the Form I9 employment eligibility verification requirements. The list included long-term workers who had been involved in company activities, parties, and picnics. They had bank accounts, driver‘s licenses, cars, homes, and mortgages. At Split Rail‘s request, the employees orally verified that they were eligible to work in the United States. Unwilling to accept the oral verifications, ICE filed a complaint against Split Rail for its continued employment of the individuals. [Split Rail Fence Co. v. United States, 852 F.3d 1228 (10th Cir. 2017)] (See Immigration Law.) 94. Using the IDDR approach, identify Split Rail‘s ethical dilemma. What steps might the company take to resolve it? Explain. Solution Split Rail‘s ethical dilemma is how to satisfy the demands of the government, and the needs and expectations of the company‘s employees. One way to resolve this dilemma is to comply with the government‘s demands while assuring the employees of the security of their employment. The first step of the IDDR approach is an Inquiry to state the issue, the stakeholders, and the ethical standards. The issue is stated in the previous paragraph above. The stakeholders include Split Rail, its employees and their families, the government, and members of the larger community, including especially those who would work for Split Rail but for the company‘s employment of persons who do not satisfy the Form I-9 requirements.

351

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

The second step of the IDDR approach is a Discussion of actions to address the issue, the strengths and weaknesses of the actions, and consequences and effects on the stakeholders. The Immigration Reform and Control Act (IRCA) makes it illegal to employ someone not authorized to work in the United States. To comply with the IRCA, an employer must complete Form I-9 (―Employment Eligibility Verification‖). The employer must review and verify documents establishing each worker‘s eligibility for employment in this country. In this problem, U.S. Immigration and Customs Enforcement (ICE) sent Split Rail a list of its employees whose documentation did not satisfy the Form I-9 requirements. To meet the government‘s demands, Split Rail would need to review acceptable documentation to verify the eligibility status of the listed employees or discharge them. The ICE list included long-term employees who had been involved in company activities, parties, and picnics. They had bank accounts, driver‘s licenses, cars, homes, and mortgages. To meet the needs and expectations of the employees, Split Rail should sufficiently verify their status to legitimately continue their employment. At Split Rail‘s request, the employees orally verified that they were eligible to work in the United States. Unwilling to accept the oral verifications, ICE filed a complaint against Split Rail for its continued employment of these individuals. Split Rail is in violation of the IRCA provisions requiring the review and verification of documents. Consequently, the employer is also in violation for continuing to employ the individuals whose status is in question. These actions clearly do not meet the demands of the government or the needs and expectations of the workers. The third step of the IDDR approach is a Decision on the action and a statement of its reasons. Here, Split Rail should decide to make a more concerted effort to comply strictly with the government‘s demands. To meet the needs and expectations of the workers, Split Rail should assure the employees that, on compliance with the government‘s requirements, their employment is secure. These seem like relatively uncomplicated steps to take to resolve the company‘s ethical dilemma. The fourth and final step of the IDDR approach is a Review of the success or failure of the actions to resolve the issue, and satisfy the stakeholders. The suggested actions have the potential to accomplish success in this case. This may be Split Rail‘s best choice—almost any other action could lead to legal penalties, on the one hand, and a decimated workforce, on the other, with the remaining employees losing faith and trust in their employer. In the actual case on which this problem is based, an administrative law judge imposed civil penalties on Split Rail for continuing to employ ―unauthorized aliens in the United States‖ in violation of the IRCA. The U.S. Court of Appeals for the Tenth Circuit denied Split Rail‘s petition for review. 95. Is penalizing employers the best approach to take in attempting to curb illegal immigration? Discuss. Solution Yes, penalizing employers is the best approach to take in attempting to reduce illegal immigration. Employment is the primary motivation for those who would immigrate illegally.

352

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 28: Employment, Immigration and Labor Law

Why else would anyone voluntarily leave their home to live where they know nearly no one, likely do not speak the language or understand much of the culture, would be unable to participate in the government, and may be subject to arrest and deportation? Sanctioning those who would employ illegal immigrants would reduce the employers‘ willingness to hire the immigrants, thus eliminating the reason for the immigration. Immigration should be curtailed and restricted because a nation might otherwise find itself overwhelmed. There could be too many persons seeking too few jobs, for example, or too many persons fleeing a temporarily discomfiting situation. There might be a movement of too many persons hostile to a nation, or its government, into its borders. There might be a large number of criminals who would seek refuge across international borders with too much ease. No, penalizing employers is not the best approach to take in attempting to reduce illegal immigration. Penalizing employers puts the onus on those who are only taking economic advantage of a situation not of their own making. In some cases, those employers might not be able to fill the jobs that they have available. Immigrants can revitalize nations and their economies, as well as enrich their cultures. Employed immigrants pay taxes, which help fund government programs, such as Social Security. Without immigration, in many countries, including the United States, the populations would grow increasingly older, resulting in, among other things, fewer workers to support those who are retired. Immigrants contribute to economies in other ways, too, often doing work that citizens reject, for example. Immigrants are often responsible for a disproportionate number of the innovations, inventions, and other achievements that can improve a nation‘s life. Immigrants often follow different customs, or religions, or artistic traditions, which can enhance and diversify a nation‘s culture.

Critical Thinking and Writing Assignments 96. Time-Limited Group Assignment—Immigration. Nicole Tipton and Sadik Seferi owned and operated a restaurant in Iowa. Acting on a tip from the local police, agents of Immigration and Customs Enforcement executed search warrants at the restaurant and at an apartment where some restaurant workers lived. The agents discovered six undocumented aliens working at the restaurant and living together. When the I-9 forms for the restaurant‘s employees were reviewed, none were found for the six aliens. They were paid in cash while other employees were paid by check. Tipton and Seferi were charged with hiring and harboring illegal aliens. (See Immigration Law.) 97. The first group will develop an argument that Tipton and Seferi were guilty of hiring and harboring illegal aliens. Solution Tipton and Seferi were guilty of hiring and harboring illegal aliens, and should be convicted and be given prison terms. The evidence was sufficient to support the convictions for hiring and harboring illegal aliens. Given the way the restaurant was run and the differential treatment of employees, it was clear the defendants knew I-9 forms were required as they kept them for most employees, but not for the undocumented workers. They also paid them in cash and did not pay taxes on behalf of those workers. They also maintained an apartment for those workers only. Separate accounts were maintained for the undocumented workers.

353

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

98. The second group will assess whether Tipton and Seferi can assert a defense by claiming that they did not know that the workers were unauthorized aliens. Solution It is not likely that Tipton and Seferi can successfully assert a defense by claiming that they did not know that the workers were unauthorized aliens. It is clear from the evidence set out in detail in the answer to the previous question that Tipton and Seferi knew the workers were illegal and they did not comply with employment verification procedures and other employment law requirements. 99. The third group will determine the potential penalties that Tipton and Seferi could face for violating the Immigration Reform and Control Act by hiring six unauthorized workers. Solution The employer can be fined up to $2,200 for each unauthorized employee for a first offense. Assuming this is their first offense, Tipton and Seferi could be fined up to $13,200 for employing the six undocumented workers.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 354 Adapting the Law to the Online Environment ................................................................................ 354 Critical Thinking Questions in Cases ................................................................................................................... 355 Case 29.1 ............................................................................................................................................... 355 Case 29.2 ............................................................................................................................................... 355 Case 29.3 ............................................................................................................................................... 356 Chapter Review ........................................................................................................................................................... 357 Practice and Review .............................................................................................................................. 357 Practice and Review: Debate This ......................................................................................................... 358 Issue Spotters ........................................................................................................................................ 359 Business Scenarios and Case Problems ................................................................................................. 359 Critical Thinking and Writing Assignments ............................................................................................ 366

Critical Thinking Questions in Features Adapting the Law to the Online Environment 100. Can you think of a way a company could use information from an applicant‘s social media posts without running the risk of being accused of hiring discrimination?

354

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Solution The EEOC has recommended the use of a third party to conduct social media screenings of applicants. In this way, the perspective employer will not receive any information about an applicant‘s protected characteristics. A third-party report can be created without disclosing the applicant‘s race, age, disability status, or other protected characteristics.

Critical Thinking Questions in Cases Case 29.1 101. Could UPS have succeeded in this case if it had claimed simply that it would be more expensive or less convenient to include pregnant women among those whom it accommodates? Explain. Solution No. UPS could not have succeeded in this case if it had claimed that it would be more expensive or less convenient to include pregnant women among those whom it accommodates. After an employee has made a prima facie showing that the employer‘s denial of an accommodation constituted disparate treatment under the Pregnancy Discrimination Act, an employer can attempt to justify its refusal to accommodate by offering legitimate, nondiscriminatory reasons for denying the accommodation. But a simple claim that it would be more expensive or less convenient to accommodate pregnant women while accommodating others subject to similar limitations would not be sufficiently strong to overcome the burden imposed on those women by the denial of accommodation.

Case 29.2 102. Because of the constant harassment, Franchina had to be placed on injured-on-duty status. Later, diagnosed with severe post-traumatic stress disorder and unable to work again as a rescue lieutenant, she ―retired.‖ What is the appropriate measure of damages for this result? Discuss. Solution Damages, of course, are purposed, in part, to make a plaintiff whole for injuries suffered as a result of misconduct by a defendant. Damages for the harm visited upon Franchina should include at least what is termed ―front pay‖—the wages and benefits that the injured party would have earned had the wrongful conduct not occurred. The amount is at the equitable discretion of the court. It can be speculative and uncertain. Its calculation requires a prediction of what might have transpired without the harm. The court might consider the plaintiff‘s age and length of employment, the pay and benefits that she was receiving, the likelihood that the employment would have continued, the raises and promotions that might have occurred, her ability to work, and other factors. To arrive at a final figure, the court might apply the effects of inflation, the rate of return on an investment of the award, and a discount for the uncertainty. Here, the court might review Franchina‘s earnings, her disability pay, the quality of her career, how long she might have been employed based on the longevity of other similarly situated employees, and her lost pension benefits. The calculated figure should be reduced to present value.

355

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Also appropriate would be damages for the emotional harm that Franchina suffered and punitive damages to deter the department, other city agencies, and other employers and employees, from engaging in similar misconduct. Punitive damages may not be available in this case, however. 103. What steps might an employer take to avoid the circumstances that occurred in the Franchina case? Solution Steps that an employer could take to avoid the circumstances and unfortunate result in the Franchina case are suggested by the facts. The Providence fire department appears to have a protocol for accepting and considering discrimination complaints. The department may further have a procedure for adjudicating the complaints. Absent was action on the part of the agency to enforce policies that discourage discriminatory comments and conduct. There could—and should—have been disciplinary action taken on each of Franchina‘s complaints. The department‘s tolerance of discriminatory remarks and misbehavior effectively encouraged more wrongful conduct. To avoid similar circumstances, any employer should take the same steps—protocol, procedure, and punishment—and publicize their existence among employees.

Case 29.3 104. Could Synovus have successfully claimed that Kassa‘s short breaks created an undue hardship? Explain. Solution Probably not. An employer can avoid providing a reasonable accommodation for the known physical or mental limitations of an employee if it would impose an undue hardship on the employer. The test is whether the specific accommodation is significantly difficult or expensive in light of the employer‘s resources. In Kassa‘s case, when he worked for Synovus in the company‘s Network Operation Center (NOC), his supervisor knew about his disorders, and granted his request to take short breaks when he got frustrated. This was subject to two conditions—to take a break, Kassa‘s area in the NOC must be covered and he must be available to be reached if necessary. In these circumstances, it does not appear that granting Kassa‘s request for short breaks was significantly difficult or expensive for Synovus. There is no indication that after Kassa‘s transfer to the ATM team, his request to take short breaks would have somehow imposed an undue hardship on Synovus. The request could have been granted subject to the same conditions in the NOC. His new supervisor simply refused the request. 105. Suppose that instead of asking to take a short break whenever he had an episode, Kassa had asked if he could take customer service calls only from technicians, work nights, or work from home. Would the result have been different? Discuss. Solution

356

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Yes, if, instead of asking to take a short break whenever he had an episode, Kassa had asked to take customer service calls only from technicians, work nights, or work from home, the result in this case would likely have been different. If an employee with a disability can perform essential functions of the job with a reasonable accommodation, the employer must make it. But an employer is not required to transform a position into different job by eliminating an essential function in order to accommodate the needs of the employee. Answering customer service calls constituted an ―essential function‖ of Kassa‘s position on the ATM team. A request to be exempted from answering all or some of those calls would have transformed the job, and therefore would not have been reasonable. This would have been demonstrably true if, for example, Synovus‘s phone system would not enable calls to be routed to off-site employees or no night shift position existed on the ATM team.

Chapter Review Practice and Review Amaani Lyle, an African American woman, took a job as a scriptwriters‘ assistant at Warner Brothers Television Productions. She worked for the writers of Friends, a popular, adult-oriented television series. One of her essential job duties was to type detailed notes for the scriptwriters during brainstorming sessions in which they discussed jokes, dialogue, and story lines. The writers then combed through Lyle‘s notes after the meetings for script material. During the meetings, the three male scriptwriters told lewd and vulgar jokes and made sexually explicit comments and gestures. They often talked about their personal sexual experiences and fantasies, and some of these conversations were later used in episodes of Friends. During the meetings, Lyle never complained that she found the writers‘ conduct offensive. After four months, Lyle was fired because she could not type fast enough to keep up with the writers‘ conversations during the meetings. She filed a suit against Warner Brothers alleging sexual harassment and claiming that her termination was based on racial discrimination. Using the information presented in the chapter, answer the following questions. 106. Would Lyle‘s claim of racial discrimination be for intentional (disparate-treatment) or unintentional (disparate-impact) discrimination? Explain. Solution Because Lyle has no direct evidence of discriminatory intent, her claim would likely be for unintentional, disparate impact discrimination. She could argue that the employer‘s requirement that she type as fast as the writers of typing speed disproportionately affected those in a protected class using the EEOC‘s ―four-fifths‖ rule. 107.

Can Lyle establish a prima facie case of racial discrimination? Why or why not?

Solution It is unlikely that Lyle could establish a prima facie case of unintentional discrimination. To do so, she would have to prove that the employer‘s typing speed requirement had a discriminatory effect, excluding members of a protected class at a substantially higher rate than nonmembers.

357

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Under the EEOC‘s ―four-fifths‖ rule, she would have to show that the selection (or retention) rate for members of a protected class was less than four-fifths, or 80 percent, of the selection rate for nonmembers. This would be difficult to show given these facts. 108. When she was hired, Lyle was told that typing speed was extremely important to her position. At the time, she maintained that she could type eighty words per minute, so she was not given a typing test. It later turned out that Lyle could type only fifty words per minute. What impact might typing speed have on Lyle‘s lawsuit? Solution Evidence that Lyle had misrepresented how fast she could type at the time of her interview would not substantially impact her claim of racial discrimination, because it would be considered afteracquired evidence of employee misconduct. The United States Supreme Court has held that such evidence cannot shield an employer entirely from liability for discrimination. It could, however, be used to limit the amount of damages that she could obtain if she was successful in her lawsuit. 109. Lyle‘s sexual harassment claim was based on the hostile work environment created by the writers‘ sexually offensive conduct at meetings that she was required to attend. The writers, however, argued that their behavior was essential to the ―creative process‖ of writing Friends, a show that routinely contained sexual innuendos and adult humor. Which defense discussed in the chapter might Warner Brothers assert using this argument? Solution Warner Brothers can assert the writer‘s sexually explicit conduct during the meetings was a business necessity, because it was necessary for the writers to freely discuss plot ideas and themes in creating the script for Friends. The television series has been popular largely because of its adult humor and sexual innuendos, and without those elements, the show would not be the same. Thus, some sexually explicit banter is necessary to write the script and Warner Brothers would be able to claim this in their defense.

Practice and Review: Debate This 110. Members of minority groups and women no longer need special legislation to protect them from employment discrimination. Solution There is little doubt that minorities and women suffered discrimination in the U.S. labor market for decades, if not longer. Today, in contrast, this country has seen much growth in the average incomes of all American, regardless of race or gender. The labor market is competitive, so employers who discriminate against minorities and women end up suffering from higher costs compared to nondiscriminating employers. Certainly there is less discrimination against minorities and women than there was one hundred years ago. That does not mean, though, that we should scrap all legislation that protects these groups. More progress needs to be made to create a color-. age-, race-, and gender-blind employment market. Without existing anti-discrimination laws, those who suffer discrimination would have no place to term for redress of their grievances.

358

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

Issue Spotters 111. Ruth is a supervisor for Subs & Suds, a restaurant. Tim is a Subs & Suds employee. The owner announces that some employees will be discharged. Ruth tells Tim that if he has sex with her, he can keep his job. Is this sexual harassment? Why or why not? Solution Yes. One type of sexual harassment occurs when a request for sexual favors is a condition of employment, and the person making the request is a supervisor or acts with the authority of the employer. A tangible employment action, such as continued employment, may also lead to the employer‘s liability for the supervisor‘s conduct. That the injured employee is a male and the supervisor a female, instead of the other way around, would not affect the outcome. Samegender harassment is also actionable. 112. Koko, a person with a disability, applies for a job at Lively Sales Corporation for which she is well qualified, but she is rejected. Lively continues to seek applicants and eventually fills the position with a person who does not have a disability. Could Koko succeed in a suit against Lively for discrimination? Explain. Solution Yes. Koko can succeed in a discrimination suit if she can show that she was not hired solely because of her disability. The other elements for a discrimination suit based on a disability are that the plaintiff (1) has a disability and (2) is otherwise qualified for the job. Both of these elements appear to be satisfied in this scenario.

Business Scenarios and Case Problems 113. Title VII Violations. Discuss fully whether either of the following actions would constitute a violation of Title VII of the Civil Rights Act. 1. Tennington, Inc., is a consulting firm with ten employees. These employees travel on consulting jobs in seven states. Tennington has an employment record of hiring only white males. (See Title VII of the Civil Rights Act.) Solution Only employers with fifteen or more employees who are engaged in an activity that affects interstate commerce come under the Civil Rights Act, Title VII. Tennington, Inc., has only ten employees, and thus its employment of only white males is not a federal civil rights violation. Tennington could be in violation of state law, however, depending on the requirements of the state statute. 2.

Novo Films, Inc., is making a film about Africa and needs to employ approximately one hundred extras for this picture. To hire these extras, Novo advertises in all major newspapers in Southern California. The ad states that only African Americans need apply. (See Defenses to Employment Discrimination.) Solution The 1964 Civil Rights Act, Title VII, as amended, prohibits discrimination at any stage of employment on the basis of race, color, religion, sex, or national origin. The advertisement, which clearly restricts employment applicants to African Americans, is in violation of the law. The Civil Rights Act does provide that it is not illegal to discriminate when such discrimination is necessary as a bona fide occupational qualification; however, race or color cannot be used

359

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

as a bona fide occupational defense. Therefore, even though the film is about Africa, Novo Films cannot advertise solely for African Americans. 114. Religious Discrimination. Gina Gomez, a devout Roman Catholic, worked for Sam‘s Department Stores, Inc., in Phoenix, Arizona. Sam‘s considered Gomez a productive employee because her sales exceeded $200,000 per year. The store gave its managers the discretion to grant unpaid leave to employees but prohibited vacations or leave during the holiday season— October through December. Gomez felt that she had a ―calling‖ to go on a ―pilgrimage‖ in October to a location in Bosnia where some persons claimed to have had visions of the Virgin Mary. The Catholic Church had not designated the site an official pilgrimage site, the visions were not expected to be stronger in October, and tours were available at other times. The store managers denied Gomez‘s request for leave, but she had a nonrefundable ticket and left anyway. Sam‘s terminated her employment, and she could not find another job. Can Gomez establish a prima facie case of religious discrimination? Explain. (See Title VII of the Civil Rights Act.) Solution Gomez cannot establish a prima facie case of religious discrimination. The facts show only a bona fide religious belief that she needs to go to Medjugorje at some time, not at a particular time. When an employee claims that religious beliefs require a particular pilgrimage, or some other duty, the employee must prove that this mandate is part of a bona fide religious belief. Otherwise, an employer would be forced to accommodate the employee‘s personal preference (in this problem, the timing of the trip). If the visions of the Virgin Mary were expected to be more intense in October, for example, or the Catholic Church urged her to go at that time, she would have a stronger case. But without such factors, she cannot satisfy a crucial element of a prima facie case: a conflict between her religious belief and her employment duties. 115. Spotlight on Dress Code Policies—Discrimination Based on Gender. Burlington Coat Factory Warehouse, Inc., had a dress code that required male sales clerks to wear business attire consisting of slacks, shirt, and necktie. Female sales clerks, by contrast, were required to wear a smock so that customers could readily identify them. Karen O‘Donnell and other female employees refused to wear the smock. Instead, they reported to work in business attire and were suspended. After numerous suspensions, the female employees were fired for violating Burlington‘s dress code policy. All other conditions of employment, including salary, hours, and benefits, were the same for female and male employees. Was the dress code policy discriminatory? Why or why not? [O’Donnell v. Burlington Coat Factory Warehouse, Inc., 656 F.Supp. 263 (S.D.Ohio 1987)] (See Title VII of the Civil Rights Act.) Solution Yes. The dress code policy was illegal discrimination based upon gender. Unlike hair and grooming codes, which are based on well-established social expectations, there is no justifiable basis for women to wear smocks in the workplace. There is a natural tendency to believe that uniformed women wearing smocks have lower professional status than their male colleagues in business attire. The smock requirement thus perpetuated sexual stereotypes of inferiority. Therefore, the dress code policy violated Title VII of the Civil Rights Act. 116. Age Discrimination. Beginning in 1986, Paul Rangel was a sales professional for pharmaceutical company Sanofi- Aventis U.S., LLC (S-A). Rangel had satisfactory performance reviews until 2006, when S-A issued new expectations guidelines with sales call quotas and other standards that he failed to meet. After two years of negative performance reviews, Rangel—who

360

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

was then more than forty years old— was terminated as part of a nationwide reduction of sales professionals who had not met the expectations guidelines. This sales force reduction also included younger workers. Did S-A engage in age discrimination? Discuss. [Rangel v. Sanofi Aventis U.S. LLC, 507 Fed.Appx. 782 (10th Cir. 2013)] (See Discrimination Based on Age, Disability, or Military Status.) Solution No. Sanofi-Aventis U.S. LLC (S-A) does not appear to have engaged in age discrimination. The Age Discrimination in Employment Act (ADEA) prohibits employment discrimination on the basis of age against individuals forty years of age or older. For the act to apply, an employer must have twenty or more employees, and the employer‘s business activities must affect interstate commerce. To establish a prima facie case, plaintiffs must show that they were (1) members of the protected age group, (2) qualified for the position from which they were discharged, and (3) discharged because of age discrimination. If the employer offers a legitimate reason for its action, the plaintiff must show that the stated reason is only a pretext. In this problem, Rangel was over forty years old. But he also had negative sales performance reviews for more than two years before he was terminated as part of S-A‘s nationwide reduction in force of all sales professionals who had not met the ―Expectations‖ guidelines, including younger workers. The facts do not indicate that a person younger than Rangel replaced him or that S-A intended to discriminate against him on the basis of age. Based on these facts, Rangel could not establish a prima facie case of age discrimination on the part of S-A. In the actual case on which this problem is based, in Rangel‘s suit against S-A under the ADEA, alleging age discrimination, a federal district court issued a judgment in S-A‘s favor. On Rangel‘s appeal, the U.S. Court of Appeals for the Tenth Circuit affirmed, according to the reasoning stated above. 117. Discrimination Based on Disability. Cynthia Horn worked for Knight Facilities Management–GM, Inc., in Detroit, Michigan, as a janitor. When Horn developed a sensitivity to cleaning products, her physician gave her a ―no exposure to cleaning solutions‖ restriction. Knight discussed possible accommodations with Horn. She suggested that restrooms be eliminated from her cleaning route or that she be provided with a respirator. Knight explained that she would be exposed to cleaning solutions in any situation and concluded that there was no work available within her physician‘s restriction. Has Knight violated the Americans with Disabilities Act by failing to provide Horn with the requested accommodations? Explain. [Horn v. Knight Facilities Management–GM, Inc., 556 Fed.Appx. 452 (6th Cir. 2014)] (See Discrimination Based on Age, Disability, or Military Status.) Solution No. Knight has not violated the Americans with Disabilities Act (ADA) by failing to provide Horn‘s requested accommodations. The ADA requires that certain employers ―reasonably accommodate‖ the needs of persons with disabilities unless to do so would cause the employer to suffer ―undue hardship.‖ Thus, if an employee with a disability, with reasonable accommodation, can perform essential job functions, the employer must make the accommodation. Generally, employers should give primary consideration to employees‘ preferences in deciding what accommodations

361

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

to make. But the ADA does not require that employers accommodate the needs of employees with disabilities who are not otherwise qualified to do the work. In the facts of this problem, Horn worked as a janitor for Knight. When she developed sensitivity to cleaning products, her physician gave her a ―no exposure to cleaning solutions‖ restriction. She suggested to her employer that restrooms be eliminated from her route or that she be provided with a respirator as an accommodation to allow her to continue to work. Knight explained that she would be exposed to cleaning solutions in any situation because they were airborne, and concluded that there was no work available within her restriction. In other words, Horn‘s suggested accommodations were not reasonable because neither one complied with her restriction. Further, it appears that Knight could not in any other way reasonably accommodate the restriction. In the actual case on which this problem is based, Horn filed a suit against Knight. The court dismissed her claim. The U.S. Court of Appeals for the Sixth Circuit affirmed, according to the reasoning set out above. 118. Business Case Problem with Sample Answer— Sexual Harassment. Jamel Blanton, a male employee at a Pizza Hut restaurant operated by Newton Associates, Inc., in San Antonio, Texas, was subjected to sexual and racial harassment by the general manager, who was female. Newton had a clear, straightforward antidiscrimination policy and complaint procedure. The policy provided that in such a situation, an employee should complain to the harasser‘s supervisor. Blanton alerted a shift leader and an assistant manager about the harassment, but they were subordinate to the general manager and did not report the harassment to higher-level management. When Blanton finally complained to a manager with authority over the general manager, the employer investigated and fired the general manager within four days. Blanton filed a suit in a federal district court against Newton, seeking to impose liability on the employer for the general manager‘s actions. What is Newton‘s best defense? Discuss. [Blanton v. Newton Associates, Inc., 593 Fed.Appx. 389 (5th Cir. 2015)] (See Title VII of the Civil Rights Act.) —For a sample answer to Problem 29–6, go to Appendix E. Solution Newton‘s best defense to Blanton‘s assertion of liability against the employer for its general manager‘s actions is the ―Ellerth/Faragher affirmative defense.‖ To establish this defense, an employer must show that it has taken reasonable care to prevent and promptly correct any sexually harassing behavior and that the plaintiff unreasonably failed to take advantage of any opportunity provided by the employer to avoid the harm. In this problem, Blanton was subjected to sexual harassment by the general manager at their place of employment, a Pizza Hut restaurant operated by Newton. Blanton alerted low-level supervisors about the harassment, but they, like Blanton, were subordinate to the general manager and had no authority over her. Newton had a clear, straightforward anti-discrimination policy and complaint procedure that provided an employee should complain to the harasser's supervisor in such a situation. Once Blanton finally complained to a manager with authority over the general manager, their employer promptly and effectively responded to Blanton's proper complaint. His delay in reporting the harassment to the appropriate authority can be construed as an unreasonable failure to take advantage of the opportunity provided by the employer to avoid the harm.

362

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

In the actual case on which this problem is based, in Blanton‘s suit against Newton, a jury found that the plaintiff was harassed as he claimed, but also that the defendant proved the Ellerth/Faragher affirmative defense, and the court issued a judgment in the employer‘s favor. The U.S. Court of Appeals for the Fifth Circuit affirmed. 119. Discrimination Based on Disability. Dennis Wallace was a deputy sheriff for Stanislaus County, California, when he injured his left knee. After surgery, he was subject to limits on prolonged standing, walking, and running. The county assigned him to work as a bailiff. The sergeants who supervised him rated his performance above average. Less than a year later, without consulting those supervisors, the county placed him on an unpaid leave of absence, under the mistaken belief that he could not safely perform the essential functions of the job. Wallace filed an action in a California state court against the county, alleging discrimination based on disability. Under state law, discriminatory intent is shown by evidence that an actual or perceived disability was a ―substantial motivating factor or reason‖ for an employer‘s adverse employment action. An employee is not required to show that the action was motivated by animosity or ill will. Could Wallace likely prove the ―substantial motivating factor or reason‖ element? Explain. [Wallace v. County of Stanislaus, 245 Cal.App.4th 109, 199 Cal.Rptr.3d 462 (5 Dist. 2016)] (See Discrimination Based on Age, Disability, or Military Status.) Solution Yes. Based on the facts, Wallace could likely prove the ―substantial motivating factor or reason‖ element of the state‘s disability discrimination law. As stated in the problem, under that law, discriminatory intent can be shown by evidence that an actual or perceived disability was a ―substantial motivating factor or reason‖ for an employer‘s adverse employment action. A showing of an employer‘s animosity of ill will is not required. Wallace was a county deputy sheriff in California, when he suffered an injury to his knee that limited prolonged standing, walking, and running. Sometime after his return to work following surgery, he was assigned to the position of bailiff. His supervisors evaluated his performance in that capacity as above average. Despite this review, and without consulting the supervisors, the county removed Wallace from the bailiff position and forced him to take an unpaid administrative leave. In Wallace‘s subsequent suit in a California state court against the county, he alleged discrimination based on disability. In these circumstances, Wallace could prove the requisite discriminatory intent by showing his actual or perceived disability was a ―substantial motivating factor or reason‖ for the county‘s decision to remove him from his job as bailiff and place him on the unpaid leave of absence. In the actual case on which this problem is based, in Wallace‘s action against the county, the court instructed the jury that animus or ill will was a requirement of his cause. The jury found that Wallace proved his claim but for this requirement. The court issued a judgment in the county‘s favor. A state intermediate appellate court reversed, holding that the lower court‘s instruction was erroneous. With the element of animus or ill will eliminated, the jury‘s findings favored Wallace. The appellate court remanded the case for a retrial on the issue of damages only. 120. Discrimination Based on Gender. The Fresno County Office of Education hired Aileen Rizo as a math consultant. She had previously worked as a middle and high school math teacher, earning about $50,000 a year. Fresno based the salary of its new hires on the individual‘s prior salary, according to the county‘s Standard Operating Procedure (SOP). When Rizo learned that

363

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

she was being paid less than comparable male employees for the same work, she filed a complaint. The county responded that all salaries were set under the SOP. Rizo filed a suit against Jim Yovino, the Fresno superintendent, claiming a violation of the Equal Pay Act. She asserted that under the Equal Pay Act, an employer should not be able to justify a wage differential between men and women on the basis of prior salary. Yovino argued that basing pay on a prior salary was permissible under an exception in the act for ―any factor other than gender.‖ Did the county violate the Equal Pay Act? Discuss. [Rizo v. Yovino, 887 F.3d 453 (9th Cir. 2018)] (See Title VII of the Civil Rights Act.) Solution Yes. The county violated the Equal Pay Act. This act requires equal pay for male and female employees doing similar work at the same establishment. If the wage differential is due to ―any factor other than gender,‖ then it does not violate the act. Otherwise, it might. In this problem, Fresno County hired Aileen Rizo as a math consultant. The county based her initial salary on her prior salary, as a middle and high school math teacher, according to the county‘s Standard Operating Procedure. When Rizo learned that she was being paid less than comparable male employees for the same work, she filed a suit against Jim Yovino, the Fresno superintendent, claiming a violation of the Equal Pay Act. Yovino argued that basing pay on a prior salary was permissible under the act‘s exception for ―any factor other than gender.‖ ―Factors other than gender‖ include seniority and merit systems, and an individual‘s experience, educational background, ability, and prior job performance. In other words, a ―factor other than gender‖ must be a legitimate, job-related factor. A female‘s prior salary does not justify the current and future payment of a lower wage to her. To conclude otherwise be to allow an employer to capitalize on a gender-based wage gap and continue it forever. This would be contrary to the purpose of the Equal Pay Act. In the actual case on which this problem is based, Yovino filed a motion for summary judgment, which the court denied. The U.S. Court of Appeals for the Ninth Circuit affirmed and remanded. ―To accept the County‘s argument would be to perpetuate rather than eliminate the pervasive discrimination at which the Act was aimed.‖ 121. A Question of Ethics—The IDDR Approach and Unintentional Discrimination. McLane Company is a supply-chain services company that distributes goods to retailers. McLane requires employees with physically demanding jobs to have physical evaluations, both when they start work and when they return after medical leave. After working in a physically demanding job for McLane for eight years, Damiana Ochoa took maternity leave. When she returned to work, she failed the physical evaluation and was fired. She filed a discrimination complaint with the Equal Employment Opportunity Commission (EEOC). The agency issued a subpoena—an order to appear in court—seeking the names and contact information of McLane employees who had been asked to have evaluations throughout the company‘s national operations. [McLane Co. v. E.E.O.C., 581 U.S.___, 137 S.Ct. 1159, 197 L.Ed.2d 500 (2017)] (See Title VII of the Civil Rights Act.) 1. On what legal ground might McLane legitimately refuse to comply with the EEOC‘s subpoena? What practical factors could affect the choice not to comply? Discuss. Solution

364

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

A business has a legal obligation to comply with a subpoena unless compliance would be ―unduly burdensome.‖ On this ground, McLane might legitimately refuse to comply with the subpoena issued by the Equal Employment Opportunity Commission (EEOC). Title VII of the Civil Rights Act prohibits unintentional discrimination. This can occur when a protected group of people is adversely affected by an employer‘s test, even though it does not appear to be discriminatory. To succeed on a claim of unintentional discrimination, it must be shown statistically that the employer‘s test is discriminatory in effect. A statistical showing requires hard data. Accurate information about the effect of a specific test can be obtained from the employer who imposes it. This may require a subpoena. The EEOC monitors compliance with Title VII. Before filing a suit, a person who alleges discrimination must file a claim with the EEOC, which can issue a subpoena as part of its investigation into the facts. In this problem, Ochoa held a physically demanding job with McLane. McLane requires employees with such jobs to take physical evaluations. When Ochoa failed the evaluation, McLane fired her. She filed a claim with the EEOC, which issued a subpoena, seeking the personal information of other McLane employees who took the evaluation. Responding to a subpoena can be ―unduly burdensome.‖ The most important factor is the requested information‘s relevance—the relationship between the material sought and the matter under investigation. This might include access to virtually anything that casts light on an allegation against an employer. But a request that is for an illegitimate purpose, or that is too indefinite, overbroad, arbitrary, or capricious is likely also overly burdensome. Privacy interests can be a factor. The difficulty of producing the requested materials is certainly a prime concern of the party who is asked to provide them. In the actual case on which this problem is based, McLane refused to comply. A federal district court quashed the subpoena. The U.S. Court of Appeals for the Ninth Circuit reviewed this decision de novo and reversed. On appeal, the United States Supreme Court reversed the appellate court‘s judgment and remanded the case, holding that the appropriate standard for review was abuse of discretion, not de novo. 2.

Using the IDDR approach, consider whether McLane has an ethical duty to comply with the subpoena. Solution Yes. McLane has an ethical duty to comply with the EEOC‘s subpoena, at least to the extent of its legitimacy. Of course, the company does not violate this duty by initially attempting to resist the subpoena. Both actions should satisfy the stakeholders. Use of the IDDR approach requires an Inquiry to identify the issue, the stakeholders, and the ethical standards. The ethical issue for McLane is whether to comply with the EEOC‘s subpoena. The stakeholders include Ochoa, McLane‘s other employees, and the company‘s owners, suppliers, and customers, as well as the society at large, especially third parties affected through the other stakeholders and potential employees. Applicable ethical standards include at a minimum McLane‘s legal obligation to comply and the company‘s expressed or implied policy to generally act in compliance with the law.

365

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

The IDDR approach also requires a Discussion of actions to address the issue, the strengths and weaknesses of the actions, and the consequences and effects on stakeholders. McLane can stubbornly refuse to comply without proffering a reason, but this might result in significant penalties, to the benefit of none of the stakeholders. Instead, McLane can object to the subpoena and offer a reasoned defense. Or the company might choose to fully comply without objection. Either of these actions would recognize the interests of all of the stakeholders by avoiding the appearance of impropriety and illegality, and the onus of sanctions. A Decision on the action and a statement of its reasons is the next step in the IDDR approach. It seems clear that McLane should not baldly refuse to comply with the subpoena, but should fully comply or offer a defense, for the reasons stated in the preceding paragraph. Among likely defenses, for example, whether responding to a subpoena is ―unduly burdensome‖ can help to determine the ethics of compliance. For the purpose of weighing an ethical duty to comply, an important factor might be the privacy interests of the employees. McLane could also assert that the request for information is overbroad and that the data sought is not relevant. The last step of the IDDR approach is a Review of the success or failure of the actions to resolve the issue, and satisfy the stakeholders. Either full compliance or objection to compliance on a legitimate basis should reassure stakeholders of the company‘s lawful conduct and the soundness of its policies and procedures. This should positively resolve the ethical issue.

Critical Thinking and Writing Assignments 122. Critical Legal Thinking. Why has the federal government limited the application of the statutes discussed in this chapter to firms with a specified number of employees, such as fifteen or twenty? Should these laws apply to all employers regardless of size? Why or why not? (See Title VII of the Civil Rights Act.) Solution The application of any statute can be limited by the legislative body that enacts the statute. In the case of federal antidiscrimination legislation, Congress sets the number of employees that a firm may have without being subject to the federal laws. For example, in 1972 Congress reduced the number of employees that an employer could have and still avoid liability for violation of Title VII of the Civil Rights Act of 1964. Why does Congress set these numbers at the levels that it does? The reasons are as varied as the times in which the laws are passed. Most likely the reasons are political: constituents who feel strongly about being subject to the laws, or who oppose exempting employers, or who favor employee protection against discrimination, for example. These reasons may be founded on economic projections about the cost of employer compliance, the cost of government enforcement, or the cost not to comply or not to enforce. Sometimes limits are part of a compromise. Whether all antidiscrimination laws should apply to all employers regardless of their size can be argued on the basis of ―fairness:‖ why should an employer with fourteen full-time permanent employees be exempt from a statute that applies to an employer with fifteen employees who work no more than twenty weeks every two years? The question can be debated on the issue of social effect: the policies of an employer with a few jobs through which pass many employees on an informal basis may have less effect in a community than the policies of an employer who maintains formally a larger, permanent staff. The numbers can be drawn according to the bottom line: whether a small business with only a few employees can

366

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 29: Employment Discrimination

afford the cost of compliance, whether a large business with many employees can afford not to comply, and whether the government can afford the cost of enforcement. 123. Time-Limited Group Assignment—Discrimination Based on Race. Two African American plaintiffs sued the producers of the reality television series The Bachelor and The Bachelorette for racial discrimination. The plaintiffs claimed that the shows had never featured a person of color in the lead role. Plaintiffs also alleged that the producers had failed to provide people of color who auditioned for lead roles with the same opportunities to compete as white people who auditioned. (See Title VII of the Civil Rights Act.) 1.

The first group will assess whether the plaintiffs can establish a prima facie case of disparatetreatment discrimination. Solution To succeed on a claim of disparate-treatment discrimination in hiring, plaintiffs must show that (1) they are a member of a protected class, (2) they applied for and were qualified for the job in question, (3) they were rejected by the employer, and (4) the employer continued to seek applicants for the position or filled the position with a person not in a protected class. If the plaintiff can meet these relatively easy requirements, that individual has made out a prima facie case of illegal discrimination. This means that the plaintiff has met the initial burden of proof and will win in the absence of a legally acceptable employer defense. In this problem, a prima facie case could likely be established if people of color who auditioned for lead roles were not given the same opportunities to compete as white people who auditioned.

The second group will consider what the plaintiffs would have to show to establish disparateimpact discrimination. Solution In a disparate-impact discrimination case, the complaining party must first show statistically that the employer‘s practices, procedures, or tests are discriminatory in effect. Once the plaintiff has made out a prima facie case, the burden of proof shifts to the employer to show that the practices or procedures in question were justified. A plaintiff can prove a disparate impact by comparing the employer‘s workforce to the pool of qualified individuals available in the local labor market. The plaintiff must show that (1) as a result of educational or other job requirements or hiring procedures, (2) the percentage of nonwhites, women, or members of other protected classes in the employer‘s workforce (3) does not reflect the percentage of that group in the pool of qualified applicants. A plaintiff can also prove disparate-impact discrimination by comparing the selection rates of whites and nonwhites (or members of another protected class). When a job requirement or hiring procedure excludes members of a protected class from an employer‘s workforce at a substantially higher rate than nonmembers, discrimination occurs. In this problem, to consider the validity of the plaintiffs‘ claim requires consideration of the requirements to appear on the shows and the numbers and races of the applicants. If, however, the shows have never featured a person of color in a lead role, it seems likely that there is discrimination.

The third group will assume that the plaintiffs established a prima facie case and that the burden has shifted to the employer to articulate a legal reason for not hiring the plaintiffs. What legitimate reasons might the employer assert for not hiring the plaintiffs in this

367

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

situation? Should the law require television producers to hire persons of color for lead roles in reality television shows? Explain your answer. Solution Despite the assumption in the facts that the plaintiffs can establish a prima facie case, the employer‘s best defenses most likely relate to the elements of such a case. For example, if few persons of color applied for the lead roles, the disposition of their applications would have little statistical significance in a disparate-impact discrimination case. And those who did apply may not have met the shows‘ criteria for the lead roles, undercutting a claim of disparate-treatment discrimination in hiring. Of the other defenses discussed in the text, the employer might argue that whatever criterion the rejected applicants failed to meet is a business necessity—necessary for the performance of the role. There is no indication that color is a bona fide occupational qualification (BFOQ) for the role, and in any circumstance there is little likelihood it would be an acceptable BFOQ. In an analogy to a fair seniority system, in which persons with more years of service are promoted first, the employer might assert that the lead roles are filled on a first-to-apply, first-to-be-cast basis.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 368 Adapting the Law to the Online Environment ................................................................................ 368 Critical Thinking Questions in Cases ................................................................................................................... 370 Case 30.1 ............................................................................................................................................... 370 Case 30.2 ............................................................................................................................................... 371 Case 30.3 ............................................................................................................................................... 371 Chapter Review ........................................................................................................................................................... 372 Practice and Review .............................................................................................................................. 372 Practice and Review: Debate This ......................................................................................................... 373 Issue Spotters ........................................................................................................................................ 373 Business Scenarios and Case Problems ................................................................................................. 374 Critical Thinking and Writing Assignments ............................................................................................ 380

Critical Thinking Questions in Features Adapting the Law to the Online Environment 124. After filing (often online) a DBA or FBN, the sole proprietor must publish the statement in a newspaper to notify the public. For the most part, online DBA notification is not available. Should it be? Explain your answer.

368

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

Solution The goal of the legal notice requirement for DBAs is to inform the general public that the trade name of a sole proprietorship or other business is different from its legal name or the name of its owner. This notice usually must be published in a newspaper with a daily or weekly circulation, and for several consecutive days or weeks. Given the extent to which business transactions have moved online, these rules seem highly anachronistic. If the goal of the legal notice requirement is to generate awareness and transparency, then relying on print newspapers hardly seems the most practical method of doing so.

369

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

125. Suppose a franchisor has two choices when it comes to cybersecurity provisions in its FDD. The franchisor can either (a) assume control and responsibility for a franchisee‘s privacy security system, or (b) avoid this control and responsibility, leaving point-of-sale security in the hands of the franchisee. Which is the better choice? Why? Solution The temptation for franchisors to cede cybersecurity control and responsibility to franchisees in the FDD is easy to understand. If the franchisor is only minimally involved in the franchisee‘s privacy and security policies, then it can hope to avoid liability if those policies prove insufficient to protect against a data breach. The reality, however, is that it is very difficult for the franchisor to escape responsibility when a franchisee is hacked, regardless of the terms of the FDD. As noted in the feature, plaintiffs‘ lawyers will almost always focus their attention on the franchisor, and consumers are generally unaware of the difference between franchisors and franchisees. So, if a single Subway franchise is hacked, consumers will be wary of all the Sunway franchises, ultimately damaging the franchisor‘s bottom line. Consequently, franchisors are generally better served to assume control of IT security in an FDD. As part of this strategy, the franchisor should centralize and standardize each franchisee‘s practices when it comes to pont-of-sale system security and have quality control protocols in place to make sure these security systems are functioning properly. Ideally, the franchisor should also provide data-protection training to managers and employees of each franchise. These steps will provide a layer of liability protection should a franchisee experience a data breach.

Critical Thinking Questions in Cases Case 30.1 126. The trial court ruled that Wagner could have been an agent for ―the business.‖ Why, in the view of the appellate court, did this ruling make no sense? Solution The appellate court concluded that ―the business,‖ Northwest Cabinets & Furniture, a sole proprietorship, was inseparable from Misenar. In other words, Misenar and the sole proprietorship were indistinguishable. The court also concluded that, as Misenar‘s spouse, Wagner had a community property interest in the business. In this context, Wagner, had he been construed to act in the capacity of an agent, as the trial court suggested, would have been acting as an agent for himself. In the words of the trial court, ―this business is [Misenar‘s] separate property * * * . Now [Wagner] can be an agent. And she could have authorized him to do anything * * * . He can sign checks. He can work in the shop. He can make contracts. He can do all these things. * * * But him having that authority and stuff does not * * * give him the standing to make the claim * * * . He‘s simply acting as her agent.‖ To this statement, the appellate court responded, ―The trial court‘s ruling suggests that Wagner was an agent for the business, but he cannot be. This ruling would only make sense if the court believed that the business is a separate legal entity, but it is not.‖ 127. Suppose that instead of Wagner, Misenar had pursued the claim in the case against Port Orchard. Would the result have been different? Discuss. Solution

370

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

No, if, instead of Wagner, Misenar had pursued the claim in the case against Port Orchard, the result would not likely have been different. As a sole proprietorship, the business was inseparable, or indistinguishable, from Misenar, its owner. Misenar bought the business from Wagner, whom she later married. Even if they had not married, however, as the sole proprietor of Northwest Cabinets & Furniture, Misenar could have filed the claim for breach in this case. And if she had not bought the business from Wagner, she would still have had standing to bring such a claim. In the interpretation of the appellate court, whichever spouse was the owner of the sole proprietorship, the business would have constituted community property. ―And a community property interest is a sufficiently real interest to confer standing.‖

Case 30.2 128. The department concluded that S&P‘s failure to use more effective marketing strategies and to hire more sales staff breached the franchise agreement. S&P argued that these were not material breaches because the agreement‘s fundamental purpose was to sell trucks. Is S&P correct? Discuss. Solution No. S&P is not correct. The franchisee‘s failure to use more effective marketing strategies and to hire more sales staff materially breached the franchise agreement. A material breach undercuts the fundamental purpose of a contract and prevents accomplishing the object of the parties in making the deal. The purpose of the contract between Daimler and S&P was to sell trucks. S&P‘s use of the same unsuccessful marketing strategy year after year, especially after Daimler advised the dealer to do something ―more effective,‖ prevented the object of the contract from being accomplished. Daimler‘s advice to hire more sales staff indicated that S&P‘s poor sales performance was also a result of maintaining inadequate personnel. S&P‘s failure to act on this advice further prevented attaining the object of the contract. Both failures materially breached the franchise agreement, lending support to the department‘s finding of good cause for termination of the franchise. 129. Considering that S&P was the only Western Star truck dealer in Yellowstone County, did discontinuing the franchise injure the public interest? Explain. Solution No. Discontinuing S&P‘s franchise did not injure the public interest, even considering that S&P was the only Western Star truck dealer in Yellowstone County. Of course, as a result of the termination of S&P‘s franchise, county residents would have to go elsewhere to obtain Western Star trucks and service. But the evidence showed that S&P was not reaching and serving local customers well—few Western Star vehicles were registered in Yellowstone County, and most of those had not been sold by S&P. This provided further support for the good cause termination of S&P‘s franchise. Arguably, the public would be better served by a franchisee that was more engaged with local customers.

Case 30.3 130. Why should House and HAI have been advised of Holiday Inn‘s plan to grant a franchise to a different hotel in their territory? Solution House and HAI should have been informed of Holiday Inn‘s plan to grant a franchise to a different local hotel in order to evaluate the economic risk of spending millions of dollars on the

371

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

franchisor‘s requested renovations. This might not be as warranted in a case involving a different relationship between the parties, but these parties had done business on a basis of trust for decades

Chapter Review Practice and Review Carlos Del Rey decided to open a fast-food Mexican restaurant and signed a franchise contract with a national chain called La Grande Enchilada. Under the franchise agreement, Del Rey purchased the building, and La Grande Enchilada supplied the equipment. The contract required the franchisee to strictly follow the franchisor‘s operating manual and stated that failure to do so would be grounds for terminating the franchise contract. The manual set forth detailed operating procedures and safety standards, and provided that a La Grande Enchilada representative would inspect the restaurant monthly to ensure compliance. Nine months after Del Rey began operating his restaurant, a spark from the grill ignited an oily towel in the kitchen. No one was injured, but by the time firefighters put out the fire, the kitchen had sustained extensive damage. The cook told the fire department that the towel was ―about two feet from the grill‖ when it caught fire, which was in compliance with the franchisor‘s manual that required towels to be at least one foot from the grills. Nevertheless, the next day La Grande Enchilada notified Del Rey that his franchise would terminate in thirty days for failure to follow the prescribed safety procedures. Using the information presented in the chapter, answer the following questions. 131.

What type of franchise was Del Rey‘s La Grande Enchilada restaurant?

Solution This is a chain-style business operation. Taco Bell, Burger King, and McDonald‘s restaurants are other examples of chain-style business operations. 132. If Del Rey operates the restaurant as a sole proprietorship, who bears the loss for the damaged kitchen? Explain. Solution In the event that Del Rey operated the restaurant as a sole proprietorship, the loss for the damaged kitchen would most likely be Del Rey‘s (although insurance might cover the cost).

372

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

133. Assume that Del Rey files a lawsuit against La Grande Enchilada, claiming that his franchise was wrongfully terminated. What is the main factor a court would consider in determining whether the franchise was wrongfully terminated? Solution The franchisor‘s good faith and fair dealing in terminating the franchise would be the chief factor that a court would consider in determining whether the termination was wrongful. 134. Would a court be likely to rule that La Grande Enchilada had good cause to terminate Del Rey‘s franchise in this situation? Why or why not? Solution If the reason for the termination is identified as entirely a failure to follow the franchisor‘s safety procedures, it would appear that the termination was wrongful, because according to the facts, the franchisee did not violate those procedures.

Practice and Review: Debate This 135. All franchisors should be required by law to provide comprehensive estimates of the profitability of a prospective franchise based on the experiences of their existing franchisees. Solution Because many franchisors seem only to survive by selling more franchises—rather than from current operations—they tend to exaggerate the potential profits than can be made. Those seeking to buy a new franchise are therefore often provided with little hard evidence about how much profit they can expect to make. To prevent individuals from succumbing to franchisors‘ exaggerated sales pitches, government should require that verifiable estimates of profitability be provided. These should be available in print and on the Web and be current. The profitability of any given franchise depends on many factors, including the business acumen of the franchisee. Even if franchisors provided accurate estimates of potential profitability for the average franchisee, there would be no guarantee that a new franchisee could earn the average profits so estimated. Hence, if franchisors were required to provide profitability estimates to prospective franchisees, the former would end up defending numerous lawsuits from franchisees whose business abilities turned out to be poor.

Issue Spotters 136. Frank plans to open a sporting goods store and to hire Gogi and Hap. Frank will invest only his own funds. He expects that he will not make a profit for at least eighteen months and will make only a small profit in the three years after that. He hopes to expand eventually. Would a sole proprietorship be an appropriate form for Frank‘s business? Why or why not? Solution Yes. When a business is relatively small and is not diversified, employs relatively few people, has modest profits, and is not likely to expand significantly or require extensive financing in the immediate future, the most appropriate form for doing business may be a sole proprietorship. 137. Thirsty Bottling Company and U.S. Beverages, Inc. (USB), enter into a franchise agreement that states that the franchise may be terminated at any time ―for cause.‖ Thirsty fails to meet USB‘s specified sales quota. Does this constitute ―cause‖ for termination? Why or why not?

373

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

Solution Yes. Failing to meet a specified sales quota can constitute a breach of a franchise agreement. If the franchisor is acting in good faith, ―cause‖ may also include the death or disability of the franchisee, the insolvency of the franchisee, and a breach of another term of the franchise agreement.

Business Scenarios and Case Problems 138. Franchising. Maria, Pablo, and Vicky are recent college graduates who would like to go into business for themselves. They are considering purchasing a franchise. If they enter into a franchising arrangement, they would have the support of a large company that could answer any questions they might have. Also, a firm that has been in business for many years would be experienced in dealing with some of the problems that novice businesspersons might encounter. These and other attributes of franchises can lessen some of the risks of the marketplace. What other aspects of franchising—positive and negative— should Maria, Pablo, and Vicky consider before committing themselves to a particular franchise? (See Franchises.) Solution Factors that potential franchisees might want to consider before committing themselves to a franchise include: how long the franchisor has been in business, how profitable the business is, how the financial statements of the business look, what fees will have to be paid, what kind of assistance a franchisor will provide in terms of hiring and training employees, the promotional and advertising help a franchisor will provide, what kind of capital and credit is available, how much help a franchisor will offer in finding a location and negotiating terms, the terms of the franchise contract, and the size and exclusivity of a franchise territory, as well the experience of other franchisees who have been successful and those who have not. 139. Control of a Franchise. National Foods, Inc., sells franchises to its fast-food restaurants, known as Chicky-D‘s. Under the franchise agreement, franchisees agree to hire and train employees strictly according to Chicky-D‘s standards. In addition, Chicky-D‘s regional supervisors must approve all new hires and policies, which they generally do. Chicky-D‘s reserves the right to terminate a franchise for violating the franchisor‘s rules. After several incidents of racist comments and conduct by Tim, a recently hired assistant manager at a Chicky-D‘s, Sharon, a counterperson at the restaurant, resigns. Sharon files a suit against National. National files a motion for summary judgment, arguing that it is not liable for harassment by franchise employees. Will the court grant National‘s motion? Why or why not? (See The Franchise Contract.) Solution The court would likely conclude that National Foods was responsible for the acts of harassment by the manager at the franchised restaurant because the employees were the agents of National Foods. An agency relationship can be implied from the circumstances and conduct of the parties. The important question is the degree of control that a franchisor has over its franchisees. Whether the franchisor actually exercises that control is beside the point. Here, National Foods retained considerable control over new hires and the franchisee‘s policies, as well as the right to terminate the franchise for violations. That its supervisors routinely approved the policies would not undercut National Foods‘ liability. 140. Spotlight on McDonald’s—Franchise Termination. C.B. Management, Inc., had a franchise agreement with McDonald‘s Corp. to operate McDonald‘s restaurants in Cleveland,

374

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

Ohio. The agreement required C.B. to make monthly payments of certain percentages of the gross sales to McDonald‘s. If any payment was more than thirty days late, McDonald‘s had the right to terminate the franchise. The agreement also stated that even if McDonald‘s accepted a late payment, that would not ―constitute a waiver of any subsequent breach.‖ McDonald‘s sometimes accepted C.B.‘s late payments, but when C.B. defaulted on the payments in July, McDonald‘s gave notice of thirty days to comply or surrender possession of the restaurants. C.B. missed the deadline. McDonald‘s demanded that C.B. vacate the restaurants, but C.B. refused. McDonald‘s alleged that C.B. had violated the franchise agreement. C.B. claimed that McDonald‘s had breached the implied covenant of good faith and fair dealing. Which party should prevail, and why? [McDonald’s Corp. v. C.B. Management Co., 13 F.Supp.2d 705 (N.D.Ill. 1998)] (See Franchise Termination.) Solution McDonald‘s should prevail. J.C. failed to comply with the terms of the franchise agreement. J.C. might argue that McDonald‘s previous exercises of discretion, in regards to late payments, meant that its failure to accept a late payment in the summer of 1997 was a breach of the implied covenant of good faith and fair dealing. But the terms of the agreement control this issue. The agreement specifically provided that a waiver of one breach by the franchisor was not to be taken as a waiver of later breaches. That McDonald‘s may have declined to exercise its contractual right to terminate in the past did not transform that right into a discretionary decision governed by the standard of good faith and fair dealing. McDonald‘s simply exercised privileges expressly reserved in the agreement. McDonald‘s is entitled to immediate possession of the restaurants, as well as damages for J.C.‘s post-termination use of the McDonald‘s trademarks. 141. Business Case Problem with Sample Answer— Quality Control. JTH Tax, Inc., doing business as Liberty Tax Service, provides tax preparation and related loan services throughout the United States in more than two thousand company-owned and franchised stores. Liberty‘s agreement with its franchisees reserved the right to control their ads. In company operations manuals, Liberty provided step-by-step instructions, directions, and limitations to its franchisees regarding their ads. Liberty retained the right to unilaterally modify the steps at any time. The California Attorney General filed a suit in a California state court against Liberty, alleging misleading or deceptive ads by its franchisees regarding refund anticipation loans and e-refund checks. Can Liberty be held liable? Discuss. [People v. JTH Tax, Inc., 212 Cal.App.4th 1219, 151 Cal.Rptr.3d 728 (1 Dist. 2013)] (See The Franchise Contract.) —For a sample answer to Problem 30–4, go to Appendix E. Solution Yes. Liberty can be held liable for the statements in its franchisees‘ ads. The validity of a provision permitting the franchisor to establish and enforce certain quality standards is unquestioned. The franchisor has a legitimate interest in maintaining the quality of the product or service to protect its name and reputation. If a franchisor exercises too much control over the operations of its franchisees, however, the franchisor risks potential liability. A franchisor may occasionally be held liable under the doctrine of respondeat superior for the tortious acts of a franchisee or the franchisees‘ employees. In this problem, Liberty‘s agreement with its franchisees reserved the right to control their ads. In operations manuals, Liberty provided step-by-step instructions, directions, and limitations to its franchisees regarding their ads and retained the right to unilaterally modify the steps at any time. This seems to give the franchisor a great deal of control over its franchisees‘ marketing, which

375

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

under the principles stated above, points to the franchisor‘s liability for the franchisees‘ misleading or deceptive ads. In the actual case on which this problem is based, the court issued a judgment in California‘s favor. Liberty appealed. A state intermediate appellate court affirmed. ―Liberty retained the right to control, and in fact did seek to control, its franchisees' advertising and other marketing activities beyond that necessary to protect its marks and goodwill.‖ 142. Quality Control. The franchise agreement of Domino‘s Pizza, LLC, sets out operational standards, including safety requirements, for a franchisee to follow but provides that the franchisee is an independent contractor. Each franchisee is free to use its own means and methods. For example, Domino‘s does not know whether a franchisee‘s delivery drivers are complying with vehicle safety requirements. MAC Pizza Management, Inc., operates a Domino‘s franchise. A vehicle driven by Joshua Balka, a MAC delivery driver, hydroplaned due to a bald tire and wet pavement, and struck the vehicle of Devavaram and Ruth Christopher, killing Ruth and injuring Devavaram. Is Domino‘s liable for negligence? Explain. [Domino’s Pizza, LLC v. Reddy, 2015 WL 1247349 (Tex.App.—Beaumont 2015)] (See The Franchise Contract.) Solution No. Domino‘s Pizza, L.L.C., is not liable for negligence in the circumstances of this problem. The operation of a franchise normally is left to the franchisee. When a franchise involves the preparation of food, however, the franchise agreement often establishes certain standards for the franchisee to follow. If the agreement gives a franchisor a significant degree of control over the operation of its franchisee, the franchisor may be liable—under the doctrine of respondeat superior—for the tortious acts of the franchisee‘s employees. Here, Domino‘s franchise agreement set out operational standards, including safety requirements, for its franchisee to follow. But the agreement also provided that each franchisee was an independent contractor, free to use its own means and methods. This included compliance on the part of the franchisee and its delivery drivers with vehicle safety requirements. MAC Pizza Management, Inc., operated a Domino‘s franchise. A vehicle driven by a MAC delivery driver hydroplaned due to a bald tire and wet pavement, and struck the vehicle of Devavaram and Ruth Christopher, killing Ruth and injuring Devavaram. The delivery driver and, by vicarious liability, MAC might be liable for negligence with respect to the injury and death of the Christophers, But by the terms of the franchise agreement and the other facts in the problem, Domino‘s is not. In the actual case on which this problem is based, on behalf of Devavaram and Ruth‘s estate, Raghurami Reddy filed a suit in a Texas state court against Domino's for negligence. A jury found that Balka was operating his vehicle subject to Domino‘s control, and the court entered a judgment in Reddy‘s favor. A state intermediate appellate court reversed this judgment, in part for the reasons stated here. 143. Franchise Termination. Executive Home Care Franchising, LLC, sells in-home health-care franchises. Clint, Massare, and Greer Marshall entered into a franchise agreement with Executive Home Care. The agreement provided that the franchisees‘ failure to comply with the agreement‘s terms would likely cause irreparable harm to the franchisor, entitling it to an injunction. About two years later, the Marshalls gave up their franchise. They returned thirteen boxes of documents, stationery, operating manuals, marketing materials, and other items—everything in their possession that featured Executive Home Care trademarks. They quit operating out of the

376

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

franchised location. They transferred the phone number back to the franchisor and informed their clients that they were no longer associated with Executive Home Care. They continued to engage in the home health-care business, however, under the name ―Well-Being Home Care Corp.‖ Is Executive Home Care entitled to an injunction against the Marshalls and their new company? Discuss. [Executive Home Care Franchising, LLC v. Marshall Health Corp., 642 Fed.Appx. 181 (3d Cir. 2016)] (See Franchise Termination.) Solution No. Executive Care is not entitled to an injunction against the Marshals and their new company. An injunction is an extraordinary remedy. To obtain an injunction before a suit is resolved, or arbitration or other alternative dispute resolution procedure is undertaken and completed, a party must establish that it will suffer irreparable harm if the injunction is denied. In the facts of this problem, the Marshalls entered into a franchise agreement with Executive Care to operate a home healthcare franchise. The agreement provided that the franchisees‘ failure to comply with the terms would likely cause irreparable harm to the franchisor, thereby entitling it to an injunction. When the Marshalls gave up their franchise, presumably before the end of its term under the franchise agreement, they returned everything in their possession with Executive Care trademarks. They quit operating out of the franchised location. They transferred the phone number back to Executive Care and informed their clients that they were no longer associated with that firm. Although he Marshalls continued to operate a home healthcare business, they did so under the name ―Well–Being Home Care Corp.‖ There is nothing in these facts to establish that Executive Care is entitled to a preliminary injunction on the basis of irreparable harm. There appears to be little else the Marshalls might have done to prevent such harm to the franchisor. In the actual case on which this problem is based, Executive Care filed a suit in a federal district court against the Marshalls and asked the court to issue a preliminary injunction. The court denied the request. On the reasoning stated here, the U.S. Court of Appeals for the Third Circuit affirmed.

377

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

144. Location of the Franchise. Chrysler, LLC, awarded a Chrysler-Jeep franchise in Billings, Montana, to Lithia Motors, Inc. Lithia exceeded the sales goals and other expectations expressed in the franchise agreement. Later, Chrysler approved an application by Rimrock Chrysler, Inc., to open an additional Chrysler-Jeep franchise less than a mile from Lithia‘s location. Lithia‘s agreement was silent on the issue of territorial rights, but the dealer protested Chrysler‘s approval of Rimrock‘s application. Could Chrysler‘s actions be considered a breach of the franchisor‘s deal with Lithia? Discuss. [Rimrock Chrysler, Inc. v. State of Montana Department of Justice, Motor Vehicle Division, 2018 MT 24, 390 Mont. 235, 411 P.3d 1278 (2018)] (See The Franchise Contract.) Solution Yes. Chrysler‘s approval of Rimrock‘s application could be considered a breach of the franchisor‘s deal with Lithia. In franchise disputes over territorial rights, the implied covenant of good faith and fair dealing often comes into play. If a franchise agreement does not grant exclusive territorial rights to a franchisee, and the franchisor allows a competing franchise to be established nearby, the existing franchisee may suffer a significant loss in profits. The franchisor‘s actions could thereby be held to breach an implied covenant of good faith and fair dealing. In this problem, Chrysler awarded a Chrysler-Jeep franchise in Billings, Montana, to Lithia Motors. Lithia exceeded its contractual expectations. Later, Chrysler approved Rimrock‘s application to open an additional Chrysler-Jeep franchise less than a mile from Lithia‘s location. Lithia protested. Establishing a competing franchise nearby would likely reduce Lithia‘s profits. Its franchise agreement was silent on the issue of territorial rights, but Chrysler‘s actions could nevertheless constitute a breach of an implied covenant of good faith and fair dealing. In the actual case on which this problem is based, Lithia protested to the Montana Department of Justice, Motor Vehicle Division. Under the Montana Dealer Act, to open a new dealership near an existing franchise for the same line, a franchisor must show that there is ―good cause‖ for the new franchise. At a hearing on the dispute, Chrysler‘s witness testified that Lithia was exceeding its contractual expectations. The agency ruled in Lithia‘s favor. Rimrock filed a petition in a state court for review. The court upheld the agency‘s decision. The Montana Supreme Court affirmed. ―Chrysler‘s failure to . . . show good cause to establish an additional franchise is dispositive.‖ 145. A Question of Ethics—The IDDR Approach and Sole Proprietorships. Tom George was the sole owner of Turbine Component Super Market, LLC (TCSM), when its existence was terminated by the state of Texas. A TCSM creditor, Turbine Resources Unlimited, filed and won a suit in a Texas state court against George for breach of contract. The plaintiff sought to collect the amount of the judgment through a sale of George‘s property. Instead of turning his assets over to the court, however, George tried to hide them by reforming TCSM. Without telling the court, he paid an unrelated debt with $100,000 of TCSM‘s funds. George claimed that the funds were a loan and that he was merely an employee of TCSM. [Mitchell v. Turbine Resources Unlimited, Inc., 523 S.W.3d 189 (Tex.App.— Houston [14th Dist.] 2017)] (See Sole Proprietorships.) 1.

Is it more likely that the court will recognize TCSM as an LLC or a sole proprietorship? Why? Solution It is more likely that the court will see through Tom George‘s subterfuge and hold that TCSM is a sole proprietorship. In a sole proprietorship, the owner is the business. Anyone who does business without creating a separate organization has a sole proprietorship. A limited liability company (LLC) must be formed and operated in compliance with state law.

378

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

A court has several methods to divine the truth in the circumstances of a case. Not the least of these is the ability of the judge to carefully weigh the testimony of a witness and correctly determine that person‘s credibility. This determination may be supported by the judge‘s experience with litigants in many cases, and by the physical evidence in the case at hand. For example, in George‘s case, his demeanor would likely have betrayed the truth. Or there may have been state-issued documents that reveal the actual status of his businesses and their assets. Here, when George lost a suit, the court ordered his assets sold to pay the judgment. Instead of tendering those assets to the court, however, George attempted to hide his assets within Turbine Component Super Market, LLC (TCSM). This firm had earlier been terminated by the state of Texas. George claimed to be TCSM‘s employee, but he was its sole owner. And there was little or no distinction between the two, as evidenced by TCSM‘s ―loan‖ to George of $100,000. In other words, TCSM was in fact a sole proprietorship, not an LLC. 2.

Using the Discussion step of the IDDR approach, consider whether the owner of a business has an ethical obligation to represent the character and purpose of the organization truthfully. Solution The owner of a business has an ethical obligation to represent the character and purpose of a business organization truthfully. At the very least, the obligation is owed by the owner to himself or herself in order to avoid the inevitable consequences. As in this problem, for example, misrepresentation is likely to be discovered by a court. The avoidance of liability or other negative results is likely to be short-term only. The IDDR approach consists of four steps. The first step is an Inquiry to identify the issue, the stakeholders, and the ethical standards in a given situation. In this problem, for example, George was presented with the dilemma of whether to represent the status of TCSM truthfully, and thereby lose certain assets, or misrepresent its status in an attempt to avoid that loss. The stakeholders included George and the party from whom he wished to hide those assets (as well as the state court in which George would misrepresent his firm‘s status). The ethical standards include honesty and integrity, both generally and specifically in the oath George would be required to follow by the court (which has its own ethical code to follow).

379

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

The second step is the Discussion of actions to address the issue, the strengths and weaknesses of the actions, and the consequences and effects on stakeholders. So, here, George has to decide whether to misrepresent the true status of his business firm. By misrepresenting it, George might effectively retain assets that could otherwise be forfeited to satisfy a judgment. But he would sacrifice honesty in the process. This could wear on his conscience and, more practically, form the basis for a later fraud suit. By presenting the status of his firm truthfully, George would lose the assets, but retain his integrity and could avoid further litigation. The third step is to make a Decision and express the reasons for it. In this case, the decision seems clear—George should not have misrepresented his firm as a limited liability company. Instead, he should have confessed to its status as a sole proprietorship and suffered the inevitable consequences. This would have preserved his honesty and integrity, and avoided later regret and litigation. The final step is a Review of the success or failure of the actions to resolve the issue, and satisfy the stakeholders. George‘s decision to attempt to defraud the court and his opposing party did not succeed, and would not have satisfied the stakeholders if it had. A decision to act truthfully would have worked to the ultimate satisfaction of the issue and the stakeholders. In the actual case on which this problem is based, on an appeal from the court-ordered sale of George‘s property (by Jennifer Mitchell, George‘s girlfriend, who claimed an interest in the property), a state intermediate appellate court affirmed the order for the sale.

Critical Thinking and Writing Assignments 146. Business Law Writing. Jordan Mendelson is interested in purchasing a franchise in a meal-preparation business. Customers will come to the business to assemble gourmet dinners and then take the prepared meals to their homes for cooking. The franchisor requires each store to use a specific layout and provides the recipes for various dinners, but the franchisee is not required to purchase the food products from the franchisor. What general factors should Mendelson consider before entering into a contract to buy such a franchise? Is location important? Are there any laws that Mendelson should consider, given that this franchise involves food preparation and sales? Should Mendelson operate this business as a sole proprietorship? Why or why not? (See The Franchise Contract.) Solution Factors as to whether to enter into a franchise include its financial viability and possible profitability. In this regard, a potential franchisee should weigh the substantiality and truth of the franchisor‘s representations and disclosures to prospective franchisees. For example, a franchisor is required to disclose whether the projected earnings figures are based on actual data or hypothetical examples. If a franchisor makes sales or earnings projections based on actual data for a specific franchise location, the franchisor must disclose the number and percentage of its actual franchises that have achieved this result. These figures and all other representations made to a prospective franchisee should have a reasonable basis. Has the franchisor terminated franchises in the past? If so, why? Is the franchisor honest, reliable, and reasonable with its other franchisees?

380

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 30: Sole Proprietorships and Franchises

Franchisors are required to explain termination, cancellation, and renewal provisions of the franchise contract to potential franchisees before a franchise agreement is signed. The details of the contract—organizational form, premises requirements, business location, franchise standards, and payment and pricing arrangements, as well as other financial arrangements—are important factors. As for the location, even if a business is Web based, there may be distribution and other logistic factors that should be taken into consideration. The ―fit‖ between the prospective franchisee and the business may be a factor. Relevant state and federal laws may be a consideration. In this problem, laws that cover food preparation and sales would be significant. Operating the franchise as a sole proprietorship would enable the franchisee to realize all of the profits, but this form of business organization would also subject the franchisee to the risk of unlimited legal liability. 147. Time-Limited Group Assignment—Franchise Termination. Walid Elkhatib, an Arab American, bought a Dunkin‘ Donuts franchise in Illinois. Ten years later, Dunkin‘ Donuts began offering breakfast sandwiches with bacon, ham, or sausage through its franchises. Elkhatib refused to sell these items at his store on the ground that his religion forbade the handling of pork. Elkhatib then opened a second franchise, at which he also refused to sell pork products. The next year, at both locations, Elkhatib began selling meatless sandwiches. He also opened a third franchise. When he proposed to relocate this franchise, Dunkin‘ Donuts refused to approve the new location and informed him that it would not renew any of his franchise agreements because he did not carry the full sandwich line. Elkhatib filed a lawsuit against Dunkin‘ Donuts. (See Franchise Termination.) 1.

The first group will argue on behalf of Elkhatib that Dunkin‘ Donuts wrongfully terminated his franchises. Solution Elkhatib‘s refusal to offer breakfast sandwiches containing pork at his franchise locations was based on his religious beliefs. When he sought to relocate one of the franchises, Dunkin‘ Doughnuts (the franchisor) notified him that it would not allow relocation and furthermore would not renew his franchise agreement. The court should grant the franchisee a remedy. Dunkin‘ Doughnuts acted unfairly and wrongfully. The dietary restrictions Elkhatib observed are associated with his religion. Both Islamic and Jewish law prohibits the handling and consumption of pork.

381

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

The second group will take the side of Dunkin‘ Donuts and justify its decision to terminate the franchises. Solution Dunkin‘ Doughnuts (the franchisor) has a right to require franchisees to offer a uniform menu to protect its name and reputation. Quality standards are particularly important in chain-style business operations. Dunkin Doughnuts acted fairly and honestly when it notified Elkhatib that it would not allow relocation and would not renew his franchise agreement. Its reasons were not arbitrary. The court should issue a judgment in the defendants‘ favor.

The third group will assess whether Dunkin‘ Donuts acted in good faith in its relationship with Elkhatib. It will also consider whether Dunkin‘ Donuts should be required to accommodate Elkhatib‘s religious beliefs and allow him to not serve pork in these three locations. Solution Elkhatib‘s obligations under his current franchise agreement presumably requires all franchisees to carry the full food product line of Dunkin‘ Donuts. Because Elkhatib failed to carry the full line of food products, the franchisor would not extend his current franchise agreement or allow the relocation of his store. In determining whether a franchisor has acted in good faith when terminating a franchise agreement, the courts generally try to balance the rights of both parties. If the court perceives that the franchisor acted arbitrarily or unfairly, the court will grant the franchisee a remedy. In this situation, the court would consider the fact that the franchisee‘s refusal to offer breakfast sandwiches containing pork was based on his religious beliefs. Nonetheless, the court would balance this against the fact that the Dunkin‘ Doughnuts has a right to require its franchisees to offer a uniform menu to protect its name and reputation. Dunkin‘ Doughnuts acted in good faith. As for the franchisor‘s refusal to allow its franchisee‘s relocation, it is within a franchisor‘s rights to determine the location of a franchise.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 383 Case 31.1 ............................................................................................................................................... 383 Case 31.2 ............................................................................................................................................... 383 Case 31.3 ............................................................................................................................................... 384 Chapter Review ........................................................................................................................................................... 385 Practice and Review .............................................................................................................................. 385 Practice and Review: Debate This ......................................................................................................... 386 Issue Spotters ........................................................................................................................................ 386 Business Scenarios and Case Problems ................................................................................................. 387

382

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Critical Thinking and Writing Assignments ............................................................................................ 393

Critical Thinking Questions in Cases Case 31.1 148. Harun‘s income tax return and other documents prepared by the bookkeeper on behalf of Spice–N–Rice identified the business as a sole proprietorship. Should the appellate court have reversed the finding of a partnership on this basis? Explain. Solution No. The appellate court should not have reversed the finding of a partnership between Harun and Rashid on the basis stated in the question. The identification of the type of organization of a business on documents is not sufficient evidence of the existence of that organization. In the circumstance of an alleged partnership, essential factors include a sharing of profits, indications of joint ownership, and an apparent equal right to manage the business. The court found all of these factors in the Harun case. Also, as noted in the facts, the bookkeeper expressed concern about the reporting of Spice–N–Rice‘s income on Harun‘s tax return. This fact indicates that the bookkeeper knew the business was a partnership. 149. Suppose that the appellants had complained there was a lack of evidence of an agreement between Harun and Rashid to share losses. Would the result have been different? Why or why not? Solution No. If the appellants had complained there was a lack of evidence of an agreement between Harun and Rashid to share losses, the result would not have been different. The Uniform Partnership Act defines a partnership as ―an association of two or more persons to carry on as co-owners a business for profit.‖ The sharing of both profits and losses from a business is enough to create a presumption that a partnership exists. But an agreement to share losses is not necessary to create a partnership. In the absence of an agreement to the contrary, partnership losses are generally charged against each partner in accord with the partner‘s share of the business. Moreover, in the Harun case, and contrary to the assertion in the question, Rashid presented evidence that he and Harun agreed to share in the losses of the business. Consequently, even assuming an agreement to share losses is necessary to the existence of a partnership, the court found that it here.

Case 31.2 150. Suppose that Salmon had disclosed the proposed deal to Meinhard, who had said that he was not interested. Would the result in this case have been different? Explain. Solution Yes, because telling Meinhard about the offer would have met Salmon‘s fiduciary duty of loyalty to his partner. Without a breach of the duty, there would not have been the same ground on which to award Meinhard ―the value of half of the entire lease.‖

383

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Case 31.3 151. Could the partnership in this case have avoided the liquidation of its assets during the winding up process? Explain. Solution Yes, the partnership in this case could have avoided the liquidation of its assets during the winding up process if the partners had agreed on a different method for the distribution. Under Idaho partnership statutes, during the judicial dissolution and winding up of a partnership‘s business, the entity‘s assets must be sold and the cash realized on their sale distributed to the firm‘s creditors and partners—unless the partners agree to an alternate method for the distribution. In other words, the statutory requirements are default provisions. A partnership agreement cannot change the requirements that a dissolved partnership must be wound up, its liabilities discharged, and its assets marshaled and distributed. But an agreement can alter the default provisions of the Idaho statutes for the distribution of the assets. Partners who agree not to liquidate the assets can take a different course. One partner might buy out another‘s interest, for example, and continue the business. Guenther and Ryerson formed a partnership to buy land on Lost Sage Lane in Boise, Idaho, and develop a vineyard and build a house on the property. After expending considerable funds and effort in pursuit of the project, they agreed to dissolve the partnership. Guenther filed a suit in an Idaho state court for a judicial dissolution. In the Guenther case, of course, the parties initially did not, and later could not, agree on the method of distribution. This triggered the application of the Idaho default provisions. 152. How should the lower court, on remand, structure the sale of the partnership‘s Lost Sage Lane property? Discuss. Solution In winding up the business of a partnership, in a judicial dissolution under Idaho‘s partnership statutes, a court should seek to sell the entity‘s assets at their fair market value. Fair market value is the amount that a willing buyer, who desires to buy but is under no obligation to buy, would pay a willing seller, who desires to sell but is under no obligation to sell. To obtain fair market value, property should be sold at the highest price the market will bear. Thus, in the Guenther case, on remand, the court should order the Lost Sage Lane property to be sold on the open market at its fair market value. After all of the partnership‘s assets have been sold, the costs of the sale have been paid from its proceeds, and the firm‘s obligations to its creditors have been satisfied, the court can determine the amount of each partner‘s capital contribution. If the remaining proceeds are not enough to reimburse the partners for their uncompensated contributions, each partner should be paid a pro rata share based on their contributions. If the proceeds are sufficient to compensate the partners for their contributions, on the payment of those contributions, any remaining amount should be distributed based on each partner‘s right to share in the partnership‘s profits. In this case, because there was no partnership agreement, under Idaho partnership law, Guenther and Ryerson have a right to share equally in the partnership‘s profits

384

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Chapter Review Practice and Review Grace Tarnavsky and her sons, Manny and Jason, bought a ranch known as the Cowboy Palace in March 2019. The three orally agreed to share the business for five years. Grace contributed 50 percent of the investment, and each son contributed 25 percent. Manny agreed to handle the livestock, and Jason agreed to do the bookkeeping. The Tarnavskys took out joint loans and opened a joint bank account into which they deposited the ranch‘s proceeds and from which they made payments for property, cattle, equipment, and supplies. In September 2021, Manny severely injured his back while baling hay and became permanently unable to handle livestock. Manny therefore hired additional laborers to tend the livestock, causing the Cowboy Palace to incur significant debt. In September 2022, Al‘s Feed Barn filed a lawsuit against Jason to collect $32,400 in unpaid debts. Using the information presented in the chapter, answer the following questions. 153.

Was this relationship a partnership for a term or a partnership at will?

Solution This is a general partnership, and the facts in the scenario indicate that it is a partnership at will. A partnership agreement can limit the duration of a partnership to a certain date or a particular project. This would be a partnership for a term. If no fixed duration is specified, as in this scenario, a partnership is a partnership at will. 154. Did Manny have the authority to hire additional laborers to work at the ranch after his injury? Why or why not? Solution Yes. The principles of agency law apply to partnerships to give each partner all powers necessary to the carrying on of the ordinary business of the firm. In a general partnership, all partners have equal rights in managing the partnership. Often, in a large partnership, partners will delegate daily responsibilities to a management committee made up of one or more of the partners. Here, the partnership is not large, although the management did appear to be split among the partners. In that division of labor, it was Manny‘s responsibility to handle the livestock. After his injury, the responsibility was apparently still his, and he acted on it. Unanimous consent of all of the partners is required in some circumstances, but that none of those circumstances appear to exist here. 155. Under the UPA, can Al‘s Feed Barn bring an action against Jason individually for the Cowboy Palace‘s debt? Why or why not? Solution Yes. A partner is jointly and severally (separately, or individually) liable for all partnership obligations, including such debts as the one in this question, even if the partner did not participate in, ratify, or know about whatever it was that gave rise to the obligation. There was a step or two that the creditor in this question would have to take before succeeding in the suit against this partner, however. Generally, a creditor cannot collect a partnership debt from a partner of a non-bankrupt partnership without first attempting to collect from the partnership, or convincing a court that the attempt would not succeed.

385

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

156. Suppose that after his back injury in 2021, Manny sent his mother and brother notice indicating his intent to withdraw from the partnership. Can he still be held liable for the debt to Al‘s Feed Barn? Why or why not? Solution For two years after a partner dissociates from a continuing partnership, the partners may be liable for partnership obligations entered into during a two-year period following dissociation. In other words, the partner may be liable to a third party with whom the firm enters into a transaction if the third party reasonably believed that the dissociated partner was still a partner. This same principle applies to the liability of the firm for transactions entered into by dissociated partners within two years after their withdrawal. To avoid this possible liability, a partnership can notify its creditors, customers, and clients of a partner‘s dissociation, and file a statement of dissociation in a certain state office to limit the dissociated partner‘s authority. Presumably, the partner could take a similar action to reduce any potential liability.

Practice and Review: Debate This 157.

A partnership should automatically end when one partner disassociates from the firm.

Solution Prior to a change in the UPA, when a partner left the partnership, it had to be dissolved. That makes sense, given that any partnership is an association of named partners. A new partnership can be created without the partner who left. After all, one of the major distinctions between a corporation and a partnership used to be that the corporation was not dependent on people who owe shares in it. Now, it seems as if a partnership can live forever, too, even if partners come and go. It was an inefficient legal requirement before when the departure of a partner required the dissolution of the partnership. If we returned to the former law, we would again see partners wasting partnership assets, including the remaining partners‘ time, to dissolve the partnership and create a new one every time a partner left the firm. In any event, partnerships now survive for decades after one or more partners leave the firm, which shows that they are viable with a different set of partners.

Issue Spotters 158. Darnell and Eliana are partners in D&E Designs, an architectural firm. When Darnell dies, his widow claims that as Darnell‘s heir, she is entitled to take his place as Eliana‘s partner or to receive a share of the firm‘s assets. Is she right? Why or why not? Solution No. A widow (or widower) has no right to take a dead partner‘s place. A partner‘s death causes dissociation after which the partnership must purchase the dissociated partner‘s partnership interest. Therefore, the surviving partners must pay the decedent‘s estate (for his widow) the value of the deceased partner‘s interest in the partnership. 159. Finian and Gloria are partners in F&G Delivery Service. When business is slow, without Gloria‘s knowledge, Finian leases the delivery vehicles as moving vans. Because the vehicles would otherwise be sitting idle in a parking lot, can Finian keep the income that results from leasing the delivery vehicles? Explain your answer.

386

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Solution No. Under the partners‘ fiduciary duty, a partner must account to the partnership for any personal profits or benefits derived without the consent of all the partners in connection with the use of any partnership property. Here, the leasing partner may not keep the funds.

Business Scenarios and Case Problems 160. Partnership Formation. Daniel is the owner of a chain of shoe stores. He hires Rubya to be the manager of a new store, which is to open in Grand Rapids, Michigan. Daniel, by written contract, agrees to pay Rubya a monthly salary and 20 percent of the profits. Without Daniel‘s knowledge, Rubya represents himself to Classen as Daniel‘s partner, showing Classen the agreement to share profits. Classen extends credit to Rubya. Rubya defaults. Discuss whether Classen can hold Daniel liable as a partner. (See Formation and Operation.) Solution Classen cannot hold Daniel liable as a partner, because a true partnership never existed; nor is Daniel liable under a theory of partnership by estoppel. A partnership is defined as an association of two or more persons to conduct, as co-owners, a business for profit [UPA 101(6)]. To determine that a partnership was created, the court must look for a sharing of profits and a joint ownership of the business, with each party having an equal right to manage the business. When specific evidence that this situation existed is lacking, some guidelines are applied. First, the sharing of profits from a business is prima facie evidence of the existence of a partnership, unless such sharing is by means of one party receiving wages as an employee [UPA 202(c)(3)]. Rubya is not a co-owner of the business and his share of profits is partially the means of paying his salary. Therefore, a partnership is not created, and Daniel is not liable as a partner. To be liable as a partner by estoppel, Daniel must either have represented himself to Classen as Rubya‘s partner or have impliedly (or expressly) consented to Rubya‘s representing himself as a partner. Because Daniel did not even know of Rubya‘s assertions and did nothing to lead Classen to believe he was Rubya‘s partner, Classen can look only to Rubya for payment of the debt. No partnership by estoppel was created. 161. Limited Partnership. Dorinda, Luis, and Elizabeth form a limited partnership. Dorinda is a general partner, and Luis and Elizabeth are limited partners. Discuss fully whether each of the separate events below constitutes a dissolution of the limited partnership. (See Limited Partnerships.) 1. Luis assigns his partnership interest to Ashley. Solution A limited partner‘s interest is assignable. In fact, assignment allows the assignee to become a substituted limited partner with the consent of the remaining partners. The assignment does not dissolve the limited partnership. 2.

Elizabeth is petitioned into involuntary bankruptcy. Solution Bankruptcy of the limited partnership itself causes dissolution, but bankruptcy of one of the limited partners does not dissolve the partnership unless it causes the bankruptcy of the firm.

Dorinda dies.

387

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

Solution The retirement, death, or insanity of a general partner dissolves the partnership unless the business can be continued by the remaining general partners. Because Dorinda was the only general partner, her death dissolves the limited partnership. 162. Winding Up. Dan and Lori Cole operated a Curves franchise exercise facility in Angola, Indiana, as a partnership. The firm leased commercial space from Flying Cat, LLC, for a renewable three-year term. The Coles renewed the lease for a second three-year term. Two years later, however, the Coles divorced. By the end of the second term, the Coles owed Flying Cat more than $21,000 on the lease. Without telling the landlord about the divorce, Lori signed another extension. More rent went unpaid. Flying Cat obtained a judgment in an Indiana state court against the partnership for almost $50,000. Can Dan be held liable? Why or why not? [Curves for Women Angola v. Flying Cat, LLC, 983 N.E.2d 629 (Ind.App. 2013)] (See Dissociation and Termination.) Solution Yes. Dan can be held liable for the amount of the debt owed to Flying Cat. Even after a partnership has been dissolved, a partner may still bind the firm by engaging in a transaction that would have bound the partnership if it had not been dissolved, provided the other party to the transaction had known of the partnership before dissolution and had no knowledge or notice of the dissolution. In this problem, the Coles operated their business as a partnership during their marriage. The partnership was dissolved by the parties‘ divorce, but Dan could be held liable under the extension of the lease entered into by Lori alone after the divorce. The lease fell within the scope of the former partnership‘s business. The lease was executed with the authority that would have bound the firm if it had not been dissolved. And the landlord did not have notice that the Coles, who had held themselves out as partners during the previous lease terms, had dissolved their partnership. In the actual case on which this problem is based, in the landlord‘s suit to collect on the judgment, the court ruled in Flying Cat‘s favor. Dan appealed, claiming that he was not liable. A state intermediate appellate court held that he was—although the partnership was dissolved when the couple divorced, the landlord had no notice of the dissolution. 163. Business Case Problem with Sample Answer— Partnerships. Karyl Paxton asked Christopher

Sacco to work with her interior design business, Pierce Paxton Collections, in New Orleans. At the time, they were in a romantic relationship. Sacco was involved in every aspect of the business— bookkeeping, marketing, and design—but was not paid a salary. He was reimbursed, however, for expenses charged to his personal credit card, which Paxton also used. Sacco took no profits from the firm, saying that he wanted to ―grow the business‖ and ―build sweat equity.‖ When Paxton and Sacco‘s personal relationship soured, she fired him. Sacco objected, claiming that they were partners. Is Sacco entitled to 50 percent of the profits of Pierce Paxton Collections? Explain. [Sacco v. Paxton, 133 So.3d 213 (La.App. 2014)] (See Formation and Operation.) —For a sample answer to Problem 31–4, go to Appendix E. Solution Yes. Sacco is entitled to 50 percent of the profits of Pierce Paxton Collections, PPDS, and KPD. The requirements for establishing a partnership are (1) a sharing of profits and losses, (2) a joint

388

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

ownership of the business, and (3) an equal right to be involved in the management of the business. The effort and time that Sacco expended in the business constituted a sharing of losses, and his proprietary interest in the assets of the partnership consisted of his share of the profits, which he had expressly left in the business to ―grow the company‖ and ―build sweat equity‖ for the future. He was involved in every aspect of the business. Although he was not paid a salary, he was reimbursed for business expenses charged to his personal credit card, which Paxton also used. These facts arguably meet the requirements for establishing a partnership. In the actual case on which this problem is based, Sacco filed a suit in a Louisiana state court against Paxton, and the court awarded Sacco 50 percent of the profits. A state intermediate appellate court affirmed, based generally on the reasoning stated above. 164. Formation. Leisa Reed and Randell Thurman lived together in Spring City, Tennessee. Randell and his father, Leroy, formed a cattle-raising operation and opened a bank account in the name of L&R Farm. Within a few years, Leroy quit the operation. Leisa and Randell each wrote a personal check for $5,000 to buy his cattle. Leisa picked up supplies, fed and administered medicine to cattle, collected hay, and participated in the bookkeeping for L&R. Later, checks drawn on her personal account for $12,000 to buy equipment and $35,000 to buy cattle were deposited into the L&R account. After several years, Leisa decided that she no longer wanted to associate with Randell, but they could not agree on a financial settlement. Was Leisa a partner in L&R? Is she entitled to half of the value of L&R‘s assets? Explain. [Reed v. Thurman, 2015 WL 1119449 (Tenn.App. 2015)] (See Formation and Operation.) Solution Yes. Leisa was a partner in L&R. In the circumstances of this problem, she is entitled to half of the value of the partnership‘s assets. Under the UPA, a partnership is ―an association of two or more persons to carry on as co-owners a business for profit.‖ When there is no formal, written partnership agreement, an agreement to form a partnership can be implied by conduct. If an agreement does not apportion profits and losses, the UPA provides that they will be shared equally. On a partner‘s dissociation, partners are entitled to have their interest in the partnership bought by the firm. Here, Randell and Leroy formed a cattle-raising operation and opened a bank account in the name of L&R Farm. When Leroy quit the operation, Leisa and Randell each wrote a personal check for $5,000 to buy his cattle. Meanwhile, Leisa picked up supplies, fed and administered medicine to cattle, collected hay, and participated in L&R‘s bookkeeping. Later, checks drawn on her personal account for $12,000 to buy equipment and $35,000 to buy cattle were deposited into the L&R account. An implied partnership arose between Randall and Leisa when she wrote a personal check to buy the cattle from Leroy for L&R. On her quitting the firm, she was entitled to half of the value of the remaining L&R cattle, the funds in the L&R account, and the equipment bought during her time as a partner. In the actual case on which this problem is based, Leisa filed a suit in a Tennessee state court against Randell, seeking a declaration that she was a partner in the cattle operation. Randell denied that they were partners. The court issued a judgment in Leisa‘s favor. A state intermediate appellate court affirmed this judgment in accord with the reasoning stated above.

389

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

165. Formation and Operation. FS Partners is a general partnership whose partners are Jerry Stahlman, a professional engineer, and Fitz & Smith, Inc., a corporation in the business of excavating and paving. Timothy Smith signed the partnership agreement on Fitz & Smith‘s behalf and deals with FS matters on Fitz & Smith‘s behalf. Stahlman handles the payment of FS‘s bills, including its tax bills, and is the designated partner on FS‘s federal tax return. FS was formed to buy and develop twenty acres of unoccupied, wooded land in York County, Pennsylvania. The deed to the property lists the owner as ―FS Partners, a general partnership.‖ When the taxes on the real estate were not paid, the York County Tax Claim Bureau published notice that the property would be sold at a tax sale. The bureau also mailed a notice to FS‘s address of record and posted a notice on the land. Is this sufficient notice of the tax sale? Discuss. [FS Partners v. York County Tax Claim Bureau, 132 A.3d 577 (Pa. 2016)] (See Formation and Operation.) Solution Yes. The notice published by the York County Tax Bureau, mailed to FS‘s address of record, and posted on the partnership‘s land, declaring that it would be sold at a sale for unpaid taxes, was sufficient. Property acquired by a partnership is the property of the partnership and not of the partners individually. This includes property that was acquired by the partnership or in the partnership‘s name after its formation. A partner is not a co-owner of partnership property and has no right to sell, mortgage, or transfer it to another. Here, FS Partners is a general partnership. The partners are Stahlman and Fitz & Smith, Inc. Timothy Smith represents Fitz & Smith in FS matters. Stahlman handles the payment of FS‘s bills, including its tax bills, and is the designated partner on FS‘s federal tax return. FS was formed to buy and develop certain land in York County, Pennsylvania. The deed lists the owner as ―FS Partners, a general partnership.‖ When the taxes on the land were not paid, the York County Tax Claim Bureau published, mailed, and posted notice that the property would be sold at a tax sale. This is sufficient notice—the individual partners do not need to be notified separately. A general partnership can hold title to property in its own name. Although one partner in a general partnership does not have the authority to bind the partnership to a sale of the partnership‘s property, a notice with respect to that property does not need to be sent to all of the partners. In fact, notice to the partnership, or to any partner in the partnership, concerning partnership affairs, is sufficient. In the actual case on which this problem is based, the land was sold at a tax sale. Later, FS filed a petition to set aside the sale, challenging the sufficiency of the notice. The court confirmed the sale. On the reasoning stated here, a state intermediate appellate court affirmed. 166. Dissociation and Termination. Marc Malfitano and seven others formed Poughkeepsie Galleria as a partnership to own and manage a shopping mall in New York. The partnership agreement stated that ―all decisions to be made by the Partners shall be made by the casting of votes‖ with ―no less than fifty-one percent‖ of the partners ―required to approve any matter.‖ The agreement also provided that the partnership would dissolve on ―the election of the Partners‖ or ―the happening of any event which makes it unlawful for the business . . . to be carried on.‖ Later, Malfitano decided to dissociate from the firm and wrote to the other partners, ―I hereby elect to dissolve the Partnership.‖ Did Malfitano have the power and the right to dissociate from Poughkeepsie Galleria? Could he unilaterally dissolve the partnership? Can the other partners continue the business? Which, if any, of these actions violate the partnership agreement? Discuss.

390

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

[Congel v. Malfitano, 101 N.E.3d 341, 2018 WL 1473551 (N.Y.S.2d 2018)] (See Dissociation and Termination.) Solution Malfitano had the power and the right to dissociate from Poughkeepsie Galleria, and his notice to the other partners effectively dissolved the partnership. But the dissolution violated the partnership agreement. Therefore, the others could lawfully continue the business. A partner always has the power to dissociate from a partnership, but may rightfully do so only if the withdrawal does not breach the partnership agreement. A partner can dissociate by voluntarily giving notice of intent to withdraw. The remaining partners can decide whether to continue the business. If the decision is to cease, the partner‘s dissociation dissolves the firm. A partnership may also be dissolved by an agreement of the partners, or by the occurrence of an event identified in the partnership agreement. In this problem, the agreement provided that the partnership would dissolve on ―the election of the Partners‖ or ―the happening of any event which makes it unlawful for the business‖ to continue. The agreement also stated that ―all decisions‖ were ―to be made by the Partners . . . by . . . votes‖ with ―no less than fifty-one percent‖ of the partners ―required to approve any matter.‖ When Marc Malfitano, one of the partners, decided to dissociate from the firm, he wrote to the others, ―I hereby elect to dissolve the Partnership.‖ Malfitano‘s dissociation does not appear to have violated the partnership agreement. His unilateral dissolution of the firm, however, was wrongful—the conditions stated in the agreement for dissolution had not occurred. In the actual case on which this problem is based, the remaining partners filed a suit in a New York state court against Malfitano, alleging that his action breached the partnership agreement. The court issued a judgment in the plaintiffs‘ favor, which a state intermediate appellate court upheld. The New York Court of Appeals affirmed. 167. A Question of Ethics—The IDDR Approach and a Partner’s Fiduciary Duty. Floyd Finch and Bruce Campbell were partners in a law firm. They did not have a written partnership agreement, but they shared the firm‘s expenses and profits equally. The partnership operated on a cash basis, using billing software to track time spent on client matters. Instead of using the software, however, Finch would review e-mails and other work product to create and generate bills months or years after the work had been performed. As a result, large amounts of the firm‘s accounts receivable were uncollectible. Upset over the lost revenue, Campbell filed a claim in a Missouri state court against Finch. Campbell argued that failing to bill clients in a timely manner was a breach of a partner‘s fiduciary duty. He alleged that Finch was trying to lower his income because he was involved in divorce proceedings. Finch responded that billing clients was a matter of partnership management and operation reserved to the judgment of each partner. [Finch v. Campbell, 541 S.W.3d 616 (Mo.App.W.D. 2017)] (See Formation and Operation.) 1.

Is Finch‘s billing practice a breach of ethics? Explain, using the IDDR approach. Solution Yes. Finch‘s billing method is a breach of ethics.

391

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

The first step of the IDDR approach is an Inquiry, which involves a statement of the ethical issue, its stakeholders, and the relevant standards. In this problem, the issue concerns how a partner bills the firm‘s clients. The stakeholders include the Campbell and Finch partnership, the partners, and their employees, creditors, and clients. The relevant standards include the applicable professional code, state accounting and business laws, and the ethical principle of honesty. The next steps of the IDDR approach are a Discussion and a Decision. The former considers actions to resolve the issue, with their strengths and weaknesses. The latter involves a choice of action, and its consequences and effects. In terms of the billing issue, a partner might use the partnership‘s generally accepted accounting practice. Or the partner might elect to follow a different procedure. The strongest choice would be accurate and fair, and result in the quickest payment of the entire amounts owed. In this case, the firm used billing software to keep track of the time spent on a client matter. Finch chose not to use the software. Instead, he reviewed his work months or years after its completion to create and generate a bill. This led to large amounts of the firm‘s accounts receivable being uncollectable. This effect indicates the weakness of Finch‘s method. The last step of the IDDR approach is a Review of the success or failure of the action to resolve the issue and satisfy the stakeholders. Finch‘s choice to substitute the partnership‘s billing software with his own ad hoc method was an ethical failure. It was probably inaccurate, due to the passage of time and the nature of the records used to create the bills. It was unfair to the partnership and its clients, who would benefit from a more timely assessment. It was unsatisfactory to the partners, as shown by Campbell‘s suit, because of the loss of revenue to the firm. For the same reason, there might have been a negative impact on the income of the firm‘s employees and the payments to its creditors. Finally, if Campbell‘s allegation is true—that Finch was only trying to lower his income for his divorce proceedings—then Finch was acting in his personal interest, not in the best interest of the partnership. That Finch did not admit this would indicate a lack of honesty on his part towards his firm (and his spouse) and point further to a breach of ethics. 2.

Finch asserted that there must be self-dealing for a partner‘s act to be a breach of fiduciary duty. Is he correct? Discuss. Solution No. Finch is not correct. Self-dealing is not necessary for a partner‘s act to be a breach of fiduciary duty. A partner owes a fiduciary duty to the partnership and its partners. This duty can be breached in a variety of ways. There is no requirement of a profit or an attempt to profit for an act to constitute a breach. Harm to the firm or a partner is sufficient.

392

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

In this case, Finch was a partner in the Campbell and Finch law firm. As a partner, he owed a fiduciary duty to the firm and its partners. This included a duty to record and facilitate the firm‘s collection of fees for work performed. But Finch did not bill his clients in a timely manner. As a consequence, not all amounts billed were paid. This harmed the partnership and its partners in the form of decreased revenue. The late billing also likely led to client dissatisfaction, which would have further harmed the firm. Campbell was upset. As part of his claim against Finch charging a breach of fiduciary duty, Campbell argued that Finch intentionally failed to bill clients appropriately because he wanted to lower his income for his divorce proceedings. A partner‘s fiduciary duty to a partnership includes putting the interest of the firm before the partner‘s self-interest. If Campbell‘s argument were true, it would indicate that Finch put his own interest ahead of those of the partnership. This would be a violation of his fiduciary duty to the partnership. In the actual case on which this problem is based, Finch and Campbell filed claims against each other, alleging breaches of fiduciary duty. The state trial court awarded Campbell a judgment against Finch. A state intermediate appellate court affirmed the award. ―Finch failed to timely bill his clients, possibly to lower his income for his divorce proceedings. This was a violation of Finch‘s fiduciary duty to the partnership.‖

Critical Thinking and Writing Assignments 168. Business Law Writing. Sandra Lerner and Patricia Holmes were friends. One evening, while applying nail polish to Lerner, Holmes layered a raspberry color over black to produce a new color, which Lerner liked. Later, the two created other colors with names like ―Bruise,‖ ―Smog,‖ and ―Oil Slick,‖ and titled their concept ―Urban Decay.‖ Lerner and Holmes started a firm to produce and market the polishes but never discussed the sharing of profits and losses. They agreed to build the business and then sell it. Together, they did market research, worked on a logo and advertising, obtained capital, and hired employees. Then Lerner began scheming to edge Holmes out of the firm. (See Formation and Operation.) 1.

Lerner claimed that there was no partnership agreement because there was no agreement on how to divide profits. Was Lerner right? Why or why not? Solution A court would likely rule in favor of Holmes on this issue. An express agreement to divide profits is not a prerequisite to the existence of a partnership. Under the UPA, association with the intent to carry on a business for profit is the essential requirement for a partnership. In other words, profit sharing is evidence of a partnership, but not a required element of the definition of a partnership. The important factor is the intent of the parties as expressed in their agreement, through their conduct, and by the surrounding circumstances. Implicit in the Holmes-Lerner agreement, as in any other partnership‘s agreement, would be an understanding to share in profits and losses as any business owners would.

Suppose that Lerner, but not Holmes, had contributed a significant amount of personal funds to developing and marketing the new nail polish. Would this entitle Lerner to receive more of the profit? Explain. Solution

393

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 31: All Forms of Partnership

The amount of a partner‘s financial contribution to a partnership does not determine the partner‘s share of the firm‘s profits (or the partner‘s share of the firm‘s losses). Profits (and losses) are divided equally, unless an agreement among or between the partners provides otherwise. 3.

Did Lerner violate her fiduciary duty? Why or why not? Solution Lerner‘s attempt to freeze Holmes out of the partnership could be seen as a breach of the partners‘ fiduciary duties to one another. Such a breach could also be described as unethical. The agreement between Holmes and Lerner was to take Holmes‘ idea and reduce it to concrete form. They engaged in the entire process together. Then, Holmes began to be frozen out of the business, in apparent violation of her agreement with Lerner. The parties‘ agreement and their subsequent acts determine the existence of a breach and a remedy.

169. Time-Limited Group Assignment—Partnership Formation and Operation. At least six months before the Summer Olympic Games in Atlanta, Georgia, a group made up of Stafford Fontenot, Steve Turner, Mike Montelaro, Joe Sokol, and Doug Brinsmade agreed to sell Cajun food at the games and began making preparations. On May 19, the group (calling themselves Prairie Cajun Seafood Catering of Louisiana) applied for a business license with the county health department. Ted Norris sold members of the group a mobile kitchen in return for an $8,000 check drawn on the ―Prairie Cajun Seafood Catering of Louisiana‖ account and two promissory notes, one for $12,000 and the other for $20,000. The notes, which were dated June 12, listed only Fontenot ―d/b/a Prairie Cajun Seafood‖ as the maker (d/b/a is an abbreviation for ―doing business as‖). On July 31, Fontenot and his friends signed a partnership agreement, which listed specific percentages of profits and losses. They drove the mobile kitchen to Atlanta, but business was disastrous. When the notes were not paid, Norris filed a suit in a Louisiana state court against Fontenot, seeking payment. (See Formation and Operation.) 1.

The first group will discuss the elements of a partnership and determine whether there was a partnership among Fontenot and the others.

Solution Partnership agreements can be oral, written, or implied by contract. The elements of a partnership are (1) a sharing of profits and losses, (2) a joint ownership of the business, and (3) an equal right to be involved in the management of the business. Several months before the Olympics, Fontenot and his friends agreed to sell Cajun food in Atlanta and on May 19 applied for a license as a group. Although the partnership agreement was not signed until July 31, Fontenot and his friends had an oral agreement to form an association and to work together toward a common goal before they purchased the mobile kitchen on June 12. At that point, a partnership existed between Fontenot and his friends. In other words, in signing the notes, Fontenot entered into the act of sale on behalf of the partnership. 2. The second group will determine who can be held liable on the notes and why. Solution The partnership and all of the partners jointly or severally are liable on the notes. In other words, each partner can be held individually and personally liable on the notes, but could obtain reimbursement for the liability from the partnership and the other partners. Of course, the partnership assets must be exhausted before a judgment could be enforced against the personal assets of individual partners. Fontenot and his friends agreed to sell Cajun food in

394

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Atlanta and on May 19 applied for a license as a group. Although the partnership agreement was not signed until July 31, Fontenot and his friends had an oral agreement to form an association and to work together toward a common goal before they bought the mobile kitchen on June 12. Thus, in signing the notes, Fontenot entered into the act of sale on behalf of the partnership.

3. The third group will discuss the concept of ―d/b/a,‖ or ―doing business as.‖ Does a person who uses this designation when signing checks or promissory notes avoid liability on the checks or notes? Solution No. A person who signs ―d/b/a,‖ or ―doing business as,‖ as part of the signature on a check or a note does not thereby generally avoid liability for payment of the item. A partner is a general agent of the partnership in carrying out the usual business of the firm. A partner has the authority to bind the partnership to a contract. And a partner is generally liable for the firm‘s obligations. Every contract, including checks and notes, signed in the partnership‘s name binds the firm and its partners. Of course, this assessment of liability assumes that the partner acted within the scope of the partnership‘s business and had the authority to do so. If not, and the payee of the note or check knew it, then the person who signed the item is liable on it, but neither the partnership nor the other partners are not. To apply these principles to the facts in this problem, Prairie Cajun Seafood, and Fontenot and all of the other partners are jointly or severally liable on the notes that Fontenot signed ―d/b/a.‖ These same parties are likewise liable for payment of the check drawn on the Prairie Cajun account. That is, each partner, including Fontenot, could be held individually and personally liable on all of the items.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 396 Case 32.1 ............................................................................................................................................... 396 Case 32.2 ............................................................................................................................................... 397 Case 32.3 ............................................................................................................................................... 398 Chapter Review ........................................................................................................................................................... 398 Practice and Review .............................................................................................................................. 398 Practice and Review: Debate This ......................................................................................................... 400 Issue Spotters ........................................................................................................................................ 400 Business Scenarios and Case Problems ................................................................................................. 401

395

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Critical Thinking and Writing Assignments ............................................................................................ 409

Critical Thinking Questions in Features Managerial Strategy 170. Should a manager for an LLC respond to employee complaints of discrimination any differently from a manager at a corporation, a partnership, or a sole proprietorship? Why or why not? Solution Every manager, no matter what the organizational form of employment, must be keenly aware that some employees may be acting in a manner that is not only illegal but also morally indefensible. In today‘s world, especially in the United States, what might have been acceptable behavior in the past is unacceptable behavior. 171. How can a company, whether an LLC or some other business form, reduce the possibility of discrimination lawsuits? Solution Managers should be given a course in ethics training. They should also strive to create a workplace that promotes tolerance and diversity and discourages discrimination on any basis. These managers should then be responsible for passing along to employees the ethical standard that the company expects of each person working in the establishment. Everyone in the firm should know what kind of remarks cross the line and potentially expose the company to liability. Also, clear-cut procedures for filing discrimination complaints must be provided to both managers and employees.

Critical Thinking Questions in Cases Case 32.1 172. Besides the ―exceptional circumstances‖ noted by the court in the Nesset case, in what situations might an LLC‘s member or manager be personally liable for the liability of the company? Explain. Solution Under most circumstances, a member or manager of a limited liability company is not liable for a debt, obligation, or other liability of the firm. Situations in which piercing the veil of an LLC might be warranted include, as noted by the court in the Nesset case, that the company is undercapitalized, lacks separate books or finances, promotes a fraud or illegality, or is otherwise ―merely a sham.‖ Although ―sham‖ can encompass considerable potential grounds for the personal liability of an LLC‘s member or manager in the context of the firm‘s obligations, this list is not exhaustive. A member or manager may be liable for the breach of a professional duty. A licensed engineer, for example, might be personally liable for the harm caused by the faulty design of a product marketed by the LLC to an injured plaintiff. Some other negligent or wrongful act might also serve

396

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

as the predicate for personal liability when a member or manager owed a duty of care to a plaintiff beyond the LLC‘s contractual obligations. A statute can impose personal liability. For example, personal liability might be ascribed to a member or manager who is assumed under a state‘s tax code to be responsible for the collection and remittance of the tax. Of course, a member or manager of an LLC is personally liable for their own torts or crimes, for which, depending on the circumstances, the company might also be held to account. 173. Why does the law allow—and even encourage—limits on the liability of a business organization‘s owners and managers for the firm‘s actions? Discuss. Solution The law allows, and encourages, limits to the liability of a business organization‘s owners and managers for the firm‘s actions in order to facilitate business investment, which contributes to a more thriving economy. Imposing personal liability in all circumstances on the owners and operators would tend to discourage investment by providing a disincentive to going into business at all. Of course, as noted in the court‘s opinion in the Nesset case, there are exceptions. Particularly when a business form is used to perpetrate fraud or commit other wrongdoing, personal liability may be assessed. But in situations that do not fall within the exceptions, a party who claims injury, damage, or loss through the actions of a business firm must normally seek relief through the assets of the firm, not those of its owners and managers.

Case 32.2 174. The operating agreement stated that an ―aggrieved party may pursue all redress permitted by law,‖ including attorneys‘ fees. Under this provision, would Schaefer be entitled to an award of attorneys‘ fees even though the trial court granted Orth‘s motion for a directed verdict? Discuss. Solution No. Schaefer is not entitled to an award of attorneys‘ fees under the operating agreement‘s provision that allows the pursuit of ―all redress permitted by law.‖ Of course, attorneys‘ fees can be part of the ―redress permitted by law.‖ But Schaefer has no redress at law against Orth for the damages Schaefer sought on his breach of contract claim—that is, Schaefer‘s unpaid salary and bonuses—because Orth was not personally liable for those amounts. Under the parties‘ operating agreement, the LLC, not Orth, was responsible. In these circumstances, it would be absurd to conclude that, even though Orth is not personally responsible to pay Schaefer‘s claim, the operating agreement makes him personally liable for the unsuccessful plaintiff‘s attorneys‘ fees. It is a legal maxim applicable here that a contract should be interpreted to avoid an absurd result. 175.

Could Schaefer have sued the LLC to recover his unpaid salary and bonuses? Explain.

Solution Yes. Schaefer could have sued the LLC to recover his unpaid salary and bonuses. The operating agreement expressly made the LLC responsible for the payment of Schaefer‘s salary and bonuses.

397

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

At trial, both Schaefer and Orth testified that it was the LLC‘s responsibility to pay those amounts. It appears to be undisputed that Schaefer performed the restaurant‘s day-to-day operations for which he was entitled to be paid. It appears to be further undisputed that the LLC did not pay him for some of his service. Under these circumstances, Schaefer clearly had a claim against the LLC for the unpaid salary and bonuses. The LLC was not a party to the operating agreement, but Schaefer could base a claim against the company on quasi contract. The argument could be that the LLC was unjustly enriched by the provision of his service for which he was not paid. A cause founded on quasi contract does not require the existence of a formal, written contract between a plaintiff and defendant.

Case 32.3 176. Newman alleged that after she delivered her notice to dissolve ANR, Reese locked her out of the LLC‘s bank accounts, blocked her access to the LLC‘s files and e-mail, and ended her salary and health benefits. Do these allegations, if proved, support or refute the court‘s decision to dissolve the firm? Explain. Solution Newman‘s allegations, if proved, would lend support to the court‘s decision to dissolve the parties‘ LLC. Reese and Newman were the owners of ANR Construction Management, LLC, but could not agree over the company‘s management. Newman told Reese that she was going to dissolve and wind up the firm. Reese wanted Newman to dissociate from ANR, so that Reese could continue the business. This dispute led to Newman‘s filing a suit against Reese, seeking an order of dissolution. Newman then alleged that after she delivered her notice of intent to dissolve ANR, Reese locked Newman out of the LLC‘s bank accounts, blocked her remote access to the LLC‘s files and e-mail, and ended her salary and health benefits. Newman asked the court to enjoin Reese from any further action intended to dissociate Newman from the LLC. Following a trial, a jury found grounds for both ANR‘s dissolution and Newman‘s dissociation. In support of dissolution, the jury found that Reese acted in an illegal or fraudulent manner that was or would be directly harmful to Newman. The court chose to exercise its discretion under the state statutes governing dissociation and dissolution to order the dissolution of ANR but not the expulsion of Newman. On Reese‘s appeal, a state intermediate appellate court affirmed the exercise of discretion and the lower court‘s decision as a result.

Chapter Review Practice and Review The city of Papagos, Arizona, had a deteriorating bridge in need of repair on a prominent public roadway. The city posted notices seeking proposals for an artistic bridge design and reconstruction. Davidson Masonry, LLC—owned and managed by Carl Davidson and his wife, Marilyn Rowe—decided to submit a bid for a decorative concrete project that incorporated artistic metalwork. They contacted Shana Lafayette, a local sculptor who specialized in large-scale metal creations, to help them design the bridge. The city selected their bridge design and awarded them the contract for a commission of $184,000. Davidson Masonry and Lafayette then entered into an agreement to work together on the bridge project.

398

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Davidson Masonry agreed to install and pay for concrete and structural work, and Lafayette agreed to install the metalwork at her expense. They agreed that overall profits would be split, with 25 percent going to Lafayette and 75 percent going to Davidson Masonry. Lafayette designed numerous metal salmon sculptures that were incorporated into colorful decorative concrete forms designed by Rowe, while Davidson performed the structural engineering. The group worked together successfully until the completion of the project. Using the information presented in the chapter, answer the following questions. 177. Would Davidson Masonry automatically be taxed as a partnership or a corporation? Explain. Solution This limited liability company (LLC) would be taxed as a partnership unless it opted to be taxed as a corporation. With a few exceptions, any LLC with at least two members can choose whether to be taxed as a partnership or a corporation. (A one-member LLC is taxed as a sole proprietorship unless it chooses to be taxed as a corporation.) If a firm prefers to be taxed as a corporation, it can check a box on a certain federal tax form to indicate this choice. Taxed as a partnership, an LLC would pay no taxes: its profits would be ―passed through‖ to its members, who would however pay taxes on the profits. The corporate taxing option might be preferable to LLC members who want to reinvest the profits in the business, because corporate tax rates are often lower than personal tax rates. 178.

Is Davidson Masonry member managed or manager managed?

Solution In a member-managed LLC, all members participate in management, and decisions are made by majority vote. In a manager-managed firm, the members designate managers, who may or may not be members of the firm. The LLC in this problem is a member-managed firm—the owners are the managers. 179. When Davidson Masonry and Lafayette entered into an agreement to work together, what kind of special business form was created? Explain. Solution These parties formed a joint venture. In a joint venture, two or more persons or entities combine their efforts or property for a single transaction or project or a related series of transactions or projects. The elements of a joint venture are (1) a contract to engage in a common undertaking; (2) the parties‘ contributions of money, property, time, or skill to it; (3) an interest in, and mutual right to control, its property; and (4) an agreement to share its profits. The agreement between the parties in this problem and their subsequent conduct meets all of these requirements. 180. Suppose that during construction, Lafayette entered into an agreement to rent space in a warehouse that was close to the bridge so that she could work on her sculptures near the location where they would be installed. She entered into the contract without the knowledge or consent of Davidson Masonry. In this situation, would a court be likely to hold that Davidson Masonry was bound by the contract? Why or why not? Solution

399

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Yes, because most courts apply the same principles to joint ventures as they apply to partnerships. A joint venturer can be held personally liable for the debts incurred on the venture‘s behalf (because joint venturers share profits and losses). No, because joint ventures differ from partnerships in some significant ways. Joint venturers have less implied and apparent authority to bind their venture than partners do to bind their partnership, because the activities of a venture are more limited than the business of a partnership.

Practice and Review: Debate This 181. Because LLCs are essentially just partnerships with limited liability for members, all partnership laws should apply. Solution While there are certainly some differences between how LLCs operate relative to how partnerships operate, the similarities are sufficiently obvious that no new laws or operating rules need be created for LLCs, except with respect to the limited liability of LLC members. The law of partnerships has a long history, one that has created a solid body of case law that should be applied to LLCs, too. Yes, LLCs do resemble partnerships in many respects. But since their humble beginnings in 1997, they have become a form of business organization in their own rights. Why shouldn‘t business owners be allowed to choose from the largest array of business organizations possible? The more that LLCs are used, the more they will gradually become increasingly distinct from partnerships. Blanket application of partnership law to LLCs would stifle their development.

Issue Spotters 182. Gabriel, Harry, and Ida are members of Jeweled Watches, LLC. What are their options with respect to the management of their firm? Solution The members of a limited liability company (LLC) may designate a group to run their firm, in which situation the firm would be considered a manager-managed LLC. The group may include only members, only nonmembers, or members and nonmembers. If instead, all members participate in management, the firm would be a member-managed LLC. In fact, unless the members agree otherwise, all members are considered to participate in the management of the firm. 183. Greener Delivery Company and Hiway Trucking, Inc., form a business trust. Insta Equipment Company and Jiffy Supply Corporation form a joint stock company. Kwik Mart, Inc., and Luscious Produce, Inc., form an incorporated cooperative. What do these forms of business organization have in common? Solution Although there are differences, all of these forms of business organizations resemble corporations. A joint stock company, for example, features ownership by shares of stock, it is managed by directors and officers, and it has perpetual existence. A business trust, like a corporation, distributes profits to persons who are not personally responsible for the debts of the organization, and management of the business is in the hands of trustees, just as the management of a corporation is in the hands of directors and officers.

400

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

An incorporated cooperative, which is subject to state laws covering nonprofit corporations, distributes profits to its owners.

Business Scenarios and Case Problems 184. Limited Liability Companies. John, Lesa, and Trevor form a limited liability company. John contributes 60 percent of the capital, and Lesa and Trevor each contribute 20 percent. Nothing is decided about how profits will be divided. John assumes that he will be entitled to 60 percent of the profits, in accordance with his contribution. Lesa and Trevor, however, assume that the profits will be divided equally. A dispute over the profits arises, and ultimately a court has to decide the issue. What law will the court apply? In most states, what will result? How could this dispute have been avoided in the first place? Discuss fully. (See The Limited Liability Company.) Solution Limited liability company (LLC) operating agreements typically state how profits will be divided. An operating agreement is not necessary for the formation of an LLC, and even if there is an operating agreement, it does need not to be in writing. Generally, though, members protect their interests by signing a written operating agreement that spells out the terms of their LLC, including a division of profits and losses. If there is no agreement covering how profits will be divided, the applicable state LLC statute will govern. Most LLC statutes provide that if members do not specify how profits are to be divided, they will be divided equally. If there is no operating agreement or LLC statute addressing the particular issue, the principles of partnership law apply. Those principles also indicate that profits are divided equally among the owners of a firm unless specified otherwise. 185. Special Business Forms. Faraway Corp. supplies business equipment. Faraway is considering entering into two contracts, one with a joint stock company east of the Mississippi River and the other with a business trust formed by a number of sole proprietors on the West Coast. Both contracts require Faraway to make large capital outlays in order to supply the businesses with restaurant equipment. In both business organizations, at least two shareholders or beneficiaries are personally wealthy, but each organization has limited financial resources. The owner-managers of Faraway are not familiar with either form of business organization. Because each form resembles a corporation, they are concerned about whether they will be able to collect payments from the wealthy members of the business organizations in the event that either organization breaches the contract by failing to make the payments. Discuss fully Faraway‘s concern. (See Special Business Forms.) Solution Although a joint stock company has characteristics of a corporation, it is usually treated as a partnership. Therefore, although the joint stock company issues transferable shares of stock and is managed by directors and officers, the shareholders have personal liability. Unless the shareholders transfer their stock and ownership to a third party, not only are the joint stock company‘s assets available for damages caused by a breach, but the individual shareholders‘ assets are also subject to such liability. A business trust resembles and is treated like a corporation in many respects. One is the limited liability of the beneficiaries. Unless state law treats the beneficiaries are treated as partners,

401

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

making them liable to the business trust‘s creditors, Faraway Corp. can look to only the business trust‘s assets in the event of a breach. 186. Jurisdiction. Joe, a resident of New Jersey, wants to open a restaurant. He asks his friend Kay, who is an experienced attorney and a New Yorker, for her business and legal advice in exchange for a 20 percent ownership interest in the restaurant. Kay helps Joe negotiate a lease for the restaurant premises and advises Joe to organize the business as a limited liability company (LLC). Joe forms Café Olé, LLC, and, with Kay‘s help, obtains financing. Then, the night before the restaurant opens, Joe tells Kay that he is ―cutting her out of the deal.‖ The restaurant proves to be a success. Kay wants to file a suit in a federal district court against Joe and the LLC. Can a federal court exercise jurisdiction over the parties based on diversity of citizenship? Explain. (See The Limited Liability Company.) Solution Assuming that the amount in controversy exceeds $75,000, a federal court could exercise jurisdiction in this case. If Café Olé were a corporation, the owner‘s state of citizenship would be irrelevant as to whether there is the required diversity of citizenship for a federal court to hear this suit. If Café Olé were a partnership, however, the owners‘ state of citizenship would be crucial. The citizenship of a partnership is the citizenship of its partners. Thus, when a partnership is a defendant, if even one of the partners is a citizen of the same state as the plaintiff, the suit cannot be brought as a diversity suit. Like a partnership, the citizenship of an LLC for purposes of diversity jurisdiction is the same as the citizenship of its members. Here, because Café Olé has only one member, Joe, who is not a citizen of the same state as Kay, a federal court would have jurisdiction to hear the suit. (In this case, too, the outcome would likely favor Kay.) 187. Business Case Problem with Sample Answer— LLC Operation. James Williford, Patricia Mosser,

Marquetta Smith, and Michael Floyd formed Bluewater Logistics, LLC, to bid on construction contracts after Hurricane Katrina struck the Gulf Coast. Under Mississippi law, every member of a member-managed LLC is entitled to participate in managing the business. The operating agreement provided for a ―supermajority‖ 75 percent vote to remove a member who ―has either committed a felony or under any other circumstances that would jeopardize the company status‖ as a contractor. After Bluewater had completed more than $5 million in contracts, Smith told Williford that she, Mosser, and Floyd were exercising their ―supermajority‖ vote to fire him. No reason was provided. Williford sued Bluewater and the other members. Did Smith, Mosser, and Floyd breach the state LLC statute, their fiduciary duties, or the Bluewater operating agreement? Discuss. [Bluewater Logistics, LLC v. Williford, 55 So.3d 148 (Miss. 2011)] (See LLC Operation and Management.) —For a sample answer to Problem 32–4, go to Appendix E. Solution No. One Bluewater member could not unilaterally ―fire‖ another member without providing a reason. Part of the attractiveness of an LLC as a form of business enterprise is its flexibility. The members can decide how to operate the business through an operating agreement. For example, the agreement can set forth procedures for choosing or removing members or managers. Here, the Bluewater operating agreement provided for a ―super majority‖ vote to remove a member under circumstances that would jeopardize the firm‘s contractor status. Thus, one Bluewater member could not unilaterally ―fire‖ another member without providing a reason. In

402

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

fact, a majority of the members could not terminate the other‘s interest in the firm without providing a reason. Moreover, the only acceptable reason would be a circumstance that undercut the firm‘s status as a contractor. The flexibility of the LLC business form relates to its framework, not to its members‘ capacity to violate its operating agreement. In the actual case on which this problem is based, Smith attempted to ―fire‖ Williford without providing a reason. In Williford‘s suit, the court issued a judgment in his favor.

403

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

188. Jurisdictional Requirements. Fadal Machining Centers, LLC, and MAG Industrial Automation Centers, LLC, sued a New Jersey–based corporation, Mid-Atlantic CNC, Inc., in federal district court. Ten percent of MAG was owned by SP MAG Holdings, a Delaware LLC. SP MAG had six members, including a Delaware limited partnership called Silver Point Capital Fund and a Delaware LLC called SPCP Group III. In turn, Silver Point and SPCP Group had a common member, Robert O‘Shea, who was a New Jersey citizen. Assuming that the amount in controversy exceeds $75,000, does the district court have diversity jurisdiction? Why or why not? [Fadal Machining Centers, LLC v. Mid-Atlantic CNC, Inc., 464 Fed.Appx. 672 (9th Cir. 2012)] (See The Limited Liability Company.) Solution The district court does not have diversity jurisdiction. For diversity jurisdiction to exist, there must be complete diversity of citizenship, meaning that all of the plaintiffs must be from different states than all of the defendants. In this case, Mid-Atlantic is not diverse from MAG. Mid-Atlantic is a New Jersey citizen because it is a New Jersey corporation. MAG is also a New Jersey citizen because LLCs and partnerships are citizens of every state of which their members are citizens. In this instance, Robert O‘Shea is a New Jersey citizen. Because O‘Shea is a member of Silver Point and SPCP, they are also New Jersey citizens, and so are SP MAG and MAG itself. 189. Jurisdictional Requirements. Siloam Springs Hotel, LLC, operates a Hampton Inn in Siloam Springs, Arkansas. Siloam bought insurance from Century Surety Co. to cover the hotel. When guests suffered injuries due to a leak of carbon monoxide from the heating element of an indoor swimming pool, Siloam filed a claim with Century. Century denied coverage. Siloam disputed the denial. Century asked a federal district court to resolve the dispute. In asserting that the federal court had jurisdiction, Century noted that the amount in controversy exceeded $75,000 and that the parties had complete diversity of citizenship: Century is ―a corporation organized under the laws of Ohio, with its principal place of business in Michigan,‖ and Siloam is ―a corporation organized under the laws of Oklahoma, with its principal place of business in Arkansas.‖ Can the court exercise diversity jurisdiction in this case? Discuss. [Siloam Springs Hotel, L.L.C. v. Century Surety Co., 781 F.3d 1233 (10th Cir. 2015)] (See The Limited Liability Company.) Solution No. Based on the facts provided in the problem, the trial court cannot exercise diversity jurisdiction in the Siloam case—at least, not yet. When the parties to a suit are from different states, a federal court can exercise diversity jurisdiction if the amount in controversy exceeds $75,000. Total diversity of citizenship must exist, however. An LLC's citizenship is determined by reference to the citizenship of each and every one of its members. Siloam Springs Hotel, LLC, operates a Hampton Inn. When Siloam‘s insurer Century Surety Co. denied coverage for a certain claim, Siloam disputed the denial. Century asked a federal district court to resolve the dispute. The plaintiff asserted as the basis for jurisdiction an amount in controversy exceeding $75,000 and complete diversity of citizenship—Century is ―a corporation organized under the laws of Ohio, with its principal place of business in Michigan,‖ and Siloam is ―a corporation organized under the laws of Oklahoma, with its principal place of business in Arkansas.‖ The amount in controversy meets the requirement for diversity. Siloam, however, is not a corporation—it is an LLC. But the facts stated here do not reveal whether there was complete diversity between the parties.

404

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

In the actual case on which this problem is based, the court issued a summary judgment in Century‘s favor. The U.S. Court of Appeals for the Tenth Circuit reversed this judgment for the reasons above. The court remanded the case for the lower court to determine whether complete diversity existed at the time of the complaint. 190. Special Business Forms. Randall and Peggy Norman operated a dairy farm in Pine River, Minnesota. About ten years after the operation was begun, the cows started to experience health issues. Over the next eighteen years, the herd suffered many serious health problems. Eventually, stray electrical voltage— which can use cow hooves as an unintended pathway, causing health issues—was detected. By then, milk production in the Normans‘ herd had declined from 27 percent above the state average to 20 percent below it. The Normans filed a suit in a Minnesota state court against Crow Wing Cooperative Power & Light Company, a member-owned electrical cooperative that provided electricity to the Normans‘ farm. If Crow Wing is found to have acted negligently, can its members be held jointly liable for the cooperative‘s acts? Explain. [Norman v. Crow Wing Cooperative Power & Light Co., 2016 WL 687472 (Minn.App. 2016)] (See Special Business Forms.) Solution If Crow Wing is found to have acted negligently, its members may be held jointly liable for the cooperative‘s acts. A cooperative is an association that is organized to provide an economic service to its members. It may or may not be incorporated. Members of incorporated cooperatives have limited liability, like the shareholders of corporations and the members of limited liability companies. Cooperatives that are not incorporated, however, are often treated like partnerships. The members have joint liability for the cooperative‘s acts. The Normans operated a dairy farm in Minnesota. After about a decade in operation, their herd started to develop health problems. Over the next eighteen years, the cows suffered many maladies, causing a decline in milk production. Eventually, stray electrical voltage was detected. Stray voltage can use animals‘ hooves as an unintended pathway causing health issues in, for example, cows. Milk production in the Normans‘ herd had declined from 27 percent above the state average to 20 percent below it. The Normans filed a suit in a Minnesota state court against Crow Wing Cooperative Power & Light Company, a member-owned electrical cooperative that provided electricity to the Normans‘ farm. If Crow Wing is unincorporated, and the cooperative is found to have acted negligently, its members can be held jointly liable for the amount of the judgment. In the actual case on which this problem is based, the court held the cooperative liable on negligence and nuisance theories, and awarded the plaintiffs more than $6 million in damages. A state intermediate appellate court affirmed.

405

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

191. Limited Liability. Vision Metals, Inc., owned and operated a pipe manufacturing facility that caused groundwater contamination. The Texas Commission on Environmental Quality (TCEQ) issued a plan that obligated Vision to treat the water and monitor the treatment. Later, Vision sold the property to White Lion Holdings, LLC. Bernard Morello, the sole member of White Lion, knew of the environmental obligations accompanying the property. When White Lion failed to comply with the TCEQ plan, the agency filed a suit in a Texas state court against Morello, asserting violations of the state‘s environmental rules. Morello was charged with personally removing the facility‘s treatment plant and monitoring system. Considering the nature of an LLC, what is Morello‘s best argument that he is not liable? Is this argument likely to succeed? Explain. [State of Texas v. Morello, 61 Tex.Sup.Ct.J. 381, 547 S.W.3d 881 (2018)] (See Limited Liability Companies.) Solution Morello‘s best argument that he is not liable for his personal violations of the state‘s environmental rules is a member of an LLC is not liable for a debt, obligation, or liability of the company. But this argument is not likely to succeed. Like shareholders of a corporation, the members of an LLC enjoy limited liability. That is, a key advantage of the LLC form of business organization is that the liability of its members for the debts, obligations, and liability of the firm is limited to the amount of the members‘ investment in the company. The LLC as an entity can be held liable for harm caused by the wrongful acts of its members, but the members themselves are not generally personally liable. But a member may be subject to personal liability for the results caused by negligent or wrongful acts. This requires, however, that the member owe a duty beyond the duties owed by the LLC to the plaintiff. In this problem, a manufacturing facility owned by White Lion Holdings, L.L.C. was subject to a plan issued by the Texas Commission on Environmental Quality (TCEQ) that required the LLC to treat the facility‘s contaminated groundwater and monitor the treatment. Morello, White Lion‘s sole member, knew of the environmental obligations. When White Lion failed to comply with the plan, the TCEQ filed a suit in a Texas state court against Morello, charging him with personally removing the facility‘s treatment plant and monitoring system. If Morello were to make the argument stated above, it would not likely succeed as a defense because the charge was based on his personal actions, not on the company‘s liability. In the actual case on which this problem is based, Morello made the claim stated above. The court issued a judgment in the state‘s favor. A state intermediate appellate court reversed. The Texas Supreme Court reversed the appellate decision, reasoning that Morello was liable ―because of his own actions and liability . . . , not because of the company‘s liability.‖ 192. A Question of Ethics—The IDDR Approach and LLC Operation and Management. Q Restaurant Group Holdings, LLC, owns and operates Q-BBQ restaurants. Michael Lapidus managed the restaurants and conducted the day-to-day operations. This included bargaining with the restaurants‘ vendors, buying the supplies, keeping the books and records of account, and handling the company‘s money. Lapidus dealt with the staff and made the hiring and firing decisions. He was expected to use his best efforts to grow the profitability of the restaurants. The LLC discovered, however, that Lapidus was misappropriating and converting company funds to his own use. He was also exposing the LLC to liability by mistreating female employees and vendors. When the members voted to terminate Lapidus, he changed the passwords on the Q-BBQ social

406

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

media accounts, interfered with the employees during their work hours, and refused to return company property in his possession. [Q Restaurant Group Holdings, LLC v. Lapidus, 2017 IL App (2d) 170804-U, 2017 WL 6550606 (2017)] (See LLC Operation and Management.) 1.

What action should the LLC take against Lapidus? Consider the ethics of the options, using the IDDR approach. Solution Q Restaurant Group Holdings, LLC, should take action against Michael Lapidus, its restaurant manager, based on his misconduct. Besides terminating Lapidus, the company should file a suit against him to obtain an order to stop his continuing wrongful behavior and to recover the firm‘s property. The company might also seek damages, legal fees, and court costs. The first step of the IDDR approach is an Inquiry, which involves a statement of the ethical issue, its stakeholders, and the relevant standards. In this problem, the issue concerns the actions that the LLC‘s members might take in light of the misconduct of their restaurants‘ manager. The stakeholders include the LLC, the members, and the manager, as well as the company‘s employees, vendors, competitors, and customers. The relevant standards include the state‘s LLC laws, and the ethical principles of trust and fairness. The IDDR approach also includes a Discussion and a Decision. The Discussion considers actions to resolve the issue, with their strengths and weaknesses. The Decision requires a choice of action, and its consequences and effects. In this case, the members might choose to do nothing. Or, if they decide to act, those actions are most likely to include negotiation and litigation. The members‘ objectives would probably be to stop Lapidus‘s misconduct, recover the company‘s property, and discourage others from engaging in similar wrongful acts. The strongest action would be whatever accomplishes these objectives. This would depend in part on Lapidus‘s acquiescence and cooperation. There is much at stake in the circumstances. The members of an LLC decide how to operate the business. Of course, the members are bound by the operating agreement that they make. Here, the LLC is member-managed, as indicated by the vote to terminate Lapidus. In that capacity, the members owe fiduciary duties to their firm. This includes a duty of care. And they should be aware of the company‘s potential liability under employment-discrimination and other laws. An LLC can be held liable for any loss or injury caused by the wrongful acts of its members, managers, or employees. Of course, the members are not generally personally liable. But if they should learn of serious misconduct and take no steps to stop it, they could be personally liable for subsequent harm. This could be on a theory of negligence or other wrongful act. For example, a mistreated employee might successfully allege that a specific member or manager of the LLC breached a duty of care owed to that employee in particular. Furthermore, if a court determines that the members have engaged in illegal or oppressive conduct, the court might order the LLC to be dissolved. Doing nothing in the context of this case could be construed as condoning Lapidus‘s conduct. This could be seen as illegal or oppressive, particularly with respect to those employees and vendors mistreated by the manager. Taking action could have the consequence of avoiding these perceptions. For example, if negotiations between the firm and the manager attained the goals

407

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

stated above, the LLC could be considered by its employees and the other stakeholders to be trustworthy and fair. If negotiations failed, then the firm could proceed with legal action. This could keep the company in the stakeholders‘ good esteem. The last step of the IDDR approach is a Review of the success or failure of the action to resolve the issue and satisfy the stakeholders. The members have already terminated their LLC‘s errant manager. They should now direct their company to take further action—perhaps negotiation followed up with litigation—to more fully satisfy the stakeholders. 2.

Suppose that Lapidus was in the midst of a contentious divorce, experiencing severe financial problems, and undergoing psychological distress as a consequence. Could these issues excuse his conduct at work? Discuss. Solution No. The issues framed in the question would not excuse Lapidus‘s behavior at his job. At best, they might ameliorate the degree of any sanctions imposed on him. Managers owe a fiduciary duty to their employers that includes the duties of loyalty and care. The duty of loyalty requires the manager to put the interests of the firm before any personal interests. Using company funds for personal advantage would violate this duty. The duty of care means that the manager must act in good faith, exercise due care, and pursue the best interests of the employer. Self-dealing is not required to violate the duty of care—engaging in tortious or criminal acts, or other conduct that harms the company, is enough. In this case, Lapidus worked for Q Restaurant Group Holdings, LLC. The company owns and operates Q-BBQ restaurants, which Lapidus managed. The LLC learned, however, that Lapidus was converting company funds to his own use. He was also exposing the firm to liability by mistreating female employees and vendors. On the members‘ vote, Lapidus was terminated. He then changed the passwords on the Q-BBQ social media accounts, interfered with the employees during their work hours, and refused to return LLC property in his possession. Clearly, Lapidus breached the fiduciary duties owed to his employer. And following his termination, he committed tortious and criminal acts towards the LLC and its employees. In these situations, he put his personal interest ahead of the firm‘s and otherwise harmed the company. In the hypothetical facts of the question, it is suggested that his behavior might have been exacerbated by a divorce, financial problems and psychological distress. These circumstances are not likely to sufficiently excuse his negligent and criminal acts or their harmful effects. His personal problems might mitigate the imposition of some punishment, however. For example, Lapidus might agree to cease and desist, to make full restitution, and to take other remedial steps. He might agree to consult with mental health counselors and financial professionals, and follow plans of rehabilitation. If he were to successfully complete these promises, then he might avoid criminal charges, or at least imprisonment, for theft. In the actual case on which this problem is based, the LLC filed a suit in an Illinois state court against Lapidus, alleging a breach of fiduciary duty. Lapidus sought to compel the firm to arbitrate the dispute. The court denied his motion to dismiss the company‘s complaint. A state intermediate appellate court affirmed.

408

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 32: Limited Liability Companies and Special Business Forms

Critical Thinking and Writing Assignments 193. Time-Limited Group Assignment—Fiduciary Duties. Newbury Properties Group owns, manages, and develops real property. Jerry Stoker and the Stoker Group, Inc. (the Stokers), also develop real property. Newbury entered into agreements with the Stokers concerning a large tract of property in Georgia. The parties formed Bellemare, LLC, to develop various parcels of the tract for residential purposes. The operating agreement of Bellemare indicated that ―no Member shall be accountable to the LLC or to any other Member with respect to any other business or activity even if the business or activity competes with the LLC‘s business.‖ Later, when the Newbury group contracted with other parties to develop parcels within the tract in competition with Bellemare, LLC, the Stokers sued, alleging breach of fiduciary duty. (See LLC Operation and Management.) 1.

The first group will discuss and outline the fiduciary duties that the members of an LLC owe to each other. Solution A member of a limited liability company (LLC) has a fiduciary duty to act in a manner that the member believes in good faith to be in the best interests of the LLC and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances. But this duty may be expanded, restricted, or eliminated by a written operating agreement under the principle of freedom of contract.

The second group will determine whether the terms of an operating agreement can alter these fiduciary duties. Solution The fiduciary duty of a member of an LLC to act in a manner that the member believes in good faith to be in the best interests of the LLC and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances may be expanded, restricted, or eliminated by a written operating agreement under the principle of freedom of contract.

409

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

The last group will decide in whose favor the court should rule in this situation. Solution In this problem, the court should rule in the Newbury group‘s favor. There is no basis for finding that the Newbury group breached its fiduciary duties as members of the LLC. A member of an LLC has a fiduciary duty to act in a manner that the member believes in good faith to be in the best interests of the LLC and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances. This duty can be expanded, restricted, or eliminated by a written operating agreement. Here, the operating agreement between the Stokers and the Newbury group clearly stated that the members could engage in activities that competed with the LLC‘s business.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 410 Cybersecurity and the Law ................................................................................................................ 410 Critical Thinking Questions in Cases ................................................................................................................... 411 Case 33.1 ............................................................................................................................................... 411 Case 33.2 ............................................................................................................................................... 412 Case 33.3 ............................................................................................................................................... 413 Chapter Review ........................................................................................................................................................... 414 Practice and Review .............................................................................................................................. 414 Practice and Review: Debate This ......................................................................................................... 415 Issue Spotters ........................................................................................................................................ 416 Business Scenarios and Case Problems ................................................................................................. 416 Critical Thinking and Writing Assignments ............................................................................................ 422

Critical Thinking Questions in Features Cybersecurity and the Law 194. What type of American businesses are impacted by the CLOUD Act? What steps should these businesses take in response to the CLOUD Act? Solution The CLOUD Act impacts cloud service providers (CSPs) such as Amazon, Apple, Facebook, Google, and Microsoft, as well as any other business that uses a CSP to store its data or the data of its clients on the cloud. In theory, any business that stores data in any capacity could be subject to a CLOUD Act request by an American law enforcement agency at any time.

410

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

To protect this data, the company must make sure that it is encrypted, meaning that it can be unlocked and accessed only by someone who has the proper authorization, usually via a password. The key to unlocking encrypted data must remain with the client, or with the entity that wishes to control the data being stored in the cloud. Importantly, the CSP must not have access to the encryption password, meaning that the CSP cannot access the cloud-based data without the permission of the business or person that owns and controls that data. That way, if a government agency requests access to the encrypted data from the CSP, the CSP will not be able to comply without first alerting its client

Critical Thinking Questions in Cases Case 33.1 195. What are the issues of fact that need to resolved concerning Wulf‘s claim for Bravo Brio to be held liable under the doctrine of respondeat superior? Discuss. Solution To establish negligence, a party must show the existence of a duty, a breach of that duty, causation, and damages. Under the doctrine of respondeat superior, an employer is liable for an employee‘s negligence during the performance of the employee‘s work in the course of employment. Wulf did not claim that Bravo Brio was negligent in maintaining the restaurant, nor did he complain of any conditions on the property, such as a hidden step, cracked flooring, or a broken handrail. Wulf claimed that he was injured as a result of the negligence of a Bravo Brio employee, a waitress, backing into him, causing him to fall. The trial court issued a summary judgment in Bravo Brio‘s favor, finding that Wulf was unable to prove his claim chiefly due to his failure to specifically identify the waitress. On appeal, Wulf argued that there was a genuine issue of material fact as to whether his fall and injuries were caused by the negligence of the waitress employed by Bravo Brio, and thus, whether Bravo Brio was liable under the doctrine of respondeat superior. He asserted that the specific identification of the waitress was not necessary if he established that she was negligent in the course of her employment. The appellate court agreed with this position. But the court also found, ―in light of all of the foregoing, and construing the inferences to be drawn from the underlying facts * * * in a light most favorable to Wulf,‖ that there were genuine issues of material fact to be resolved on remand. For Bravo Brio to be held liable for its employee‘s negligence under the doctrine of respondeat superior, one fact to be established is whether the person wearing a Bravo uniform who apologized to Wulf after the incident was a Bravo Brio employee. Other factual issues include whether the waitress had a duty to protect against colliding with patrons while performing her job responsibilities. There is the issue of whether she failed to look out before she bumped into Wulf, and the question of whether Wulf did not see her coming because he was not looking or was simply too close to avoid her. The resolution of these issues is needed to determine whether Bravo Brio is liable under the doctrine of respondeat superior.

411

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

196. Why should a corporation be held liable for torts committed by its employees during the course of their employment? Solution Liability is imposed on a corporate employer for a tort committed by its employee under the doctrine of respondeat superior only if the employee was acting within the course of employment. In other words, the employer can be liable if the incident occurred when the employee was acting on the employer's behalf by doing the job, or otherwise carrying out the company‘s business. The reasoning underlying the application of this doctrine is that employers direct the conduct of their employees on the job and thereby realize the results, whether those results are good or bad. An employer is legally entitled to profit from an employee's labor. The employer, however, is also legally liable if that same behavior causes harm. Another consideration is the goal of the legal system to compensate the victim for the cost of the harm suffered. Holding an employer responsible for an employee‘s tort committed within the course of employment is more likely to accomplish this goal. The employer is likely more capable of assuming the cost, by obtaining insurance or by pricing goods or services to spread the risk. Of course, if the employee acted independently or out of a personal motive, solely for the employee‘s own benefit, the employer might not be liable.

Case 33.2 197. Suppose that the museum had not been hosting an educational panel in its auditorium but instead had rented the facility to an organization for a sales conference. Would the result have been different? Discuss. Solution The result in the Pantano case might or might not have been different if the museum had not been hosting a panel discussion in its auditorium but had rented the facility to an organization for a sales conference. The outcome would depend on the purpose of the organization and its conference, and the amount of the fee. If, for example, the organization were a non-profit charity and the fee nominal, the organization, and by extension Pantano, would have been direct beneficiaries of the museum‘s charity—the nominal fee—and the museum would, as in the Pantano case, have been immune from liability under the state Charitable Immunity Act (CIA). In the actual facts of the Pantano case, Pantano was ordered by La Casa, her employer, to attend the discussion hosted by the Museum in its auditorium. On the icy steps leading into the venue, Pantano slipped and sustained an injury. In her subsequent suit alleging negligence on the museum‘s part, the court entered a judgment against the plaintiff on the ground that she was a direct beneficiary of the museum‘s charitable endeavors. The appellate court disagreed. One of the requirements for a charity‘s immunity under the CIA is that an ―injured party must have been a direct recipient of [the organization‘s] good works.‖ In this case, Pantano ―was not a beneficiary of the museum‘s charitable purposes at the time of her fall because she was on the premises at the direction of her employer.‖ Other cases in which charitable, religious, and educational institutions have been held immune under the CIA have included the following circumstances:

412

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

1. 2. 3.

The plaintiff fell while attending a concert at a hall owned by a university and rented to a nonprofit chamber symphony. The university was immune. A mother who was on the premises of a parochial school to pick up her son after class was a beneficiary of the school‘s ―benefactions‖ and thus the school was immune. A member of a Greek Orthodox parish that paid a nominal fee for the use of a different church‘s premises was the beneficiary of the other church‘s ―benefactions.‖ The owner of the premises was thus immune. A church was immune from liability for the injuries suffered by a non-parishioner guest at a wedding held on the church‘s grounds.

Case 33.3 198. Did the STR ban adopted by the association comport with or contravene its status as a benefit corporation? Discuss. Solution As in most cases, arguments can be made in support of both sides of this question. A benefit corporation is a for-profit corporation that seeks to have a material positive impact on society and the environment. Its purpose is to benefit the public as a whole rather than to solely enhance shareholder value. In this case, by adopting the STR ban, the association claimed to be acting to reduce parking, noise, and trash. Relieving these problems would seem to benefit the public in general and some of the residential members of the association in particular. But other homeowners, especially those who made their property available for STRs, would not realize a material benefit from the ban. The California Coastal Act intends to ―maximize public access . . . and . . . recreational opportunities to the coastal zone consistent with sound . . . conservation principles and constitutionally protected right of private property owners.‖ The association‘s ban may have been in pursuit of ―sound . . . conservation principles,‖ as it was meant to curtail potential air, noise, and water pollution. But this arguably ignored the other two goals expressed in the statute—the greatest possible public access and opportunity for recreation on the coast, and the rights of private property owners. Thus, the ban benefited some members of the public while it harmed others. The association may not have sufficiently considered the impact of its decision on society, which is one of the requirements for a benefit corporation. Of course, as the court held, under the act, the association did not have the authority as a private homeowners‘ association to impose an STR ban. The issue was to be decided by the city government and the state‘s Coastal Commission. In this circumstance, the association was not acting in the best interest of the public or of its members. After expending funds in defense of the ban, the association was foreseeably subject to the sanction of an injunction—which is exactly what occurred. The members (shareholders) of a benefit corporation have a right of action, called a benefit enforcement proceeding, to sue the corporation if it fails to pursue public benefit. The Greenfields may exercise this right. Ultimately, then, whether the association complied with or contradicted its status as a benefit corporation would be decided by a court.

413

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

199. Suppose that instead of adopting an STR ban on its own, the association had petitioned the city and the Coastal Commission to impose one. Would the result have been different? Explain. Solution Yes. If, instead of adopting an STR ban, the association had asked the city and the Coastal Commission to impose it, the result would likely have been different. In the situation stated in the question, the association would have been acting in compliance with state law rather than in violation of it. The Greenfields would have had a much tougher case to make—their best argument might have been that the association was not acting in pursuit of a public benefit—and they would have had to make it in proceedings before the city and the Coastal Commission, not in court. Because the association would not have imposed the ban, a court would not have had that basis to sanction the organization with an injunction. The Greenfields‘ complaint against the association would likely have been dismissed. Of course, the city or the state coastal agency might have been enjoined from enforcing such a ban. But that would have required different proceedings and arguments against those parties, not the association.

Chapter Review Practice and Review William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club‘s employees, suppliers, and entertainers in cash out of the club‘s proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club‘s proceeds and often paid other personal expenses with Chickasaw corporate funds. At 12:45 a.m. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. Chickasaw employees did not check Pursley‘s identification to verify her age, as required by a city ordinance. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 a.m. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley‘s stepfather, filed a tort lawsuit against Chickasaw Club and William Sharp. Using the information presented in the chapter, answer the following questions. 200. Under what theory might the court in this case make an exception to the limited liability of shareholders and hold Sharp personally liable for the damages? What factors would be relevant to the court‘s decision? Solution The court would be likely to pierce the veil of the corporation and hold Sharp personally liable. Because he commingled personal funds with corporate funds and generally treated the business as his alter ego, as one would treat a proprietorship, the limited liability that accompanies corporate status could be lost.

414

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

201. Suppose that Chickasaw‘s articles of incorporation failed to describe the corporation‘s purpose or management structure as required by state law. Would the court be likely to rule that Sharp is personally liable to Dancause on that basis? Why or why not? Solution Sharp is likely to be personally liable based on piercing the corporate veil due to ignoring the corporate form. Technical details in the articles of incorporation alone would not be likely to result in liability being imposed; the fact that the entire operation ignored the corporate status matters more in losing the liability shield. 202. Suppose that the club extended credit to its regular patrons in an effort to maintain a loyal clientele, although neither the articles of incorporation nor the corporate bylaws authorized this practice. Would the corporation likely have the power to engage in this activity? Explain. Solution Extending credit to customers is a normal business activity and is not improper. Such details need not be discussed in the articles of incorporation or the bylaws, which generally concern the purpose of the business itself and basic ownership structure issues. 203.

How would the court classify Chickasaw Club, Inc.—domestic or foreign, public or private?

Solution The corporation was formed and operated in Georgia, so it is a domestic corporation. One person owns the corporation, so it is private; its stock is not traded, so it is also a close corporation.

Practice and Review: Debate This 204. Sole shareholders of S corporations should not be able to avoid liability for the torts of that shareholder‘s employees. Solution Perhaps it makes sense to allow individuals to use business organization forms that allow them to pass through profits to their personal tax returns, but it makes little sense to allow them to escape liability with such structures when their employees or agents commit torts. Normally, employees do not have liability insurance or even assets that could pay for tort judgments against them. Those who suffer from these torts would therefore end up with nothing, even if they win at trial. It should make no difference whether an S corporation is owned by one person or by many persons. A major benefit of all corporations, whatever form they take, has been to shield shareholders from liability. Therefore, if shareholders of S corporations know that they will not have limited liability, there is less reason to use the S corporation structure. Its use will decrease as a result.

415

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Issue Spotters 205. Name Brand, Inc., is a small business. Twelve members of a single family own all of its stock. Ordinarily, corporate income is taxed at the corporate and shareholder levels. How can Name Brand avoid this double taxation of income? Solution Small businesses that meet certain requirements can qualify as S corporations, created specifically to permit small businesses to avoid double taxation. The six requirements of an S corporation are (1) the firm must be a domestic corporation; (2) the firm must not be a member of an affiliated group of corporations; (3) the firm must have fewer than a certain number of shareholders; (4) the shareholders must be individuals, estates, or qualified trusts (or corporations in some cases); (5) there can be only one class of stock; and (6) no shareholder can be a nonresident alien. 206. The incorporators of Consumer Investments, Inc., want their new corporation to have the authority to transact nearly any conceivable type of business. Can they grant this authority to their firm? If so, how? If not, why? Solution Broad authority to conduct business can be granted in a corporation‘s articles of incorporation. For example, the term ―any lawful purpose‖ is often used. This can be important because acts of a corporation that are beyond the authority given to it in its articles or charter (or state statutes) are considered illegal, ultra vires acts.

Business Scenarios and Case Problems 207. Preincorporation. Cummings, Okawa, and Taft are recent college graduates who want to form a corporation to manufacture and sell personal computers. Peterson tells them he will set in motion the formation of their corporation. First, Peterson makes a contract with Owens for the purchase of a piece of land for $20,000. Owens does not know of the prospective corporate formation at the time the contract is signed. Second, Peterson makes a contract with Babcock to build a small plant on the property being purchased. Babcock‘s contract is conditional on the corporation‘s formation. Peterson secures all necessary capitalization and files the articles of incorporation. Discuss whether the newly formed corporation, Peterson, or both are liable on the contracts with Owens and Babcock. Is the corporation automatically liable to Babcock on formation? Explain. (See Formation and Powers.) Solution As a general rule, a promoter is personally liable for all pre-incorporation contracts made by the promoter. The basic theory behind such liability is that the promoter cannot be an agent for a nonexistent principal (a corporation not yet formed). It is immaterial whether the contracting party knows of the prospective existence of the corporation, and the general rule of promoter liability continues even after the corporation is formed. Three basic exceptions to promoter liability are: (1) The promoter‘s contract with a third party can stipulate that the third party will look only to the new corporation, not to the promoter, for performance and liability. (2) The third party can release the promoter from liability. (3) After formation, the corporation can assume the contractual obligations and liability by novation. (If it is by adoption, most courts hold that the promoter is still personally liable.)

416

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Peterson is therefore personally liable on both contracts, because (1) neither Owens nor Babcock has released him from liability, (2) the corporation has not assumed contractual responsibility by novation, and (3) Peterson‘s contract with Babcock did not limit Babcock to holding only the corporation liable. (Peterson‘s liability was conditioned only on the corporation‘s formation, which did occur.) Incorporation in and of itself does not make the newly formed corporation liable for pre-incorporation contracts. Until the newly formed corporation assumes Peterson‘s contracts by novation (releasing Peterson from personal liability) or by adoption (undertaking to perform Peterson‘s contracts, which makes both the corporation and Peterson liable), Babcock cannot enforce Peterson‘s contract against the corporation. 208. Ultra Vires Doctrine. Kora Nayenga and two business associates formed a corporation called Nayenga Corp. for the purpose of selling computer services. Kora, who owned 50 percent of the corporate shares, served as the corporation‘s president. Kora wished to obtain a personal loan from his bank for $250,000, but the bank required the note to be cosigned by a third party. Kora cosigned the note in the name of the corporation. Later, Kora defaulted on the note, and the bank sued the corporation for payment. The corporation asserted, as a defense, that Kora had exceeded his authority when he cosigned the note. Had he? Explain. (See Formation and Powers.) Solution It could be argued that Kora exceeded his authority when he co-signed the note on behalf of the corporation. The board of directors of a corporation delegates the authority to transact all ordinary business of the corporation to the president. If co-signing a note for a personal loan is not ―ordinary business of the corporation,‖ then the board, as principal, must ratify the act. There is no indication in the question that the board did so in this instance. 209. Spotlight on Smart Inventions—Piercing the Corporate Veil. Thomas Persson and Jon Nokes founded Smart Inventions, Inc., to market household consumer products. The success of their first product, the Smart Mop, continued with later products, which were sold through infomercials. Persson and Nokes were the firm‘s officers and equal shareholders, with Persson responsible for product development and Nokes in charge of day-to-day activities. By 1998, they had become dissatisfied with each other‘s efforts. Nokes represented the firm as financially ―dying,‖ and ―in a grim state, . . . worse than ever.‖ He offered to buy all of Persson‘s shares for $1.6 million, and Persson accepted. On the day that they signed the agreement to transfer the shares, Smart Inventions began marketing a new product— the Tap Light. It was an instant success, generating millions of dollars in revenues. In negotiating with Persson, Nokes had intentionally kept the Tap Light a secret. Persson sued Smart Inventions, asserting fraud and other claims. Under what principle might Smart Inventions be liable for Nokes‘s fraud? Is Smart Inventions liable in this case? Explain. [Persson v. Smart Inventions, Inc., 125 Cal.App.4th 1141, 23 Cal.Rptr.3d 335 (2 Dist. 2005)] (See Formation and Powers.) Solution As stated in the text, the doctrine of respondeat superior applies to agents of corporations. Under this doctrine, a corporation is liable for torts (or crimes) committed by its agents or officers within the course and scope of employment. Thus, if Nokes was an agent acting in the scope of his employment, then Smart Inventions can be liable for Nokes‘ fraud.

417

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Because Nokes and Persson founded the company and were the only two shareholders and officers, Smart Inventions was most likely a close corporation. When Nokes negotiated to purchase of all of Persson‘s shares, Nokes would have been acting on behalf the corporation (since he was the only remaining officer and corporate representative). Nokes intentionally lied about the financial condition of the corporation and the withheld information about a new product that he suspected would be successful. In these circumstances, Smart Inventions should be liable for Note‘s fraud. Indeed, the court that heard the case ruled that Nokes was acting on behalf of Smart Inventions and awarded nearly $720,000 in damages, fees, and costs to Persson. On appeal, a state intermediate appellate court affirmed the award of damages against Smart Inventions. The court explained that ―Nokes possessed the information about the Tap Light and could have disclosed it at any time before the execution of the Stock Redemption Agreement. Even if . . . Nokes acted only in his individual capacity during the . . . negotiations between him and Persson, he was clearly acting for Smart Inventions by the time the agreement was executed, as his signature on behalf of Smart Inventions demonstrates. Accordingly, his continued concealment of the Tap Light was an ‗act or omission‘ of an officer of Smart Inventions within the scope of his employment and, as a matter of law, the act or omission of Smart Inventions.‖ 210. Business Case Problem with Sample Answer— Piercing the Corporate Veil. Scott Snapp contracted with Castlebrook Builders, Inc., which was owned by Stephen Kappeler, to remodel a house. Kappeler estimated that the remodeling would cost around $500,000. Eventually, however, Snapp paid Kappeler more than $1.3 million. Snapp filed a suit in an Ohio state court against Castlebrook, alleging breach of contract and fraud, among other things. During the trial, it was revealed that Castlebrook had issued no shares of stock and had commingled personal and corporate funds. The minutes of the corporate meetings all looked exactly the same. In addition, Kappeler could not provide an accounting for the Snapp project. In particular, he could not explain evidence of double and triple billing nor demonstrate that the amount Snapp paid had actually been spent on the remodeling project. Are these sufficient grounds to pierce the corporate veil? Explain. [Snapp v. Castlebrook Builders, Inc., 2014 -Ohio- 163, 7 N.E.3d 574 (2014)] (See Formation and Powers.) — For a sample answer to Problem 33–4, go to Appendix E. Solution Yes. There are sufficient grounds in the facts of this problem to support piercing the corporate veil and holding Kappeler personally liable to Snapp. First, in a case in which a plaintiff seeks to pierce a corporate veil, there must be a fraud or other injustice to be remedied. In that situation, the factors that a court will consider in determining whether to pierce the corporate veil include (1) a party is tricked or misled into dealing with the corporation rather than the individual, (2) the corporation has insufficient capital to meet its prospective debts or other potential liabilities, (3) corporate formalities, such as holding required corporate meetings, are not followed, and (4) personal and corporate interests are commingled. In this problem, the amount that Snapp ultimately paid the builder exceeded the original estimate by nearly $1 million—and the project was still unfinished. Kappeler could not provide an accounting for the Snapp project—he could not explain double and triple charges nor whether the amount that Snapp paid had actually been spent on the project. These facts support a conclusion of fraud. And they also indicate that Kappeler may have tricked or misled Snapp into

418

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

dealing with the corporation rather than with Kappeler as an individual. Castlebrook had issued no shares of stock, which indicates insufficient capitalization. The minutes of the corporate meetings ―all looked exactly the same,‖ indicating that in fact the required corporate meetings had not been held. And Kappeler had commingled personal and corporate funds. In the actual case on which this problem is based, in Snapp‘s suit against the builder, the court pierced the corporate veil and held Kappeler personally liable. A state intermediate appellate court affirmed. 211. Torts. Jennifer Hoffman took her cell phone to a store owned by R&K Trading, Inc., for repairs. Later, Hoffman filed a suit in a New York state court against R&K, Verizon Wireless, Inc., and others, seeking to recover damages for a variety of torts, including infliction of emotional distress and negligent hiring and supervision. She alleged that an R&K employee, Keith Press, had examined her phone in a back room, accessed private photos of her stored on her phone, and disseminated the photos to the public. Hoffman testified that ―after the incident, she learned from another R&K employee that personal information and pictures had been removed from the phones of other customers.‖ Can R&K be held liable for the torts of its employees? Explain. [Hoffman v. Verizon Wireless, Inc., 5 N.Y.S.3d 123, 125 A.D.3d 806 (2015)] (See Nature and Classification.) Solution Yes. R&K can be held liable for the torts of its employees. A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment. The doctrine of respondeat superior applies to corporations in the same way as it does to other agency relationships. In the facts of this problem, Jennifer Hoffman took her cell phone to a store owned by R&K for repairs. She believed that R&K‘s employee Keith Press examined her phone in a back room, accessed private photos of her stored on the phone, and disseminated the photos to the public. After the incident, Hoffman learned from another R&K employee that personal information and pictures had been removed from the phones of other customers. Hoffman filed a suit against R&K and others, seeking to recover damages for several torts, including infliction of emotional distress and negligent hiring and supervision. In this situation, the doctrine of respondeat superior applies to R&K. The corporation can be held liable for the torts committed by its employees within the course and scope of their employment. This can include Press‘s hiring and his unauthorized accessing of private data on customers‘ phones. In the actual case on which this problem is based, R&K filed a motion for summary judgment. The court denied the motion. A state intermediate appellate court affirmed the denial. In light of Hoffman‘s testimony, R&K ―failed to eliminate all triable issues of fact as to those causes of action . . . premised upon the theory of respondeat superior‖ and those alleging negligent hiring and supervision. 212. Piercing the Corporate Veil. In New York City, 2406- 12 Amsterdam Associates, LLC, brought an action in a New York state court against Alianza Dominicana and Alianza, LLC, to recover unpaid rent. The plaintiff asserted cause to pierce the corporate veil, alleging that Alianza Dominicana had made promises to pay its rent while discreetly forming Alianza, LLC, to avoid liability for it. According to 2406-12, Alianza, LLC, was 90 percent owned by Alianza Dominicana, had no employees, and had no function but to hold Alianza Dominicana‘s assets away from its

419

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

creditors. The defendants filed a motion to dismiss the plaintiff‘s claim. Assuming that 2406-12‘s allegations are true, are there sufficient grounds to pierce Alianza, LLC‘s corporate veil? Discuss. [2406-12 Amsterdam Associates, LLC v. Alianza, LLC, 136 A.D.3d 512, 25 N.Y.S.2d 167 (1 Dept. 2016)] (See Formation and Powers.) Solution Yes. Assuming that 2406–12‘s allegations are true, there are sufficient grounds to pierce Alianza LLC‘s corporate veil. When the owners of a corporation, or as in this case, an LLC, use the entity to perpetrate a fraud, circumvent the law, or in some other way accomplish an illegitimate objective, a court can ignore the business structure and pierce the corporate veil to expose the owners to liability for the harm.

One of the circumstances in which a court will pierce the shell of a business entity to hold its owners liable occurs when the entity was formed to evade an existing legal obligation. In this problem, 2406–12 Amsterdam Associates LLC—a landlord and the plaintiff in the suit— alleged that its tenant Alianza Dominicana had made promises to pay its rent while discreetly forming Alianza LLC to avoid liability for it. 2406–12 argued that Alianza LLC was 90 percent owned by Alianza Dominicana, had no employees, and had no function but to hold Alianza Dominicana‘s assets away from its creditors—in particular 2406–12. These alleged facts would be sufficient to overcome the defendant tenant‘s motion to dismiss and, if proven, could serve as a sufficient basis to pierce the LLC‘s veil. In the actual case on which this problem is based, in 2406–12‘s action against its tenant and the associated entity to recover the amount of the unpaid rent, the court denied the defendants‘ motion to dismiss. A state intermediate appellate court affirmed. 213. Certificate of Authority. Armour Pipe Line Company assigned leases to its existing oil wells in Texas to Sandel Energy, Inc. The assignment included royalties for the oil produced from the wells. Armour specified that the assignment ―does not pertain to production attributable to these leases from any new wells,‖ reserving for itself an interest in those royalties. Later, Armour— a foreign corporation in Texas—forfeited its certificate of authority to do business in the state. More than three years later, the certificate was reissued. Meanwhile, new wells were drilled on the leases. Sandel filed a suit in a Texas state court against Armour, claiming that the reservation of a royalty interest in those wells was ―ineffective‖ because of the temporary forfeiture. When and why does a corporation need a certificate of authority? Is Armour entitled to the royalties from the new wells? Discuss. [Armour Pipeline Co. v. Sandel Energy, Inc., 546 S.W.3d 455 (Tex.App.— Houston (14th Dist.) 2018)] (See Nature and Classification.) Solution Arguably, yes. Armour is entitled to the royalties from the new wells. A corporation needs a certificate of authority to do business in a state outside its state of incorporation. Once a certificate is obtained, the corporation can generally exercise in that state all of the powers conferred on it by its home state. If a foreign corporation does business in a state without a certificate of authority, the state can impose sanctions, such as fines. In this problem, Armour assigned leases to existing wells to Sandel. The assignment reserved to Armour an interest in royalties from any new wells. Armour, a foreign corporation, forfeited its certificate of authority to do business in the state, however. Later, the certificate was reissued.

420

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Meanwhile, new wells were drilled. Sandel filed a suit against Armour, claiming that the reservation of the royalties was ―ineffective‖ because of the temporary forfeiture. Armour had its certificate of authority when it assigned the leases to Sandel, reserving the royalty interest. The temporary forfeiture of the certificate could not have terminated the existence of the firm, which was not incorporated in the state. Depending on state law, a sanction might be imposed, but this appears unlikely in the circumstance of a temporary forfeiture of a certificate. In the actual case on which this problem is based, the court issued a summary judgment in Sandel‘s favor, declaring that Armour‘s reservation ―is of no legal force nor effect.‖ A state intermediate appellate court held that Armour‘s claim was not extinguished by any applicable Texas statute or case, and reversed and remanded. 214. A Question of Ethics—Piercing the Corporate Veil. Lester Fulmer sold H2O Lifts and Ramps, LLC (H2O), to Hurt-Hoover Investments, LLC (HHI). HHI agreed to pay $550,000 of the price by a note in thirty-six installments. From the installments, HHI deducted offsets, including charges for expenses incurred before the sale. Meanwhile, HHI incurred annual losses. Its owners, William Hurt and Michael Hoover, contributed funds to keep the firm in business. They followed the statutory business formalities. To collect on the note, Fulmer obtained a judgment in an Arkansas state court against HHI for the unpaid amount. Hurt and Hoover did not dissolve HHI or form another entity to avoid the judgment, but offered to pay it when the profits from H2O became sufficient.[ Fulmer v. Hurt, 2017 Ark. App. 117, 515 S.W.3d 129 (2017)] (See Piercing the Corporate Veil.) 1.

Should HHI‘s corporate veil be pierced to hold Hurt and Hoover liable? Why or why not? Solution No. HHI should not be pierced to hold its owners personally liable. When the owners of a corporation, or, as in this problem, a limited liability company, use the business entity to perpetrate a fraud, circumvent the law, or in some other way accomplish an illegitimate objective, a court will ignore the structure and pierce the corporate veil to expose its owners to personal liability. Circumstances that will lead to this result include a party being tricked or misled into dealing with the organization rather than an individual. If the organization is set up never to make a profit or always to be insolvent, or is too ―thinly‖ capitalized, it will be pierced. Not following statutory formalities or commingling personal and organizational interests may lead to the same result. In the facts of this problem, there is no indication of fraud or other illegal conduct on the part of the owners of the business organization. Fulmer sold H2O Lifts and Ramps, LLC (H2O) to Hurt–Hoover Investments, LLC (HHI). HHI agreed to pay part of the price through a note in installments. HHI deducted offsets from the installments. Meanwhile, the LLC incurred losses. Its owners Hurt and Hoover contributed funds to keep it in business and otherwise followed the statutory formalities. When Fulmer obtained a judgment on the unpaid note, Hurt and Hoover did not dissolve HHI or form another entity to avoid the judgment. In the actual case on which this problem is based, the court issued a summary judgment in favor of Hurt and Hoover. A state intermediate appellate court affirmed the order.

Did Hurt and Hoover conduct their business according to ethical standards? Explain.

421

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 33: Corporate Formation and Financing

Solution HHI‘s owners appear to have exceeded ethical standards in the conduct of their business. Not only did they meet every legal standard in its operation, as indicated by the facts, but they offered to pay the amount of the judgment against the firm when their profits were sufficient. This is more than they might have been legally bound to do.

Critical Thinking and Writing Assignments 215. Critical Legal Thinking. If you had started a business, under what circumstances would you be willing to give up a substantial percentage of its ownership to obtain venture capital financing? (See Corporate Financing.) Solution In practical terms, businesspersons must be willing to surrender some control over their enterprise when additional capital is needed to sustain the business, but it has no track record to which banks and other investors can refer to assure themselves that their investment will not be lost and may be profitable. Without such a history, an entrepreneur may have to turn to other sources of financing, such as venture capital investors, who are generally willing to accept more risk in exchange for a share of control. Of course, the added managerial and technical expertise may be a boon to the operation of the firm and its profit and long-term viability could increase. If this is the goal of the owner, this may be a reason to give up some control. Also, if the owner is not interested in remaining with the firm and would prefer to divest himself or herself of the business for a price, this may be a way to accomplish that.

422

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

216. Time-Limited Group Assignment—Corporate versus LLC Form of Business. Although a limited liability company (LLC) may be the best organizational form for most businesses, a significant number of firms may be better off as a corporation or some other form of organization. (See Nature and Classification.) 1.

The first group will outline several reasons why a firm might be better off as a corporation than as an LLC. Solution Forms of business entities such as corporations have long histories, the law is generally predictable and well known, and the agreements and other forms required are fairly standard. This is not true with limited liability companies (LLCs) and other more recent types of business entities for the law is less well established. For this reason, and because the newer forms of business allow for greater flexibility in such terms as management relations, agreements for LLCs and similar organizations can take longer to negotiate and write. The tax laws, which for the newer forms of business are not entirely clear, can add to the cost because of additional recordkeeping and accounting for the new entities. All unincorporated associations are taxed as partnerships at the federal level, and this includes limited liability organizations (except LLCs, which can elect corporate tax status). This sometimes leaves unclear such legal issues as ―piercing the veil‖ of a limited liability entity and the fiduciary duty that the participants owe to each other.

The second group will discuss the differences between corporations and LLCs in terms of their management structure. Solution An LLC of five members could be member-managed or manager-managed. The most important factor is what the state requires with respect to the management of the firm. Other factors that should be taken into consideration include whether the members want all of the members, and are willing themselves, to participate in management. In other words, work effort, motivation, ability, personal relationships among the participants, and other personal concerns are significant factors. The anticipated expenses and debts of the firm, and the extent of personal liability for these obligations, should also be weighed in the balance.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

423

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

Practice and Review .............................................................................................................................. 427 Practice and Review: Debate This ......................................................................................................... 428 Issue Spotters ........................................................................................................................................ 429 Business Scenarios and Case Problems ................................................................................................. 429 Critical Thinking and Writing Assignments ............................................................................................ 436

Critical Thinking Questions in Features Cybersecurity and the Law 217. What type of American businesses are impacted by the CLOUD Act? What steps should these businesses take in response to the CLOUD Act? Solution The CLOUD Act impacts cloud service providers (CSPs) such as Amazon, Apple, Facebook, Google, and Microsoft, as well as any other business that uses a CSP to store its data or the data of its clients on the cloud. In theory, any business that stores data in any capacity could be subject to a CLOUD Act request by an American law enforcement agency at any time. To protect this data, the company must make sure that it is encrypted, meaning that it can be unlocked and accessed only by someone who has the proper authorization, usually via a password. The key to unlocking encrypted data must remain with the client, or with the entity that wishes to control the data being stored in the cloud. Importantly, the CSP must not have access to the encryption password, meaning that the CSP cannot access the cloud-based data without the permission of the business or person that owns and controls that data. That way, if a government agency requests access to the encrypted data from the CSP, the CSP will not be able to comply without first alerting its client

Critical Thinking Questions in Cases Case 34.1 218. In a letter to the Oliveiras, the board explained that it saw ―no upside—and much downside—to the action and lawsuit proposed in the Demand.‖ What would the ―downside‖ consist of? Solution The downside of the action proposed by the Oliveiras consists of a variety of likely possibilities whether or not the action was successful. In this case, iStar promised awards of company stock to employees if the shares averaged a certain target price over a specific sustained period before a stated date. The stock‘s value tripled, but the target price was not met. The company‘s board modified the conditions for an award from performance to service—an employee with a certain period of service was entitled to an award—and issued additional shares to make the awards. The Oliveiras (shareholders) demanded that the board rescind the awards and file a suit to recover damages or obtain other relief on the company‘s behalf.

424

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

The board appointed Ridings, one of its directors, to investigate the demand. After a thorough investigation, Ridings recommended that the board reject the Oliveiras‘ demand. The board acted on this recommendation. In its response to the Oliveiras, the board stated its reasons, including the following: 1. iStar was likely to lose a suit based on the Oliveiras‘ claim, and incur costly attorney‘s fees in doing so. 2. Failing to honor the awards, or rescinding them, would create serious employee morale problems—the awards were necessary to motivate and ensure the retention of key personnel. 3. Rescinding the awards would lead to the departure of key members of management. 4. Failing to honor the awards, after they had been promised, would likely lead to litigation with key members of management, who would likely win. 219. Only one member of the iStar board—Sugarman—received an award as an employee. The others who made the decision to change the award were, like Ridings, outside directors. Suppose that the opposite had been true. Would the result have been the same? Solution It is possible that the result in this case would have been the same, even under the facts given in the question—if only one member of the board had been an outside, non-management director and the others had received awards. iStar promised awards of company stock to employees if the shares averaged a certain target price over a specific sustained period before a stated date. The stock‘s value rose 300 percent, but the conditions for the awards were not met. The board changed those conditions to base an award on service—an employee with a certain period of service was entitled to an award—and issued additional shares to pay the awards. Shareholders (the Oliveiras) demanded that the board rescind the awards and file a suit to recover damages or obtain other relief on the company‘s behalf. The board appointed an outside, non-management director to investigate the shareholders‘ claim. After a complete review, the director recommended that the board refuse the demand, which it did. The shareholders subsequently sued the directors, alleging a breach of fiduciary duty. The court dismissed the suit, and a state intermediate appellate court affirmed. The appellate court applied the business judgment rule to the board‘s decision to refuse the shareholder‘s demand.

Case 34.2 220. Suppose that Loft‘s board of directors had approved Pepsi-Cola‘s use of its personnel and equipment. Would the court‘s decision have been different? Discuss. Solution Possibly. Guth contended that the Loft board had approved Pepsi‘s use of Loft‘s personnel and facilities, but there were no board minutes, no contract, and no other record or anything else in writing to prove the directors‘ consent. The court found, among other things, that ―Guth's use of Loft's money, credit, facilities and personnel in the furtherance of the Pepsi venture was without the knowledge or authorization of Loft's directors.‖ The court also pointed out that Guth had selected the members of the board and that their livelihoods were dependent on him, intimating that even if he had sought their consent, it could be construed as coerced.

425

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

Case 34.3 221. At trial, Robinson admitted that she did not believe Langenbach‘s salary was excessive. If so, then why would she introduce evidence of his salary? Explain. Solution Perma-Jack, a franchisor of a foundation repair and stabilization system, is a small business, a public and closely held family corporation. Three siblings were its only shareholders and directors. These circumstances, and the decline in franchisees noted in the statement of facts, indicates that Perma-Jack had limited profitability at the time of this case. This would have meant that the company had a limited pool of revenue from which to pay its officers and other employees. Robinson‘s argument was that Langenbach, with Lanfri‘s cooperation, removed Robinson as an officer and director so that the entire pool of Perma-Jack‘s funds could be controlled by Langenbach as corporate president and disbursed as he saw fit, particularly to himself. The availability of these funds and the control of their disbursement by Langenbach, as president of Perma-Jack, would tend to make it more likely that he, with Lanfri‘s approval, removed Robinson to gain control that money. The defendants‘ argument would be that the evidence of Langenbach‘s self-determined salary and bonus was not relevant, because Robinson admitted that they were not excessive. This would suggest that Robinson‘s only purpose in introducing the evidence was to prejudice the jury. But a trial court has considerable discretion to admit or exclude evidence. Robinson‘s argument was clearly logical in the circumstances, and it was not unreasonable for the court to therefore allow its admission. 222. Suppose that Langenbach and Lanfri had argued that Robinson had no claim for breach of fiduciary duty because she really just sued for wrongful termination, and, as an at-will employee, she had no right to continued employment. Would the result have been the same? Discuss. Solution Yes, the result in this case would have been the same if the defendants had argued that Robinson‘s claim for breach of fiduciary duty was actually a recast claim for wrongful termination. The defendants‘ contention would have been that Robinson‘s status as a shareholder did not provide her with a fiduciary-based right to continued employment. And, further, that, as an at-will employee, under state law, she did not have a right to continuing employment. But this would have been a mischaracterization of Robinson‘s claim. She did not assert that Perma-Jack could not discharge her. In fact, if that had been her cause, she would have brought it against the corporation, her employer, and sought back pay and other employment-related damages. Instead, her claim, as presented here, was for breach of fiduciary duty on the part of Langenbach and Lanfri as directors. Thus, the trial court and appellate courts in this case would likely have rejected an argument that Robinson was actually suing for wrongful termination, and the result in this case would have otherwise been the same.

426

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

Chapter Review Practice and Review David Brock was on the board of directors of Firm Body Fitness, Inc., which owned a string of fitness clubs in New Mexico. Brock owned 15 percent of the Firm Body stock and was also employed as a tanning technician at one of the fitness clubs. After the January financial report showed that Firm Body‘s tanning division was operating at a substantial net loss, the board of directors, led by Marty Levinson, discussed terminating the tanning operations. Brock successfully convinced a majority of the board that the tanning division was necessary to market the clubs‘ overall fitness package. By April, the tanning division‘s financial losses had risen. The board hired a business analyst, who conducted surveys and determined that the tanning operations did not significantly increase membership. A shareholder, Diego Peñada, discovered that Brock owned stock in Sunglow, Inc., the company from which Firm Body purchased its tanning equipment. Peñada notified Levinson, who privately reprimanded Brock. Shortly thereafter, Brock and Mandy Vail, who owned 37 percent of the Firm Body stock and also held shares of Sunglow, voted to replace Levinson on the board of directors. Using the information presented in the chapter, answer the following questions.

427

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

223.

What duties did Brock, as a director, owe to Firm Body?

Solution As a director, Brock is in a fiduciary relationship with the corporation, which means that he owes to Firm Body the duty of care and the duty of loyalty. 224. Does the fact that Brock owned shares in Sunglow establish a conflict of interest? Why or why not? Solution The duty of loyalty requires officers and directors to disclose fully to the board of directors any possible conflict of interest that might occur in conducting corporate transactions. Because Brock failed to disclose his interest in Sunglow and continued to encourage Firm Body to purchase tanning equipment from Sunglow, he has a conflict of interest that violates his duty of loyalty to Firm Body. 225. Suppose that Firm Body brought an action against Brock claiming that he had breached the duty of loyalty by not disclosing his interest in Sunglow to the other directors. What theory might Brock use in his defense? Solution The business judgment rule immunizes decisions that are made in good faith as long as the decision complies with the manager‘s fiduciary duties and was within the manager‘s power to make. Here, Brock breached his duty of loyalty by not informing the other directors of his interest in Sunglow, so he cannot claim the business judgment rule immunizes him from liability. 226. Now suppose that Firm Body did not bring an action against Brock. What type of lawsuit might Peñada be able to bring based on these facts? Solution If the corporation does not bring suit against Brock for breaching his duty of loyalty, then Peñada could file a shareholder‘s derivative suit to redress a wrong suffered by the corporation. In other words, Peñada could file a suit on behalf of the corporation claiming that Brock‘s breach of his fiduciary duties caused harm to the corporation. If the suit were successful, any damages recovered would go to the corporation, not Peñada.

Practice and Review: Debate This 227. Because most shareholders never bother to vote for directors, shareholders have no real control over corporations. Solution The statistics are indeed shocking—almost no shareholders of corporations ever bother to vote for directors. Most shareholders don‘t know who the directors are and clearly don‘t know how publicly held companies are governed. Therefore, even though on paper shareholders control corporations because they can vote out bad directors, they really never do. When a corporation is badly managed, that corporation‘s stock price drops. That is because shareholders vote with their ―wallets‖ by selling the shares in that company, thereby lowering the price of the stock. When the price of the stock gets low enough, outside groups attempt a

428

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

takeover in order to put in place their preferred group of directors. That‘s how the market for corporate control works.

Issue Spotters 228. Wonder Corporation has an opportunity to buy stock in XL, Inc. The directors decide that, instead of buying the stock in the name of the corporation, they will buy it for themselves. Yvon, a Wonder shareholder, learns of the purchase and wants to sue the directors on Wonder‘s behalf. Can she do it? Explain. Solution Yes. A shareholder can bring a derivative suit on behalf of a corporation if some wrong is done to the corporation. Normally, any damages recovered go into the corporate treasury. 229. Nico is Omega Corporation‘s majority shareholder. He owns enough stock in Omega that if he were to sell it, the sale would be a transfer of control of the firm. Discuss whether Nico owes a duty to Omega or the minority shareholders in selling his shares. Solution Yes. A single shareholder—or a few shareholders acting together—who owns enough stock to exercise de facto control over a corporation owes the corporation and minority shareholders a fiduciary duty when transferring those shares.

Business Scenarios and Case Problems 230. Conflicts of Interest. Oxy Corp. is negotiating with the Wick Construction Co. for the renovation of the Oxy corporate headquarters. Wick, the owner of the Wick Construction Co., is also one of the five members of Oxy‘s board of directors. The contract terms are standard for this type of contract. Wick has previously informed two of the other directors of his interest in the construction company. Oxy‘s board approves the contract by a three-to-two vote, with Wick voting with the majority. Discuss whether this contract is binding on the corporation. (See Directors and Officers.) Solution Various state statutes contain different standards for contracts made between two corporations when a director of one corporation has a material interest in the other. In general, however, the courts will uphold these contracts providing that: 1. The contract was fair and reasonable to the corporation at the time the contract was entered into. 2. The director with conflicting interests gave a full disclosure of such interests to the other directors. 3. The contract was approved by a majority of the disinterested directors or shareholders. In the case of Wick and Oxy Corp., the contract may be set aside for two reasons. First, the conflict-of-interest transaction was not fully disclosed to all members of the board; and second, the contract was not approved by a majority of disinterested directors. Thus, Wick has breached his fiduciary duties to Oxy, and Oxy can set aside the contract. 231. Liability of Directors. AstroStar, Inc., has approximately five hundred shareholders. Its board of directors consists of three members—Eckhart, Dolan, and Macero. At a regular board meeting, the board selects Galiard as president of the corporation by a two-to-one vote, with Eckhart dissenting. The minutes of the meeting do not register Eckhart‘s dissenting vote. Later, an

429

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

audit reveals that Galiard is a former convict and has embezzled $500,000 from the corporation that is not covered by insurance. Can the corporation hold directors Eckhart, Dolan, and Macero personally liable? Discuss. (See Duties and Liabilities of Directors and Officers.) Solution Directors are personally answerable to the corporation and the shareholders for breach of their duty to exercise reasonable care in conducting the affairs of the corporation. Reasonable care is defined as being the degree of care that a reasonably prudent person would use in the conduct of personal business affairs. When directors delegate the running of the corporate affairs to officers, the directors are expected to use reasonable care in the selection and supervision of such officers. Failure to do so will make the directors liable for negligence or mismanagement. A director who dissents to an action by the board is not personally liable for losses resulting from that action. Unless the dissent is entered into the board meeting minutes, however, the director is presumed to have assented. Therefore, the first issue in the case of AstroStar, Inc., is whether the board members failed to use reasonable care in the selection of the president. If so, and particularly if the board failed to provide a reasonable amount of supervision (and openly embezzled funds indicate that failure), the directors will be personally liable. This liability will include Eckhart unless she can prove that she dissented and that she tried to reasonably supervise the new president. Considering the facts in this case, it is questionable that Eckhart could prove this. 232. Voting Techniques. Algonquin Corp. has issued and has outstanding 100,000 shares of common stock. Four stockholders own 60,000 of these shares, and for the past six years they have nominated a slate of candidates for membership on the board, all of whom have been elected. Sergio and twenty other shareholders, owning 20,000 shares, are dissatisfied with corporate management and want a representative on the board who shares their views. Explain under what circumstances Sergio and the twenty other shareholders can elect their representative to the board. (See Shareholders.) Solution Cumulative voting is a technique that allows minority shareholders to elect a representative to the board of directors. Some states require cumulative voting; other states permit it if the corporate charter so provides. Therefore, if cumulative voting is required by state law or permitted by corporate charter, Sergio and the other minority shareholders have an excellent chance of getting a representative on the board. The minority shareholders can multiply the number of voting shares they hold by the number of board members to be elected and can cast these votes for a single nominee. Because all nominees stand for election at the same time, the majority shareholders must spread out their votes among their entire slate. For example, if five members of the board are to be elected and the majority shareholders, even with proxies, have at best 80,000 shares, they have only 400,000 votes to be spread over their five nominees. Sergio and the minority shareholders, with their 20,000 shares, have 100,000 votes, which they can cast for their sole nominee. In this manner, the minority shareholders can elect their representative to the board. If cumulative voting is not permitted, the majority shareholders can elect the entire board.

430

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

233. Duties of Majority Shareholders. Bill McCann was the president and chief executive officer of McCann Ranch & Livestock Co. He and his brother Ron each owned 36.7 percent of the stock. Ron had been removed from the board of directors on their father‘s death, however, and was not authorized to work for the firm. Their mother, Gertrude, owned the rest of the stock, which was to pass to Bill on her death. The corporation paid Gertrude‘s personal expenses in an amount that represented about 75 percent of the net corporate income. Bill received regular salary increases. The corporation did not issue a dividend. Was Ron the victim of a freeze-out? Discuss. [McCann v. McCann, 152 Idaho 809, 275 P.3d 824 (2012)] (See Rights and Duties of Shareholders.) Solution Ron may arguably have been the victim of a freeze out by Bill and Gertrude. A majority shareholder is sometimes regarded as having a fiduciary duty to the corporation and the minority shareholders. This occurs when a few shareholders acting together own enough shares to exercise control over the corporation. A breach of fiduciary duty by those who control a close corporation can constitute oppressive conduct when the majority shareholders ―freeze out‖ the minority shareholders and exclude them from the benefits of participating in the firm. When a majority shareholder breaches the fiduciary duty to a minority shareholder, the minority shareholder can sue for damages. Here, Ron received no meaningful benefit from his ownership stake. The corporation used corporate funds to pay Gertrude's expenses. This affected Ron more than every other shareholder. Because the corporation did not use a less harmful means of providing for Gertrude—for example, the corporation might instead have issued a dividend that would benefit all shareholders—it could be argued that the transactions were not made in good faith. And these transactions, coupled with the facts that Ron had lost his voice in corporate decisions, his corporate employment, and received no meaningful benefit from his ownership stake, appeared to be an attempt to freeze out Ron. Many of the actions by the corporation were legitimate uses of corporate power and discretion, however. Regardless of Ron‘s ownership interest, he was not entitled to a seat on the board of directors, corporate employment, or necessarily a dividend. In their defense, Bill and Gertrude could assert the business judgment rule—honest mistakes of judgment and poor business decisions do not give rise to liability for damages. In the actual case on which this problem is based, the court reversed a dismissal of Ron‘s claim against Bill and remanded the case for further proceedings. 234. Business Case Problem with Sample Answer— Business Judgment Rule. Country Contractors, Inc., contracted to provide excavation services for A Westside Storage of Indianapolis, Inc., but did not complete the job and later filed for bankruptcy. Stephen Songer and Jahn Songer were Country‘s sole shareholders. The Songers had not misused the corporate form to engage in fraud. The firm had not been undercapitalized, personal and corporate funds had not been commingled, and Country had kept accounting records and minutes of its annual board meetings. Are the Songers personally liable for Country‘s failure to complete its contract? Explain. [Country Contractors, Inc. v. A Westside Storage of Indianapolis, Inc., 4 N.E.3d 677 (Ind.App. 2014)] (See Duties and Liabilities of Directors and Off icers.) — For a sample answer to Problem 34–5, go to Appendix E.

431

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

Solution No. The Songers are not personally liable for Country‘s failure to complete its contract with A Westside Storage. A hallmark of the corporate form of business organization is that shareholders are not personally liable for the debts of the corporation. If the corporation fails, the shareholders can lose their investments, but that is generally the limit of their liability. A court may pierce the corporate veil to hold the shareholders personally liable in certain instances of fraud, undercapitalization, or a failure to observe corporate formalities. But these situations are exceptions. In this problem, the facts state that the Songers had not misused the corporate form to engage in misconduct, the firm had not been undercapitalized, personal and corporate funds had not been commingled, and Country had kept accounting records and minutes of its annual board meetings. These circumstances fall under none of the exceptions to the limit on shareholders‘ liability for corporate obligations. Thus, as shareholders, the Songers are not personally liable for the failure of their company to complete its job. In the actual case on which this problem is based, A Westside Storage filed a suit in an Indiana state court against the Songers for breach of contract. The court held the defendants liable. On the Songers‘ appeal, a state intermediate appellate court reversed. There was no evidence to support piercing the corporate veil. 235. Rights of Shareholders. FCR Realty, LLC, and Clifford B. Green & Sons, Inc., were coowned by three brothers— Frederick, Clifford Jr., and Richard Green. Each brother was a shareholder of the corporation. Frederick was a controlling shareholder, as well as president. Each brother owned a onethird interest in the LLC. Clifford believed that Frederick had misused LLC and corporate funds to pay nonexistent debts and liabilities and had diverted LLC assets to the corporation. He also contended that Frederick had disbursed about $1.8 million in corporate funds to Frederick‘s own separate business. Clifford hired an attorney and filed an action on behalf of the two companies against Frederick for a breach of fiduciary duty. Frederick argued that Clifford lacked the knowledge necessary to adequately represent the companies‘ interest because he did not understand financial statements. Can Clifford maintain the action against Frederick? If so, and if the suit is successful, who recovers the damages? Explain. [FCR Realty, LLC v. Green, 2016 WL 571449 (Conn.Super. 2016)] (See Shareholders.) Solution Clifford can pursue his action on the companies‘ behalf against Frederick. When a corporation is harmed by the actions of a director or officer, the other directors can bring a suit in the name of the company against that party. If the directors do not bring a suit, the shareholders can do so filing what is known as a shareholder’s derivative suit. Any damages recovered in Clifford‘s action will go into the appropriate company treasury. When shareholders bring a derivative suit, they are not pursuing rights or benefits for themselves personally but are acting as guardians of the corporate entity. Thus, if the suit is successful, any damages recovered go into the corporate treasury, not to the shareholders personally. Here, two firms—one a limited liability company (LLC), the other a corporation—are owned by three brothers, including Frederick and Clifford. Frederick is a controlling shareholder, and the president, of the corporation. Clifford believed that Frederick had been misusing the companies‘ funds to pay non-existent debts, divert LLC assets to the corporation, and disburse about $1.8 million in corporate funds to his separate business. Clifford hired an attorney and filed an action

432

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

on behalf of the two companies against Frederick. This action qualifies as a shareholder‘s derivative. Under these facts, any damages recovered should be paid to the companies. Frederick‘s contention that shareholders who lack the knowledge necessary to adequately represent a corporation‘s interest because they do not understand financial statements may be a factor that helps defeat a frivolous suit or an action driven by an outside party. But in this case, Clifford demonstrated the requisite knowledge required to represent the firms‘ interests even if he did not know the details of the companies‘ financial documents—the action was filed on his instigation, he clearly understood the allegations, and he hired an attorney on whom he could rely to represent the companies‘ interests. In the actual case on which this problem is based, Frederick filed a motion to dismiss based on the argument that Clifford lacked standing to bring the suit because he was the wrong party to represent the companies. The court denied the motion in part on the reasoning stated above. 236. Duties and Liabilities of Directors and Officers. M&M Country Store, Inc. operated a gas station and convenience store. Debra Kelly bought M&M from Mary Millett. Under the purchase agreement, Millett was to remain as the corporation‘s sole shareholder until the price was fully paid. A default on any payment would result in the return of M&M to Millett. During Kelly‘s management of M&M, taxes were not remitted, vendors were not paid, repairs were not made, and the store‘s gas tanks and shelves were often empty. Kelly commingled company and personal funds, kept inaccurate records, and allowed M&M‘s business licenses and insurance policies to lapse. After she defaulted on her payments to Millett and surrendered M&M, the company incurred significant expenses to pay outstanding bills and replenish the inventory. Can M&M recover these costs from Kelly? Explain. [M&M Country Store, Inc. v. Kelly, 159 A.D.3d 1102, 71 N.Y.S.3d 707 (3 Dept. 2018)] (See Duties and Liabilities of Directors and Officers.) Solution Yes. M&M can recover from Kelly the costs to pay the outstanding bills and re-stock the depleted inventory resulting from her management. The basis for this recovery could be a breach of fiduciary duty. The relationship between corporate management and the shareholders is one of trust and confidence. This is the basis for the fiduciary duties of the firm‘s directors and officers. As fiduciaries, those individuals owe ethical and legal duties to the corporation and the shareholders. In performing her duties, an officer must act in good faith and exercise due care—the care that an ordinarily prudent person would exercise in similar circumstances. An action must be in what she considers the best interests of the corporation. In this problem, Kelly bought M&M, which operated a gas station and convenience store, from Mary Millett. As part of the deal, until Kelly paid the full price, Millett remained the corporation‘s sole shareholder. Under Kelly‘s management, taxes and vendors were not paid, repairs were not made, and the store‘s gas tanks and shelves were often empty. She commingled company and personal funds, kept inaccurate records, and allowed the store‘s business licenses and insurance policies to lapse. Finally, she defaulted on the payments to Millett, which triggered the return of the company to the seller. M&M expended substantial sums to pay outstanding bills and replenish the inventory. Kelly‘s mismanagement, lacking any legitimate business purpose and resulting in the waste of corporate assets, constitutes a breach of the officer‘s fiduciary duties.

433

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

In the actual case on which this problem is based, M&M filed a suit in a New York state court against Kelly, alleging a breach of fiduciary duty. The court issued a judgment in M&M‘s favor. A state intermediate appellate court affirmed. 237. A Question of Ethics—The IDDR Approach and Duties of Directors and Officers. Hewlett-Packard Company (HP) hired detectives to secretly monitor the phones and e-mail accounts of its directors to find the sources of leaks of company information to the media. When the government learned of the monitoring, criminal charges were brought against HP‘s thenchairwoman and general counsel. Mark Hurd, HP‘s chief executive officer, was found free of wrongdoing. The scandal had the effect of bolstering Hurd‘s reputation for integrity, and he became both chairman and CEO. In congressional testimony, press releases, and investor briefings, Hurd proclaimed HP‘s integrity and its intent to enforce violations of its corporate code of ethics, the Standards of Business Conduct (SBC). Hurd‘s statements concerning HP‘s commitment to ethics and compliance with the SBC reassured investors and the public, and kept HP‘s stock prices from falling. Meanwhile, an independent contractor for HP accused Hurd of sexual harassment. An investigation by HP‘s board found no harassment, but revealed that Hurd lied about his personal relationship with the woman and falsified expense reports to cover it up. Hurd resigned, causing the price of HP stock to drop. A group of shareholders sued HP claiming that Hurd‘s unethical behavior while promoting HP‘s commitment to ethics constituted fraud. [ Retail Wholesale and Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co., 845 F.3d 1268 (9th Cir. 2017)] (See Directors and Officers.) 1.

Using the Discussion step of the IDDR approach, consider whether Hurd‘s conduct constituted an ethical violation against HP and its shareholders. Solution By Hurd‘s conduct, he committed an ethical violation against Hewlett-Packard Co. (HP) and its shareholders. The IDDR approach consists of four steps. The first is an Inquiry to identify the issue, stakeholders, and ethical standards. The issue for Hurd was whether to lie as part of an effort to bolster HP‘s damaged reputation for transparency and ethics. The stakeholders included Hurd, HP, and the firm‘s directors, employees, shareholders, and third parties with which it does business. Applicable ethical standards included the company‘s code and perhaps the general prescription to ―do what is right‖ underlying every set of ethical principles. The second step is a Discussion, in question here, of actions on the issue, the strengths and weaknesses of the actions, and the consequences and effects on the stakeholders. In this problem, Hurd could publicly misrepresent HP and himself as consistently ethical, free of engaging in questionable acts. Or he could present the firm and himself as generally ethical but subject to recent lapses—monitoring the directors, in HP‘s case, and lying about business-related behavior, in Hurd‘s situation. Officers are fiduciaries of their corporation. Their duties include the duty of care and the duty of loyalty. Officers must be honest and use prudent business judgment in the conduct of corporate affairs. They must exercise the degree of care that reasonably prudent people use in conducting their personal affairs. Officers can be held to answer to the corporation and its shareholders for breaching the duty of care. The duty of loyalty requires officers to

434

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

subordinate their personal interests to the corporation‘s welfare. They cannot use corporate funds for personal advantage. HP and its shareholders may have had a cause against Hurd based on his apparent violation of an officer‘s fiduciary duties. He was not honest with the board, and this was clearly not reasonably prudent. Further, he used corporate funds for personal advantage (false expense reports). The seriousness of these transgressions would determine Hurd‘s liability in an action against him. Counterarguments to the assertion of an ethical violation include that the promotion of ethical conduct at HP did not suggest there would be no violations of its code. Hurd did not appear to guaranty that he personally complied with the company‘s code in all circumstances. And neither he nor his misconduct had any relation to the earlier monitoring scandal. The last steps of the IDDR approach include a Decision and its Review. In this case, of course, Hurd decided to misrepresent the truth. A review of the failure of this decision to resolve Hurd‘s ethical dilemma and its negative effect on the stakeholders clearly exposes this decision to have been a mistake. 2.

Using the Review step of the IDDR approach, evaluate HP‘s decision to monitor its directors‘ phones. Solution HP‘s decision to monitor its directors‘ phones was ethically wrong. In this problem, a scandal erupted at HP when the company monitored the phones of its directors. Criminal charges resulted. HP‘s chief executive officer (CEO) publicly touted the firm‘s high standards for ethics and its code, the Standards of Business Conduct (SBC). A conflict between this promotion of the SBC and the CEO‘s behavior arose when he lied about his personal relationship with a contractor and falsified related expense reports. The CEO resigned, causing the price of HP stock to drop. The IDDR approach consists of four steps, the final of which is a Review of the success or failure of an action to resolve a particular ethical issue, and satisfy the issue‘s stakeholders. Here, the issue was whether to monitor the directors‘ phones. The stakeholders included HP and the firm‘s CEO, directors, employees, shareholders, and third parties with which it does business. The most relevant ethical standard was the SBC. When HP chose to monitor the phones, it violated the SBC and threatened the stakeholders‘ trust in the firm to behave ethically. This decision may have immediately resolved the issue, but it was not successful in the long run and would not satisfy the stakeholders. To regain their confidence, HP would need to conduct itself ethically in accord with its own SBC for a reasonable period, avoiding even the appearance of impropriety. In the actual case on which this problem is based, HP shareholders filed a suit against the CEO and the company, alleging securities fraud. The court issued a judgment in the defendants‘ favor. The U.S. Court of Appeals for the Ninth Circuit affirmed, holding that the plaintiffs failed to allege that the defendants‘ representations about ethics were materially misleading.

435

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 34: Corporate Directors, Officers, and Shareholders

Critical Thinking and Writing Assignments 238. Time-Limited Group Assignment—Shareholders’ Duties. Milena Weintraub and Larry Griffith were shareholders in Grand Casino, Inc., which operated a casino in South Dakota. Griffith owned 51 percent of the stock and Weintraub 49 percent. Weintraub managed the casino, which Griffith typically visited once a week. At the end of 2012, an accounting audit showed that the cash on hand was less than the amount posted in the casino‘s books. Later, more shortfalls were discovered. In October 2014, Griffith did a complete audit. Weintraub was unable to account for $200,500 in missing cash. Griffith kept all of the casino‘s most recent profits, including Weintraub‘s $90,447.20 share, and, without telling Weintraub, sold the casino for $400,000 and kept all of the proceeds. Weintraub filed a suit against Griffith, asserting a breach of fiduciary duty. Griffith countered with evidence of Weintraub‘s misappropriation of corporate cash. (See Shareholders.) 1.

The first group will discuss the duties that these parties owed to each other and determine whether Weintraub or Griffith, or both, breached those duties. Solution These parties owed fiduciary duties to each other, which they breached by withholding cash from each other. Weintraub misappropriated corporate cash and Griffith kept all of the proceeds from the sale of the casino.

436

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

The second group will decide how this dispute should be resolved and who should pay what to whom to reconcile the finances. Solution Griffith owed $58,447.20 to Weintraub for his 49 percent share of the proceeds from the casino‘s sale and its profits. Weintraub owed Griffith $68,850 as his share of the cash that Weintraub took from the casino.

The third group will discuss whether Weintraub or Griffin violated any ethical duties to each other or to the corporation. Solution Of course, Weintraub violated his ethical duties to Griffith and to their corporation by misappropriating corporate cash. Griffith violated his ethical duties by intentionally withholding Weintraub‘s portion of the corporate assets on the sale of the casino. In both cases, it would be inequitable for the parties to enjoy the full benefits of the sale and profits of the corporation without also being responsible for the money they each withheld from the other.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 437 Case 35.1 ............................................................................................................................................... 437 Case 35.2 ............................................................................................................................................... 438 Chapter Review ........................................................................................................................................................... 439 Practice and Review .............................................................................................................................. 439 Practice and Review: Debate This ......................................................................................................... 440 Issue Spotters ........................................................................................................................................ 441 Business Scenarios and Case Problems ................................................................................................. 441 Critical Thinking and Writing Assignments ............................................................................................ 446

Critical Thinking Questions in Cases Case 35.1 239. Why is a shareholder required to make a demand on the board to pursue a claim on the corporation‘s behalf? Discuss. Solution A board of directors manages the business and the affairs of the corporation. As the court in this case stated, that responsibility ―normally includes deciding whether to bring litigation on the corporation‘s behalf.‖ To protect the directors‘ managerial authority, a shareholder must first

437

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

make a demand on the board to pursue a claim on the corporation‘s behalf. If the board declines, the shareholder, in bringing the action, must show the court that the directors wrongfully refused the demand. Litigation is expensive, and can result in negative publicity, impacting a company‘s bottom line. The demand requirement affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation that does occur. It discourages suits that are based on little more than suspicion. It also ensures that intra-corporate remedies are sought first. Of course, as the court here notes, ―When the board is disabled from making the decision, however—whether because of interestedness or lacking independence from those who are interested—a stockholder can control the litigation decision.‖ 240. Suppose that Uber‘s entire board had known, before the acquisition, that Otto employees possessed a substantial amount of proprietary Google information. Would the result have been the same? Explain. Solution No, the result in this case would not likely have been the same if Uber‘s entire board had known, before the acquisition, that Otto‘s employees possessed a substantial amount of Google intellectual property. Kalanick, Uber‘s CEO and an Uber director, was aware of the preliminary findings of an investigation that Otto employees possessed substantial files containing confidential and proprietary Google information. But Kalanick did not share this report with the other Uber directors. The court found that, with the exception of Kalanick, the Uber directors were not otherwise aware, when they approved the company‘s purchase of Otto, that any Google confidential information had been transferred to Otto or Uber. This finding made Kalanick the only interested director and supported the court‘s conclusion that the other directors‘ approval of the transaction was not in bad faith. If, however, the facts of the case would have been as set out in the question, it could have led the court to reasonably infer that the entire board intentionally ignored the risks of the transaction. The court might then have concluded that making a demand on the board before McElrath filed his suit on the firm‘s behalf would have been futile. The directors could have faced personal liability for the conduct alleged in McElrath‘s complaint. In other words, they would not have met the requirement of disinterestedness, and therefore could not have fairly considered whether to pursue the litigation.

Case 35.2 241. What actions might a purchasing corporation take to determine if withdrawal liability exists? Solution Before the closing of a purchase of the assets of a corporation, a reasonable purchaser should perform ―due diligence‖ and take other actions to determine if liability exists.

438

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

In the circumstances of this case, to determine if withdrawal liability existed, Amstar could have taken the following steps: 1. 2. 3. 4.

Review the plan‘s documents, including the annual funding notices, publicly available online. Ask Ohana to provide all plan notices. Require Ohana to obtain a statement of the amount of withdrawal liability from the plan. Submit a request to the plan for the information.

Any of these actions would have revealed Ohana‘s withdrawal liability. In the actual case, before the closing, Amstar‘s due diligence team hired engineers to look at the roofs, check for the termites, examine the condition of all the structural features, and estimate what it might take to fix any associated problems. But Amstar relied on Ohana‘s representation that the pension plan was not underfunded—―surprisingly,‖ in the view of the appellate court, which added, ―This reliance is unreasonable.‖ 242. Suppose that Amstar‘s lawyers had advised, ―Absent an express assumption of liability, a purchasing corporation does not assume a selling corporation‘s withdrawal liability.‖ Would the result have been different? Why or why not? Solution No. If lawyers had advised Amstar, ―Absent an express assumption of liability, a purchasing corporation does not assume a selling corporation‘s withdrawal liability,‖ the result would not have been different. A short statement of the reason for this result is the maxim ―Ignorance of the law is no excuse.‖ The legal advice would have been incorrect, but Amstar‘s reliance on it would not render the buyer‘s conduct reasonable. In other words, Amstar could not rely on incorrect legal advice to avoid liability. As for the advice, even if it were based on ambiguity or a lack of clarity in the case law, it would have been incorrect. Accurate advice in that situation would at least note that the law on the issue was lacking or unclear. Better advice would indicate whether a court was likely to hold a successor liable for withdrawal liability, at least in Amstar‘s circumstances.

Chapter Review Practice and Review Mario Bonsetti and Rico Sanchez incorporated Gnarly Vulcan Gear, Inc. (GVG), to manufacture windsurfing equipment. Bonsetti owned 60 percent of the corporation‘s stock, and Sanchez owned 40 percent. Both men served on the board of directors. Hula Boards, Inc., owned solely by Mai Jin Li, made a public offer to buy GVG stock. Hula offered 30 percent more than the market price per share for the stock, and Bonsetti and Sanchez each sold 20 percent of their stock to Hula. Jin Li became the third member of the GVG board of directors. An irreconcilable dispute soon arose between Bonsetti and Sanchez over design modifications of their popular Baked Chameleon board. Despite Bonsetti‘s dissent, Sanchez and Jin Li voted to merge GVG with Hula Boards under the latter name, Gnarly Vulcan Gear was dissolved, and production of the Baked Chameleon ceased. Using the information presented in the chapter, answer the following questions. 243. What rights does Bonsetti have (in most states) as a minority shareholder dissenting to the merger of GVG and Hula Boards?

439

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

Solution The shareholders of each corporation to a merger must approve the plan, by vote, at a shareholders‘ meeting. Most state statutes require the approval of two-thirds of the outstanding shares of voting stock. If a shareholder disapproves of a merger but is outvoted by the other shareholders, the dissenting shareholder is not forced to become an unwilling owner of a corporation that is different from the one in which the dissenter originally invested. The shareholder may be entitled to the fair value of the number of shares held on the date of the merger. This is the shareholder‘s appraisal right. 244. Could the parties have used a short-form merger procedure in this situation? Why or why not? Solution No. The Revised Model Business Corporation Act provides a procedure for the merger of a substantially owned subsidiary corporation into its parent. This short-form merger, or parentsubsidiary merger, can be accomplished without the approval of the shareholders of either corporation. But it can be used only when the parent owns at least 90 percent of the outstanding shares of the stock of the subsidiary. Here, the corporations are not in a parent-subsidiary relationship. 245.

What is the term used for Hula‘s offer to purchase GVG stock?

Solution An acquiring corporation, as in this problem, can deal directly with a target company‘s shareholders in seeking to buy the shares they hold and gain control of the target. The acquiring corporation does this by making a tender offer to all of the shareholders of the target. 246. Suppose that after the merger, a person who was injured on the Baked Chameleon board sued Hula (the surviving corporation). Can Hula be held liable for the injury? Why or why not? Solution After a merger, the surviving corporation automatically acquires all of the merged corporation‘s property and assets without the necessity of a formal transfer. Also, the survivor becomes liable for all of the disappearing corporation‘s debts and obligations. Thus, the survivor in this problem may be held liable for the injury suffered by the customer of the disappearing firm.

Practice and Review: Debate This 247. Corporate law should be changed to prohibit management from using most of the legal methods currently used to fight takeovers. Solution Rarely will an outside group attempt a corporate takeover if the target corporation is well run. For when a publicly held corporation is well run, its stock price will be relatively high, thereby making it an uninviting target for takeover. Therefore, if there is a takeover attempt, current management should be prevented from using many popular defenses, all of which are utilized to benefit management as opposed to shareholders. Often, corporate takeover specialists will target a corporation, not for the benefit of current shareholders, but as a quick ―hit‖ that makes large short-run profits for the former. Without any legal takeover defense tactics, current management cannot properly defend the best interests of

440

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

current shareholders (and employees, too). Takeover specialist could therefore easily take over corporations, split them up and sell the parts off for a quick profit.

Issue Spotters 248. Macro Corporation and Micro Company combine, and a new organization, MM, Inc., takes their place. What is the term for this type of combination? What happens to the assets, property, and liabilities of Micro? Solution This combination is a consolidation (a new entity takes the place of the consolidating disappearing firms). In a merger, in contrast, one of the merging entities continues to exist. In this consolidation, the new corporation, MM, Inc., inherits all of Micro‘s assets, property, and liabilities. 249. Peppertree, Inc., hired Robert McClellan, a licensed contractor, to repair a condominium complex that was damaged in an earthquake. McClellan completes the work, but Peppertree fails to pay. McClellan is awarded $181,000 in an arbitration proceeding. Peppertree then forms another corporation and transfers all of its assets to the new corporation, without notifying McClellan. Can McClellan hold Peppertree‘s shareholders personally liable for the debt? Why or why not? Solution Maybe. If a corporation organizes another corporation with practically the same shareholders and directors, and transfers all the assets but does not pay all the first corporation‘s debts, a court can hold the new corporation liable. Here, the new corporation continued to carry on the same business as Peppertree with all of Peppertree‘s assets so it would be fair for a court to hold the new corporation liable for Peppertree‘s debts.

Business Scenarios and Case Problems 250. Corporate Merger. Alir owns 10,000 shares of Ajax Corp. Her shares represent a 10 percent ownership interest in Ajax. Zeta Corp. wishes to acquire Ajax in a merger, and the board of directors of each corporation has approved. The shareholders of Zeta have already approved as well, and Ajax has called for a shareholders‘ meeting to vote on the merger. Alir disapproves of the merger and does not want to accept Zeta shares for the Ajax shares she holds. The market price of Ajax shares is $20 per share the day before the Ajax shareholder vote. On the day of the vote, the shareholders approve the merger, and the share price drops to $16. Discuss Alir‘s rights in this matter, beginning with the notice of the proposed merger. (See Merger, Consolidation, and Share Exchange.) Solution Ajax apparently has given shareholder Alir notice of the meeting for approval of the merger. In addition, however, Ajax should have notified Alir of her right to dissent and of her right, should the merger be approved, to be paid a fair value for her shares. The law recognizes that a dissenting shareholder should not be forced to become an unwilling shareholder in a new corporation. If Alir adheres strictly to statutory procedures, she has appraisal rights for the Ajax shares she holds after approval of the merger. Alir‘s appraisal rights entitle her to be paid by Zeta the ―fair value‖ of her shares. Fair value is the value of the shares on the day prior to the date on which the vote for merger is taken. This value must not reflect appreciation or depreciation of the stock in anticipation of the approval. If $20 is a true value (the market value on the day before the vote), Alir will receive $200,000 for her 10,000 Ajax shares.

441

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

251. Purchase of Assets. Paradise Pools, Inc. (PPI) entered into a contract with Vittorio, LLP, to build a pool as part of a hotel being developed by Takahashi Development. PPI built the pool, but Vittorio, the general contractor, defaulted on other parts of the project. Takahashi completed the construction. Litigation followed, and Takahashi was awarded $18,656 against PPI. Meanwhile, Paradise Corp. (PC) was incorporated with the same management as PPI, but different shareholders. PC acquired PPI‘s assets, without assuming its liabilities, and soon became known as ―Paradise Pools and Spas.‖ Takahashi sought to obtain a writ of garnishment against PC to enforce the judgment against PPI. Is PC liable for PPI‘s obligation to Takahashi? Why or why not? (See Purchase of Assets.) Solution PC is liable for PPI‘s obligation to Takahashi. Generally, a corporation that acquires the assets, but not the stock, of another corporation is not obligated for the liabilities of the acquired corporation. Exceptions to this rule exist when (1) the successor expressly or impliedly agrees to assume the liabilities of the predecessor; (2) the transaction may be considered a de facto merger; (3) the successor may be considered a mere continuation of the predecessor; or (4) the transaction was fraudulent. Here, PC was a mere continuation of Paradise Pools, Inc. (PPI). The two firms had the same management and assets, the same locations, engaged in the same business, and were both also known as ―Paradise Pools and Spas.‖ 252. Corporate Takeover. Alitech Corp. is a small midwestern business that owns a valuable patent. Alitech has approximately 1,000 shareholders with 100,000 authorized and outstanding shares. Block Corp. would like to have the use of the patent, but Alitech refuses to give Block a license. Block has tried to acquire Alitech by purchasing Alitech‘s assets, but Alitech‘s board of directors has refused to approve the acquisition. Alitech‘s shares are selling for $5 per share. Discuss how Block Corp. might proceed to gain the control and use of Alitech‘s patent. (See Takeovers.) Solution Block obviously cannot get Alitech‘s patent by merger, and the present Alitech board of directors has refused Block a license to use the patent. Therefore, Block‘s best chance to gain the control and use of the patent is to purchase enough Alitech voting shares to control the corporation. This means that Block will deal directly with Alitech‘s shareholders in seeking to purchase the shares they hold. A so-called takeover bid such as this is frequently subject to state and federal securities regulations. Block could even make a tender offer (public offer) open to all shareholders of the target Alitech Corp. To induce Alitech shareholders to sell, Block would probably offer more than the present $5 market price. The tender offer can even be made conditional on Block acquiring a specified number of shares. Moreover, Block can offer its own shares in exchange for Alitech shares held. Once Block obtains sufficient voting shares, Block can elect its own slate for the Alitech board of directors and thereby secure the right to use the patent. 253. Successor Liability. In 2004, the Watergate Hotel in Washington, D.C., obtained a loan from PB Capital. At this time, hotel employees were represented by a union. Under a collective bargaining agreement, the hotel had agreed to make contributions to an employees‘ pension fund run by the union. In 2007, the hotel was closed due to poor business, although the owner stated that the hotel would reopen in 2010. Despite this expectation, PB Capital—which was still owed $40 million by the hotel owner—instituted foreclosure proceedings. At the foreclosure sale, PB Capital bought the hotel and reopened it under new management and with a new workforce. The union sued PB Capital, contending that it should pay $637,855 owed by the previous owner

442

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

into the employees‘ pension fund. Should PB Capital, as the hotel‘s new owner, have to incur the previous owner‘s obligation to pay into the pension fund under the theory of successor liability? Why or why not? [Board of Trustees of Unite Here Local 25 v. MR Watergate, LLC, 677 F.Supp.2d 229 (D.D.C. 2010)] (See Merger, Consolidation, and Share Exchange.) Solution No. There is no successor liability in this situation. The Watergate Hotel had ceased operations in 2007. Under the new owner, PB Capital, there was new management and a new workforce. The company was not a continuation of the previous business operation. In determining whether the purchaser of corporate assets is subject to successor liability for a predecessor‘s liability to a pension fund under successor liability, the court should consider: (1) whether successor company had notice of the pension fund charge, (2) the predecessor‘s ability to provide relief, (3) whether there has been substantial continuity of business operations, (4) whether new employer uses same plant, (5) whether he uses same or substantially same workforce, (6) whether he uses same or substantially same supervisory personnel, (7) whether same jobs exist under substantially same working conditions, (8) whether he uses same machinery, equipment, and methods of production, and (9) whether he produces same products. 254. Purchase of Assets. Grand Adventures Tour & Travel Publishing Corp. (GATT) provided travel services. Duane Boyd, a former GATT director, incorporated Interline Travel & Tour, Inc. At a public sale, Interline bought GATT‘s assets. Interline moved into GATT‘s office building, hired former GATT employees, and began to serve former GATT customers. A GATT creditor, Call Center Technologies, Inc., sought to collect the unpaid amount on a contract with GATT from Interline. Is Interline liable? Why or why not? [Call Center Technologies, Inc. v. Grand Adventures Tour & Travel Publishing Corp., 635 F.3d 48 (2d Cir. 2011)] (See Merger, Consolidation, and Share Exchange.) Solution Yes. Most likely, Interline is liable for the unpaid amount on the GATT contract with Call Center. An acquiring corporation will be held to have assumed the liabilities of the selling corporation in the following situations: 1. 2. 3. 4.

The purchasing corporation expressly or impliedly assumes the seller‘s liabilities. The sale transaction is in effect a merger or consolidation of the two companies. The purchaser continues the seller‘s business and retains the same personnel (shareholders, directors, and officers). The sale is entered into fraudulently for the purpose of escaping liability.

In this problem, Interline acquired GATT‘s assets at a public sale. There is no indication that Interline agreed to assume GATT‘s liabilities, there was no merger or other combination of the two companies, and it does not appear that the sale was fraudulently entered into to escape liability. Thus, the focus is on the third item listed above—whether Interline was liable for GATT‘s debts because it continued GATT‘s business with the same personnel. Boyd was not a GATT employee, but he was a former GATT director. Other members of Interline‘s staff were former GATT employees. GATT and Interline operated out of the same office building. Both companies were in the business of providing travel services to many of the same customers. These factors indicate that Interline is responsible for GATT‘s liabilities, including its debt to Call Center. In the actual case on which this problem is based, the court focused on the same principles discussed here to issue a judgment in Call Center‘s favor.

443

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

255. Business Case Problem with Sample Answer— Purchase of Assets. Lockheed Martin Corporation owned an aluminum refinery in St. Croix, Virgin Islands, that produced hazardous waste. Lockheed sold the refinery to Glencore Ltd. Their contract provided that Glencore would indemnify Lockheed for ―pre-closing‖ environmental conditions. Alcoa World Alumina LLC bought the refinery from Glencore. Their contract stated that the buyer assumed only certain liabilities, including those relating to two specific contracts. Glencore‘s contract with Lockheed was not on the list. A decade later, the government of the Virgin Islands brought actions against the current and former owners of the refinery to recover for the environmental damage. In a settlement, Lockheed agreed to pay for certain remediation costs. Lockheed then filed a suit against Glencore to recover costs related to the settlement. Does Alcoa have to indemnify Glencore for costs related to Lockheed‘s suit? Why or why not? [Alcoa World Alumina LLC v. Glencore Ltd., 2016 WL 521193 (Del.Super.Ct. 2016)] (See Purchase of Assets.) — For a sample answer to Problem 35–6, go to Appendix E. Solution No. Alcoa does not have to indemnify Glencore for costs related to Lockheed‘s suit. Generally, a corporation that purchases the assets of another corporation is not automatically responsible for the liabilities of the selling corporation. Exceptions to this rule are made in certain circumstances, including when the purchasing corporation expressly assumes the seller‘s liabilities. Thus, as Glencore’s successor, Alcoa would not have to indemnify Glencore in Lockheed‘s suit unless Alcoa had expressly assumed liability for Glencore‘s contract with Lockheed. In this problem, Lockheed owned an aluminum refinery in the Virgin Islands that produced hazardous waste. Lockheed sold the refinery to Glencore under a contract that provided the buyer would indemnify the seller for ―pre-closing‖ environmental conditions. Alcoa bought the refinery from Glencore. When the government of the Virgin Islands brought actions against the refinery‘s current and former owners to recover for environmental damage, Lockheed agreed in a settlement to pay for some of the clean up, and filed a suit against Glencore to recover costs related to this settlement. Glencore is likely liable to Lockheed under its purchase agreement for the refinery, in which it agreed to indemnify the seller for ―pre-closing‖ environmental conditions. But Alcoa is not liable to indemnify Glencore for its costs in Lockheed‘s action. Alcoa‘s contract to buy the refinery from Glencore did not contain an express undertaking to assume Glencore‘s liability under its contract with Lockheed. Alcoa‘s contract did state that the buyer assumed certain liabilities, including those relating to two specific contracts. But Glencore‘s liability under its contract with Lockheed was not part of this list.

In the actual case on which this problem is based, Alcoa filed an action in a Delaware state court, asking for a declaratory judgment that Alcoa did not have to defend Glencore in the Lockheed suit or indemnify Glencore for costs related to it. According to the reasoning stated here, the court entered a judgment in Alcoa‘s favor. 256. Tender Offers. Apollo Global Management made a tender offer to the shareholders of Diamond Resorts International. Stephen Cloobeck, the founder of Diamond and the chairman of its board, did not approve of the deal because ―he was disappointed with the price and the company‘s management for not having run the business in a manner that would command a higher price, and that in his view, it was not the right time to sell the company.‖ The directors

444

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

voted, with Cloobeck abstaining, to recommend that the shareholders accept the offer. The recommendation did not state Cloobeck‘s concerns. Apollo acquired a sufficient number of Diamond‘s shares to take control of the company. Did the Diamond board‘s failure to disclose its chairman‘s views render the recommendation to accept Apollo‘s offer materially misleading? Discuss. [Appel v. Berkman, 180 A.3d 1055 (Del. 2018)] (See Takeovers.) Solution Yes. The Diamond board‘s failure to disclose its chairman‘s views rendered the recommendation to accept Apollo‘s tender offer materially misleading. Shareholders‘ acceptance of a tender offer must be fully informed. Disclosures by the board must contain the material facts and not describe events in a materially misleading way. Directors have a fiduciary duty to disclose fully and fairly all material information within their control that would have a significant effect on a shareholder vote when the board recommends shareholder action, such as the acceptance of a tender offer. In this problem, Apollo made a tender offer to the Diamond shareholders to buy their shares. Cloobeck, Diamond‘s founder and chairman, believed that the timing of the sale was improper— the price was too low because management had not been operating the company in a more profitable manner. With Cloobeck abstaining, the directors voted to recommend that the shareholders accept the offer. The recommendation omitted Cloobeck‘s views. It could be argued that an abstaining, or dissenting, board member‘s view is not material. Cloobeck stated that the company had been managed sub-optimally, the sale price was disappointing as a result, and it was not a good time to sell the company. The contention would be that this was Cloobeck‘s opinion, and that the shareholders‘ acceptance of the tender offer was based on all of the material facts. This argument could be countered with the principle that corporate directors have a fiduciary duty to reveal their opinions when advising shareholders on a matter, such as a tender offer, subject to the shareholders‘ vote. The basis for this duty is the directors‘ superior knowledge and the shareholders‘ reliance on that knowledge in determining how to vote on the matter. Providing Cloobeck‘s opinion to the shareholders would have materially altered the ―mix‖ of available information. Therefore, Diamond‘s directors had a duty to disclose it. Omitting it, as the directors did, was to disclose only part of the story, in a materially misleading way, and was not sufficient to satisfy their fiduciary duty. 257. A Question of Ethics—Successor Liability. Ian Bell loaned $250,000 to Bio Defense Corporation, a waste management company in Massachusetts. Before Bell‘s loan came due, Boston Local Development Corp. (BLDC) foreclosed on its own loan to Bio Defense, forcing Bio Defense to cease operations and be sold. At the foreclosure sale, BLDC bought Bio Defense‘s property, including three very valuable patents (assets). BLDC then sold these patents to Oneighty C Technologies Corporation (OCTC). Bell, who had not been paid back for his loan to Bio Defense, learned of these events and filed a lawsuit against OCTC claiming that OCTC was the corporate successor to Bio Defense. [ Bell v. Oneighty C Technologies Corp., 91 Mass.App.Ct. 1112, 81 N.E.3d 825 (2017)] (See Purchase of Assets.) 1.

Could OCTC be held legally liable on the unpaid loan to Bell?

445

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 35: Corporate Mergers, Takeovers, and Termination

Solution Yes. Generally, a corporation that purchases the assets of another corporation is not legally responsible for the liabilities of the selling corporation. Of course, liability may exist if the purchaser expressly assumes the seller‘s liabilities. This can also occur if the sale amounts to what is in effect a merger or consolidation, or if the sale is fraudulently executed to escape liability. A purchaser that continues the seller‘s business and retains the same personnel may be assessed with the seller‘s liabilities. In the latter situation, the successor is said to be a ―mere continuation‖ of its predecessor. In this problem, Ian Bell loaned $250,000 to Bio Defense. Before the loan came due, Boston Local Development Corp. (BLDC) foreclosed on its own secured loan to Bio Defense. At the foreclosure sale of the debtor‘s assets, BLDC bought it all, including in particular three patents. Bio Defense ceased operations. BLDC sold the patents to Oneighty C Technologies Corp. (OCTC). When Bell learned of the sale, he filed a suit against OCTC to collect on his unpaid loan. He argued that OCTC was the corporate successor to Bio Defense. OCTC could assert that it acquired the assets of Bio Defense through an intermediary (BLDC). But this would not affect a finding of liability if OCTC conducts the same business and has the same management. Of course, this circumstance would have to be proved. In the actual case on which this problem is based, the court dismissed Bell‘s complaint. A state intermediate appellate court vacated the dismissal and remanded the case. Bell‘s ―complaint sets forth allegations sufficient to overcome a motion to dismiss under the mere continuation theory of successor corporate liability.‖ 2.

Could OCTC owe an ethical duty to assume liability for the debt? Why or why not? Solution Yes. The basis for an imposition of liability in the absence of an express assumption is a continuation of the entity. The policy reason for the imposition of liability is the fair remuneration of innocent creditors. On this basis and for the same reason, OCTC could owe an ethical duty to assume Bio Defense‘s liability to Bell.

Critical Thinking and Writing Assignments 258. Time-Limited Group Assignment—Mergers and Acquisitions. Angie Jolson is the chair of the board of directors of Artel, Inc., and Sam Douglas is the chair of the board of directors of Fox Express, Inc. Jolson and Douglas meet to consider the possibility of combining their corporations and activities into a single corporate entity. They consider two alternative courses of action: Artel could acquire all of the stock and assets of Fox Express, or the corporations could combine to form a new corporation, called A&F Enterprises, Inc. Both Jolson and Douglas are concerned about the necessity of a formal transfer of property, liability for existing debts, and the need to amend the articles of incorporation. (See Merger, Consolidation, and Share Exchange.) 1.

The first group will identify the first proposed combination and outline its legal effect on the transfer of property, the liabilities of the combined corporations, and the need to amend the articles of incorporation. Solution

446

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

If Artel acquires the stocks and assets of Fox Express, a merger will take place. Artel will be the surviving corporation, and Fox Express will disappear as a corporation. Title to the property of the corporation that ceases to exist will pass automatically to the surviving corporation without a formal transfer being necessary. In addition, the debt liabilities of Fox Express become the liabilities of Artel. Artel‘s articles of incorporation are deemed to be amended to include the terms stated in the articles of merger. 2.

The second group will do the same for the second proposed combination—determine its identity and describe its legal effect on the transfer of property, the liabilities of the combined corporations, and the need to amend the articles of incorporation. Solution If Artel and Fox Express combine so that both corporations cease to exist and a new corporation, A&F Enterprises, is formed, a consolidation will take place. In that case, title to the property of the corporations that cease to exist will pass automatically to the new corporation without a formal transfer being necessary. A&F Enterprises also will assume liability for the debts and obligations of Artel and Fox Express. The articles of consolidation take the place of the articles of incorporation of Artel and Fox Express, and they will be regarded thereafter as the articles of incorporation of A&F Enterprises.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 447 Adapting the Law to the Online Environment ................................................................................ 447 Critical Thinking Questions in Cases ................................................................................................................... 448 Case 36.1 ............................................................................................................................................... 448 Case 36.2 ............................................................................................................................................... 449 Case 36.3 ............................................................................................................................................... 449 Chapter Review ........................................................................................................................................................... 449 Practice and Review .............................................................................................................................. 449 Practice and Review: Debate This ......................................................................................................... 450 Issue Spotters ........................................................................................................................................ 451 Business Scenarios and Case Problems ................................................................................................. 451 Critical Thinking and Writing Assignments ............................................................................................ 460

Critical Thinking Questions in Features Adapting the Law to the Online Environment 259. What alternatives are there to crowdfunding for a start-up business?

447

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Solution A start-up can obtain funding via loans from friends and family. Owners of start-ups often take out second mortgages on their homes to obtain financing. Start-ups can go to venture capitalists to request funding. Occasionally, start-ups can obtain bank financing. Usually, though, banks require that all members of the start-up sign personal guarantees for any funds loaned.

Critical Thinking Questions in Cases Case 36.1 260. Scoville argued that Adpacks were not investment contracts because there was no guarantee that buyers would receive a return on their investment. Should the court have ruled in Scoville‘s favor based on this argument? Explain. Solution No. Very few investments guarantee a return. To qualify as an investment contract, the investor, or buyer, only has to have a reasonable expectation of profits. As long as a transaction satisfies the Howey test for an investment contract, it is immaterial whether the investment is speculative. Scoville argued that Adpacks were not investment contracts because Traffic Monsoon‘s obligation to share its revenue was contingent on there being revenue to share with no guarantee this would happen. In fact, Traffic Monsoon‘s website stated that there was no guarantee there would be revenue for Adpack buyers to share. But based on Scoville‘s other representations, including the touted high rates of return, the Adpack buyers had a reasonable expectation of obtaining a share of Traffic Monsoon‘s revenue. And this was enough to meet the requirements of the test set out in the Howey case (in which the investors were likewise not guaranteed a return on their investment). 261. The return on an investment in an Adpack was not based on any underlying business activity. Instead, money from new investors was used pay earlier investors. Is this a legitimate business model? Discuss. Solution No. The Adpack business model—using money from new investors to generate returns for earlier investors—was likely to be established at trial as what is known as a Ponzi scheme. This sort of set-up is not legitimate because it is deceptive, generating a false appearance of profitability. The central characteristic of a Ponzi scheme is that returns are not based on any underlying business activity. Instead, as in this case, money from new investors is used to pay earlier investors. And often, as also appears to have occurred in this case, the money contributed by later investors generates artificially high dividends for the earlier investors. This may attract even more investors. Traffic Monsoon misrepresented the source of the revenue shared with Adpack investors. Although the company realized some income from its other advertising services, there was essentially no business activity generating the revenue shared with Adpack buyers except the amounts received from the sales of new Adpacks. This deception made the business illegitimate and likely that it would be established as a Ponzi scheme.

448

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Case 36.2 262. Suppose that further drilling revealed that there was not enough ore at this site to be mined commercially. Would the defendants still have been liable for violating SEC Rule 10b-5? Why or why not? Solution Assuming all of the other circumstances are as they are stated in the case, the answer to this question is most probably yes, because the defendants‘ trading was based on their possession of inside information of a material fact without its public disclosure, which is a violation of SEC Rule 10b-5. Depending on subsequent events in this hypothetical situation, however, there may not have been any injury for which a private party could recover (that is, the defendants might have lost money on their trading rather than profiting at the expense of uninformed stock sellers).

Case 36.3 263. In documents available to the public, TransS1 included general warnings about ―the risks of regulatory scrutiny and litigation.‖ Did this satisfy the company‘s duty to disclose its allegedly fraudulent scheme? Why or why not? Solution No. The ―general warnings‖ about ―the risks of regulatory scrutiny and litigation‖ did not satisfy TranS1‘s duty to disclose its allegedly fraudulent scheme. The misrepresentation element of a securities fraud action under Section 10(b) requires a deceptive, material misstatement or omission by a defendant with a duty to disclose. Once that duty is established, a generic warning of a general risk will not meet that requirement if there are undisclosed, more specific material facts that would affect a reasonable investor‘s decision whether to buy or sell the security. Another example of a failure to satisfy that duty is a company‘s public disclosure of a risk of fire in its facility and the installation of a sprinkler system to reduce the danger, but an omission of the fact that the system is inoperable. 264. If the plaintiffs can prove the elements of their claim, what should be the measure of their damages? Explain. Solution In a case alleging fraud, if the plaintiffs can prove the elements of their claim, the measure of their damages should be the amount of their loss. In the circumstances of this case, that could be the difference between the price of TranS1‘s stock before the company revealed the fact of the government‘s investigation and its value after that revelation.

Chapter Review Practice and Review Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc., a natural gas distributor that operated solely within North Dakota. On a weekend fishing trip with his uncle, Ernest Wallace, Emerson mentioned that he had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. When he returned from the fishing trip, Wallace purchased $20,000 worth of Reliant stock. Three weeks later,

449

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57 percent of Dakota Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72 percent before leveling out. Wallace sold his Reliant stock for a gross profit of $14,400. Using the information presented in the chapter, answer the following questions. 265. not?

Would registration with the SEC be required for Dakota Gasworks securities? Why or why

Solution No, because the securities were not newly issued or offered to the public. In this scenario, Dakota Gasworks was the target company in a successful takeover, it did not issue new securities to raise capital or offer any securities to the public. Therefore, it would not have been required to register with the SEC. 266. Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? Why or why not? Solution No, because Emerson did not fail to disclose a material fact in connection with the purchase and sale of securities, nor did he intend to defraud or have knowledge of his misconduct. Emerson did not fail to disclose a material fact in connection with the purchase or sale of securities. What he did do was use bad judgment and breach a fiduciary duty by mentioning the planned takeover to his uncle, who then took the information and used it to his advantage. There is no indication in the facts that Emerson intended to do anything wrong or knew that his uncle would use this information to trade on the information (that he should not have disclosed). 267.

What theory or theories might a court use to hold Wallace liable for insider trading?

Solution Because Wallace acquired inside information as a result of Emerson‘s breach of his fiduciary duty, Wallace could be held liable for insider trading under the tipper/tippee theory. Wallace would have to have known that the information came from a breach of the fiduciary duty. 268. Under the Sarbanes-Oxley Act, who would be required to certify the accuracy of the financial statements Reliant filed with the SEC? Solution Under the Sarbanes-Oxley Act, the chief executive officers and the chief financial officers are required to certify the financial statements.

Practice and Review: Debate This 269.

Inside trading should be legalized.

Solution The more quickly information about publicly held companies gets into the hands of the public, the more efficient the stock market becomes. Therefore, insider trading should be made legal because both good and bad company information will be made completely public more quickly. Those in publicly held companies who profit from having access to such inside information will end up with lower salaries because of competition in the labor market, even for managers.

450

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Laws against insider trading were put in place to prevent insiders—usually highly paid upper-level managers—from undeservedly benefiting from their positions in the publicly head companies. If insider trading were no longer illegal, insiders would stand to make fortunes from buying the companies‘ stock before good news is released. If the inside news is bad, insiders can make fortunes selling short the companies‘ stocks.

Issue Spotters 270. When a corporation wishes to issue certain securities, it must provide sufficient information for an unsophisticated investor to evaluate the financial risk involved. Specifically, the law imposes liability for making a false statement or omission that is ―material.‖ What sort of information would an investor consider material? Solution The average investor is concerned not with minor inaccuracies but with facts that if disclosed would tend to deter that individual from buying the securities. These include material facts that have an important bearing on the condition of the issuer and its business—such as liabilities, loans to officers and directors, customer delinquencies, and pending lawsuits. 271. Lee is an officer of Magma Oil, Inc. Lee knows that a Magma geologist has just discovered a new deposit of oil. Can Lee take advantage of this information to buy and sell Magma stock? Why or why not? Solution No. The Securities Exchange Act of 1934 extends liability to officers and directors in their personal transactions for taking advantage of inside information when they know it is unavailable to the persons with whom they are dealing.

Business Scenarios and Case Problems 272. Registration Requirements. Langley Brothers, Inc., a corporation incorporated and doing business in Kansas, decides to sell common stock worth $1 million to the public. The stock will be sold only within the state of Kansas. Joseph Langley, the chair of the board, says the offering need not be registered with the Securities and Exchange Commission. His brother, Harry, disagrees. Who is right? Explain. (See Securities Act of 1933.) Solution Joseph is right. Under Regulation A, securities issued by an issuer that has offered less than $50 million in securities in any twelve-month period are exempt from registration. With respect to the amount of the offering in this problem, the issue would also fall under Rule 504 of Regulation D, which exempts noninvestment company offerings up to $5 million in any twelve-month period. Rule 506 exempts private, noninvestment company offerings in unlimited amounts if these offerings are not generally solicited or advertised. This exemption is often referred to as the private placement exemption because it exempts ―transactions not involving any public offering.‖ The offering can involve an unlimited number of accredited investors and no more than thirty-five unaccredited investors. The issuer must believe that each unaccredited investor has sufficient knowledge or experience in financial matters to be capable of evaluating the investment‘s merits and risks. The private placement exemption is perhaps most important to firms that want to raise funds through the sale of securities without registering them.

451

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

452

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

273. Insider Trading. David Gain is the chief executive officer (CEO) of Forest Media Corp., which is interested in acquiring RS Communications, Inc. To initiate negotiations, Gain meets with RS‘s CEO, Gill Raz, on Friday, July 12. Two days later, Gain phones his brother, Mark, who buys 3,800 shares of RS stock on the following Monday. Mark discusses the deal with their father, Jordan, who buys 20,000 RS shares on Thursday. On July 25, the day before the RS bid is due, Gain phones his parents‘ home, and Mark buys another 3,200 RS shares. Over the next few days, Gain periodically phones Mark and Jordan, both of whom continued to buy RS shares. On August 5, RS refuses Forest‘s bid and announces that it is merging with another company. The price of RS stock rises 30 percent, increasing the value of Mark‘s and Jordan‘s shares by nearly $660,000 and $400,000, respectively. Is Gain guilty of insider trading? What is required to impose sanctions for this offense? Could a court hold Gain liable? Why or why not? (See Securities Exchange Act of 1934.) Solution There is likely enough evidence in the facts of this problem to find that David violated the law because there was a clear pattern—every time David called his brother or father, Mark or Jordan bought more RS stock. Establishing liability under Section 10(b) and SEC Rule 10b-5 requires proof of an intent to defraud or knowledge of misconduct with respect, in this case, to a failure to disclose material facts used at the time of a trade. People generally buy when they believe the price of a stock is going up and sell when they believe it is going down. Insider trading can be established when it can be inferred that the most likely source of that belief was an insider. For example, a stock purchase or sale‘s proximity in time to a phone conversation between a trader and one with inside information provides a reasonable basis for inferring an exchange of that information. Thus, in this problem, on this basis, a court could hold David liable for insider trading. 274. Violations of the 1934 Act. Matrixx Initiatives, Inc., makes and sells over-the-counter pharmaceutical products. Its core brand is Zicam, which accounts for 70 percent of its sales. Matrixx received reports that some consumers had lost their sense of smell (a condition called anosmia) after using Zicam Cold Remedy. Four product liability suits were filed against Matrixx, seeking damages for anosmia. In public statements relating to revenues and product safety, however, Matrixx did not reveal this information. James Siracusano and other Matrixx investors filed a suit in a federal district court against the company and its executives under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, claiming that the statements were misleading because they did not disclose the information about the product liability suits. Matrixx argued that to be material, information must consist of a statistically significant number of adverse events that require disclosure. Because Siracusano‘s claim did not allege that Matrixx knew of a statistically significant number of adverse events, the company contended that the claim should be dismissed. What is the standard for materiality in this context? Should Siracusano‘s claim be dismissed? Explain. [Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 131 S.Ct. 1309, 179 L.Ed.2d 398 (2011)] (See Securities Exchange Act of 1934.) Solution An omission or misrepresentation of a material fact in connection with the purchase or sale of a security may violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The key question is whether the omitted or misrepresented information is material. A fact, by itself, is not automatically material. A fact will be regarded as material only if it is significant enough that it would likely affect an investor‘s decision as to whether to buy or sell the company‘s securities. For

453

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

example, a company‘s potential liability in a product liability suit and the financial consequences to the firm are material facts that must be disclosed because they are significant enough to affect an investor‘s decision as to whether to buy stock in the company. In this case, the plaintiffs‘ claim should not be dismissed. To prevail on their claim that the defendants made material omissions in violation of Section 10(b) and SEC Rule 10-5, the plaintiffs must prove that the omission was material. Their complaint alleged the omission of information linking Zicam and anosmia (a loss of the sense of smell) and plausibly suggested that reasonable investors would have viewed this information as material. Zicam products account for 70 percent of Matrixx‘s sales. Matrixx received reports of consumers who suffered anosmia after using Zicam Cold Remedy. In public statements discussing revenues and product safety, Matrixx did not disclose this information. But the information was significant enough to likely affect a consumer‘s decision to use the product, and this would affect revenue and ultimately the commercial viability of the product. The information was therefore significant enough to likely affect an investor‘s decision whether to buy or sell Matrixx‘s stock, and this would affect the stock price. Thus, the plaintiffs‘ allegations were sufficient. Contrary to the defendants‘ assertion, statistical sampling is not required to show materiality—reasonable investors could view reports of adverse events as material even if the reports did not provide statistically significant evidence. 275. Business Case Problem with Sample Answer— Disclosure under SEC Rule 10b-5. Dodona I,

LLC, invested $4 million in two securities offerings from Goldman, Sachs & Co. The investments were in collateralized debt obligations (CDOs). Their value depended on residential mortgagebacked securities (RMBSs), whose value in turn depended on the performance of subprime residential mortgages. Before marketing the CDOs, Goldman had noticed several ―red flags‖ relating to investments in the subprime market, in which it had invested heavily. To limit its risk, Goldman began betting against subprime mortgages, RMBSs, and CDOs, including the CDOs it had sold to Dodona. In other words, Goldman made investments based on the assumption that subprime mortgages and the securities instruments built upon them would decrease in value. In an internal e-mail, one Goldman official commented that the company had managed to ―make some lemonade from some big old lemons.‖ Nevertheless, Goldman‘s marketing materials provided only boilerplate statements about the risks of investing in the securities. The CDOs were later downgraded to junk status, and Dodona suffered a major loss while Goldman profited. Assuming that Goldman did not affirmatively misrepresent any facts about the CDOs, can Dodona still recover under SEC Rule 10b-5? If so, how? [Dodona I, LLC v. Goldman, Sachs & Co., 847 F.Supp.2d 624 (S.D.N.Y. 2012)] (See Securities Exchange Act of 1934.) —For a sample answer to Problem 36–4, go to Appendix E.

454

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Solution Yes. Even if Goldman did not affirmatively misrepresent any facts about the CDOs, Dodona can recover if Goldman failed to disclose material facts. An omission is regarded as material if it is significant enough that it would have affected an investor‘s decision concerning the securities. Here, Dodona might recover by showing that Goldman did not fully disclose the risks of investing in the CDOs. Goldman may have misled Dodona by providing only boilerplate statements about investments that it knew were particularly risky. 276. Violations of the 1933 Act. Three shareholders of iStorage sought to sell their stock through World Trade Financial Corp. The shares were restricted securities—that is, securities acquired in an unregistered, private sale. Restricted securities typically bear a ―restrictive‖ legend clearly stating that they cannot be resold in the public marketplace. This legend had been wrongly removed from the iStorage shares, however. Information about the company that was publicly available included the fact that, despite a ten-year life, it had no operating history or earnings. In addition, it had net losses of about $200,000, and its stock was thinly traded. Without investigating the company or the status of its stock, World Trade sold more than 2.3 million shares to the public on behalf of the three customers. Did World Trade violate the Securities Act of 1933? Discuss. [World Trade Financial Corp. v. Securities and Exchange Commission, 739 F.3d 1243 (9th Cir. 2014)] (See Securities Act of 1933.) Solution Yes. World Trade violated the Securities Act of 1933. It is a violation of this act to sell securities without registration unless they qualify for an exemption. It is also a violation of the act to sell securities without registration under an exemption for which they do not qualify. Most securities can be resold without registration. Resales of restricted securities, however, trigger the registration requirements unless the securities fall under the ―safe harbor‖ exceptions of Rule 144 or Rule 144A. In this problem, the facts state that the securities were restricted. There is no indication that they fell under any of the ―safe harbor‖ exceptions of Rule 144 or Rule 144A. Thus, they could not be resold without registration unless they otherwise qualified for an exemption. And there is nothing expressed in the facts to show that these securities qualified for an exemption. In fact, it is pointed out that the securities‘ certificates included a statement disqualifying them for resale without registration. The statement had been wrongly removed. But there are a number of publicly available facts noted in the problem that should have triggered World Trade‘s inquiry into the status of the company and its stock—its lack of an operating history or earnings, its net losses, and the thin trading of its shares. The broker‘s failure to make this inquiry is likely a violation of an important duty. And of course, World Trade‘s sale of the stock without registration was a violation of the Securities Act of 1933. In the actual case on which this problem is based, the Financial Industry Regulatory Authority imposed fines and other sanctions on World Trade for its sales of the iStorage stock, and these penalties were upheld on appeal by the Securities and Exchange Commission and the U.S. Court of Appeals for the Ninth Circuit.

455

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

277. Securities Act of 1933. Big Apple Consulting USA, Inc., provided small publicly traded companies with a variety of services, including marketing, business planning, and website development and maintenance. CyberKey Corp. sold customizable USB drives. CyberKey falsely informed Big Apple that CyberKey had been awarded a $25 million contract with the Department of Homeland Security (DHS). Big Apple used this information in aggressively promoting CyberKey‘s stock and was compensated for the effort in the form of CyberKey shares. When the Securities and Exchange Commission (SEC) began to investigate, Big Apple sold its shares for $7.8 million. The SEC filed an action in a federal district court against Big Apple, alleging a violation of the Securities Act of 1933. Can liability be imposed on a seller for a false statement that was made by someone else? Explain. [U.S. Securities and Exchange Commission v. Big Apple Consulting USA, Inc., 783 F.3d 786 (11th Cir. 2015)] (See Securities Act of 1933.) Solution Yes. Liability under the Securities Act of 1933 can be imposed on a seller for a false statement that was made by someone else. It is a violation of the Securities Act to intentionally defraud investors by misrepresenting or omitting facts in a connection with the purchase or sale of securities. Liability is also imposed on those who are negligent for not discovering the fraud. In this problem, CyberKey falsely informed Big Apple that CyberKey had been awarded a $25 million contract with the Department of Homeland Security (DHS). Big Apple, a public relations firm, aggressively promoted CyberKey‘s stock and was compensated for these efforts in the form of CyberKey shares. When the Securities and Exchange Commission (SEC) began to investigate the assertions, Big Apple sold the stock for $7.8 million. In these circumstances, Big Apple may have known that CyberKey‘s representation about the DHS contract was false, in which case Big Apple might be liable for fraud. Or Big Apple may have been reckless in failing to exercise due diligence and thereby discover CyberKey‘s fraud, in which situation Big Apple could be liable for negligence. In the actual case on which this problem is based, the SEC alleged that Big Apple ―knew, or [was] severely reckless in not knowing‖ that CyberKey did not have a contract with DHS. The court issued a summary judgment in favor of the SEC‘ and against Big Apple. The U.S. Court of Appeals for the Eleventh Circuit affirmed. 278. The Securities Exchange Act of 1934. Dilean Reyes-Rivera was the president of Global Reach Trading (GRT), a corporation registered in Puerto Rico. His brother Jeffrey was the firm‘s accountant. Along with GRT sales agents and other promoters, the brothers solicited funds from individuals by promising to invest the funds in low-risk, short-term, highyield securities. The investors were guaranteed a rate of return of up to 20 percent. Through this arrangement, more than 230 persons provided the brothers with about $22 million. This money was not actually invested. Instead, the funds received from later investors were used to pay ―returns‖ to earlier investors. The Reyes-Riveras spent $4.6 million of the proceeds to buy luxury vehicles, houses, furniture, jewelry, and trips for themselves. What is this type of scheme called? What are the potential consequences? Discuss. [United States v. Reyes-Rivera, 812 F.3d 79 (1st Cir. 2016)] (See Securities Exchange Act of 1934 .)

456

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

Solution The scheme perpetrated by the Reyes-Rivera brothers—a fraudulent investment operation that paid returns to investors from new capital paid to the fraudsters rather than from a legitimate investment—is known as a Ponzi scheme. The potential consequences of such a scheme include the later investors‘ loss of their funds. In some cases, many—if not most, or even all—of the investors suffer the loss of their invested capital. What is not returned as ostensible profit to investors is often stolen or spent by a defrauding party who, like the Reyes-Rivera brothers, runs the scheme. In some circumstances, whatever assets remain in the possession of a perpetrator can be returned to investors through a court order for criminal restitution or an assessment of civil damages. Perpetrators can also be convicted of securities fraud and other violations of the law and be made to suffer appropriate sanctions. For example, the Securities and Exchange Commission has brought numerous enforcement actions against individuals and entities for carrying out Ponzi schemes. In the actual case on which this problem is based, the scheme was uncovered, and the Reyes-Rivera brothers were indicted. Eventually, Dilean pled guilty to conspiracy to commit wire fraud and bank fraud. He was sentenced to concurrent terms of imprisonment of 60 months on the wire fraud conspiracy count and 242 months on the bank fraud count. Restitution was also ordered in the amount of $10,629,021.01. Jeffrey pled guilty to the wire fraud charge and was sentenced to 48 months of imprisonment. On Dilean‘s appeal, the U.S. Court of Appeals for the First Circuit affirmed the sentences over Dilean‘s arguments about their wide disparity ―because the district court provided a plausible and sensible rationale for the sentence it imposed.‖ 279. Securities Fraud. First Solar, Inc., is one of the world‘s largest producers of photovoltaic solar panel modules. When First Solar revealed to the market that the company had discovered defects in its products, the price of the company‘s stock fell, causing the shareholders to suffer an economic loss. Mineworkers‘ Pension Scheme and other First Solar shareholders filed a suit in a federal district court against the firm and its officers, alleging a violation of Section 10(b). The plaintiffs contended that for more than two years, First Solar had wrongfully concealed its discovery, misrepresented the cost and scope of the defects, and reported false information on financial statements. On these facts, can the plaintiffs successfully plead the causation element of a securities fraud action under Section 10(b)? Explain. [Mineworkers’ Pension Scheme. v. First Solar Inc., 881 F.3d 750 (9th Cir. 2018)] (See Securities Exchange Act of 1934.) Solution Yes. The plaintiffs in the Mineworkers case can successfully plead the causation element of a securities fraud action under Section 10(b) on the facts presented in the problem. Section 10(b) proscribes the use of deception in violation of the rules of the Securities and Exchange Commission. Among those rules is Rule 10b-5, which prohibits fraud in connection with the purchase or sale of any security. The basic elements of a securities fraud action include causation, meaning that there is a causal connection between the fraud and the loss. In this problem, First Solar publicly disclosed that it had discovered defects in its products. There was a subsequent drop in the price of the company‘s stock fell, causing shareholders to suffer economic losses. The shareholders filed a suit against the firm and its officers, alleging securities fraud. The plaintiffs contended that for more than two years, First Solar had wrongfully concealed

457

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

its discovery, misrepresented the cost and scope of the defects, and reported false information on financial statements. As pleaded, these facts, if established by evidence, could satisfy the causation test. The issue is whether the defendants‘ misrepresentation, as opposed to some other fact, foreseeably caused the plaintiffs‘ loss. In the actual case on which this problem is based, the court held that ―a plaintiff can satisfy . . . causation by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff‘s economic loss.‖ The U.S. Court of Appeals for the Ninth Circuit affirmed. 280. A Question of Ethics—The IDDR Approach and InsiderTrading. Nan Huang was a senior data analyst for Capital One Financial Corporation. In violation of the company‘s confidentiality policies, Huang downloaded and analyzed confidential information regarding purchases made with Capital One credit cards at more than 200 consumer retail companies and used that information to conduct more than 2,000 trades in the securities of those companies. Capital One terminated Huang due to his violation of the company‘s policies. The next day, Huang boarded a flight to his home country of China. Four days later, the Securities and Exchange Commission filed a complaint against Huang, alleging violations of Section 10(b) and Rule 10b-5. [Securities and Exchange Commission v. Huang, 684 Fed. Appx. 167 (3d Cir. 2017)] (See Securities Exchange Act of 1934.) 1.

Evaluate the ethics of Huang‘s actions, as an employee of Capital One, using the IDDR approach. Solution Huang‘s ethical obligations included duties to follow Capital One‘s company policies and to obey the insider trading laws. The IDDR approach begins with an Inquiry that sets out the ethical dilemma, and identifies the stakeholders and the applicable ethical standards. Huang‘s initial ethical dilemma was whether to take surreptitious advantage of his position as a data analyst for Capital One, a credit-card company, to access data on consumer retail transactions. Applicable ethical standards included company policy and, of course, federal law. The stakeholders included Huang, Capital One, the company‘s other employees, its customers whose transactions Huang analyzed, and many others, such as consumers and stock traders. When a law is violated, the justice system might also be said to be a stakeholder. The Discussion and Decision steps of the IDDR approach cover actions to address the dilemma, the strengths and weaknesses, their consequences and effects, and a selection among the choices. Huang gave in to temptation. He used the data to project the profitability of the firms and its effect on their share prices. He used these projections to buy and sell those shares—i.e., Huang used information that was not publicly available to profit on stock trades, in violation of Section 10(b) and Rule 10b-5 of the federal securities laws. No doubt that all of these actions also violated Capital One‘s company policy. Discovered, Huang could guess that a criminal indictment was forthcoming. Instead of facing the situation, however, he chose to flee. When eventually confronted in court with evidence of his crime, rather than confess and testify, Huang refused to cooperate. By making the choices he did, Huang broke ethical obligations of trust to all of these parties. By itself, this shows

458

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

the weakness of his actions and points to the consequences and effects. The final step of the IDDR approach is a Review of the success or failure of the actions to resolve the issue and satisfy the stakeholders. Huang might have admitted to his wrongs, confessed his missteps to the court, and made restitution to his victims. The results of these actions would have included resetting Huang‘s moral compass with an emerging resumption of his integrity and a clearing of his conscience. He and others might have been dissuaded from similar future conduct. Instead, he chose to do none of these things, thereby adding to the list of his unethical behavior and increasing the dissatisfaction of his stakeholders. Perhaps Capital One could at least claim vindication—the employer terminated Huang immediately on learning of his misbehavior. 2.

When Capital One learned what Huang had done, was the company ethically obligated to terminate him? Explain. Solution When Capital One, a credit-card company, discovered what its employee Huang had done, the company was ethically obligated to terminate him. The Capital One database contained the confidential credit-card activity of its customers. Employed as a data analyst, Huang could access cardholder transactions. He downloaded and analyzed confidential information regarding purchases made with Capital One credit cards at consumer retail companies. This violated the company‘s confidentiality policy. Huang then used that information to conduct trades in the securities of those companies. On learning of these activities, Capital One had to determine how to approach and deal with the situation. The stakeholders to this dilemma included Capital One‘s customers, employees, job applicants, and owners, as well as the companies that accepted Capital One cards, and the owners of the firms whose stock Huang traded. Expressed or implied company policy would have been an applicable standard. But the terms of Huang‘s employment contract (if any), the principles of the governing law, and the personal ethics of his superiors could also influence a decision. Capital One could have chosen to take no action, to keep Huang employed subject to discipline, or to discharge him. Taking no action might have kept Huang‘s activities secret, preventing or at least postponing any negative effects to the company from a public exposure of his actions. Once Huang‘s violations were made known, however, if it was apparent that Capital One had done nothing in response, the company could suffer copycat conduct by other employees, and also lose clients and cardholders. There could be similar consequences if Huang remained in the company‘s employ, even if he were otherwise disciplined. The only reasonable choice would be Huang‘s discharge. And Capital One did terminate Huang. This action was likely sanctioned by the company‘s policy. It was probably in line with any employment contract—after all, Huang‘s breach of Capital One‘s confidentiality principle would have also been a breach of the contract. Nor does it seem probable that any law or the personal standards of his superiors would have required Huang‘s continued employment. All of the stakeholders, with the possible exception of Huang, would also have been gratified with this result. Perhaps the only outcome more satisfying would be Huang‘s conviction on the charges against him and an order of restitution to those with whom he traded securities.

459

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 36: Investor Protection, Insider Trading, and Corporate Governance

In the actual case on which this problem is based, the jury was asked simply whether Huang had committed insider trading. Their answer was an equally simple, ―Yes.‖ Among other penalties, the court ordered Huang to fully disgorge the profits that he had made on the illegal trades. The U.S. Court of Appeals for the Third Circuit affirmed.

Critical Thinking and Writing Assignments 281. Time-Limited Group Assignment—Violations of Securities Laws. Karel Svoboda, a credit officer for Rogue Bank, evaluated and approved his employer‘s extensions of credit to clients. These responsibilities gave Svoboda access to nonpublic information about the clients‘ earnings, performance, acquisitions, and business plans from confidential memos, e-mail, and other sources. Svoboda devised a scheme with Alena Robles, an independent accountant, to use this information to trade securities. Pursuant to their scheme, Robles traded in the securities of more than twenty different companies and profited by more than $2 million. Svoboda also executed trades for his own profit of more than $800,000, despite their agreement that Robles would do all of the trading. Aware that their scheme violated Rogue Bank‘s policy, they attempted to conduct their trades in such a way as to avoid suspicion. When the bank questioned Svoboda about his actions, he lied, refused to cooperate, and was fired. (See Securities Exchange Act of 1934.) 1. The first group will determine whether Svoboda or Robles committed any crimes. Solution Svoboda and Robles committed fraud when they traded securities using the nonpublic information that Svoboda had access to. Criminal charges could be filed against them under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission (SEC) Rule 10b-5, which generally prohibit fraud in connection with the purchase or sale of securities. Penalties could include extended incarceration and significant fines. A person commits fraud under Section 10(b) and Rule 10b-5 when that person misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. If this person tips another individual, the tippee also is liable for trading on the information if the tipper's breach of duty is established and the tippee was aware of the breach. The tipper must act with scienter—an intent to deceive, manipulate, or defraud, or at least knowing misconduct. The information must be material, which occurs if there is a substantial likelihood that a reasonable investor would view it as significantly altering the total mix of information. It must also be nonpublic, which means generally that persons trading in the stock must not have known it. In this problem, Svoboda breached fiduciary duties owed to Rogue Bank and its clients by passing along confidential information to Robles for trading purposes and by personally trading on the information. Robles is liable as a tippee because of Robles' awareness of Svoboda‘s breaches of duty, as shown by Robles' agreement to execute all of the trades. These parties acted with scienter. Their scheme involved repeated acts of fraud and steps to conceal the illegal activity. And the information on which they based their trades was material and nonpublic. 2. The second group will decide whether Svoboda or Robles is subject to civil liability. If so, who could file a suit and on what ground? What are the possible sanctions?

460

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Solution Svoboda and Robles are also subject to civil liability for their actions. The SEC could file a civil suit in a federal district court against them for their insider-trading violations. Possible sanctions include permanent injunctions against violating the securities laws, hefty civil fines, and disgorgement of their profit, plus interest. Svoboda might be assessed with joint and several liability for Robles‘s portion.

3. A third group will identify any defenses that Svoboda or Robles could raise and determine whether the defenses would be likely to succeed. Solution Svoboda‘s might defend against the civil charges by arguing that he had been ―punished enough‖—he had been caught, indicted on criminal charges, convicted, fined, and sentenced to incarceration. This defense is not likely to succeed.

Solution and Answer Guide Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 461 Case 37.1 ............................................................................................................................................... 461 Case 37.2 ............................................................................................................................................... 462 Case 37.3 ............................................................................................................................................... 463 Chapter Review ........................................................................................................................................................... 464 Practice and Review .............................................................................................................................. 464 Practice and Review: Debate This ......................................................................................................... 465 Issue Spotters ........................................................................................................................................ 465 Business Scenarios and Case Problems ................................................................................................. 465 Critical Thinking and Writing Assignments ............................................................................................ 472

Critical Thinking Questions in Cases Case 37.1 282. Why would an owner of land that falls within the boundaries of a wild and scenic river area challenge those boundaries? Solution The chief reason an owner of land that falls within the boundaries of a wild and scenic river would challenge those boundaries is most likely a belief that the value and use of the land has been, or will be, negatively affected. Some owners fear that the government will subsequently forcibly acquire the land or regulate it out of viable use.

461

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Despite these fears, there is no evidence that the designation of land to be within the boundaries of a wild and scenic river has a significant effect on property values. The purpose of the designation is to protect the quality of the river‘s environment. By law, there can be no impact on existing water rights. No new privileges are granted to the public. Current uses of the land within the designated boundaries can continue. No new hydro or power projects can be licensed. But federal administering agencies do not generally have the authority to control the public use of private land. A local, county, or regional planning or zoning commission, however, may impose physical and use limits on the land. 283. Suppose that instead of establishing the boundaries of the NSRA to protect ORVs, the NPS had drawn the boundaries to maintain the area‘s acreage at a certain number. Would the result in this case have been different? Explain. Solution Yes. If the NPS had drawn the boundaries of the NSRA to maintain the area‘s acreage at a certain number, instead of establishing the boundaries to protect ORVs, the result in this case would have been different. The NPS‘s action would have been ruled to be arbitrary and capricious. This is because the Niobrara Scenic River Designation Act required the NPS to focus on protecting the ORVs—that is, scenic, recreational, geologic, fish and wildlife, and paleontological factors. One of the bases for holding an agency action to be arbitrary and capricious is failing to consider relevant factors. No factor is more relevant than one referred by statute.

Case 37.2 284. Could a willful violation of a safety regulation be established if an employer did not know of the rule‘s requirements? Explain. Solution Yes, an employer could be found to have willfully violated a safety regulation even if the employer was not aware of its requirement. Generally, in this context, the definition of willful is an intentional disregard of, or plain indifference to, regulatory requirements. As indicated by this definition, and the reasoning of the court in the Edwin Taylor case, a willful violation can be established with proof either that (1) An employer knew of the standard prohibiting the conduct or condition and consciously disregarded it, or (2) An employer did not know of the standard, but exhibited such reckless disregard for employee safety or legal requirements generally that it could be inferred the employer would not have cared if the conduct or condition violated the standard. In other words, ignorance of a regulation‘s requirements will not excuse its violation 285. Suppose that one of the superintendents of Edwin Taylor‘s worksite had told Hernandez‘s workers to put up the railings, but they had refused. Would the result have been different? Discuss. Solution No, if an Edwin Taylor superintendent at the construction site had told Hernandez‘s workers to erect guardrails, but they had refused, the result in this case would not have been different.

462

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Edwin Taylor had general supervisory authority at the build site. This included authority over the employees of its subcontractors, including Hernandez. OSHA‘s safety standards applied to the operations at the site. Edwin Taylor‘s supervisors were tasked with identifying existing and predictable hazards. Thus, the builder had the authority both to correct safety violations and to require Hernandez‘s workers to correct the violations at the site. In general, Edwin Taylor‘s superintendents should have acted to detect and prevent violations of OSHA‘s fall protection standards at the condominium worksite. This required railings at the sides and edges of decking on a build above six feet. If a superintendent had told a subcontractor‘s workers to install the railings, and they had refused, the workers should have been told to stay off the decking, or to leave the site. Other workers might have then been instructed to add the guardrails. If, however, the superintendent had accepted the refusal, or otherwise not cautioned the workers to stay off the decking, as indicated by the facts of the case and the question, and a worker had fallen to his death, Edwin Taylor would have been no less liable for the safety standard violation

Case 37.3 286.

What impact did the Vara Declaration have on the court‘s ruling in this case?

Solution The Vara Declaration made clear that Alberto Olivares‘s (Petitioner‘s) record ―raised concerns that Petitioner might use his flight training to advance the interests of a criminal enterprise, which could include an enterprise that seeks to do harm to the United States.‖ That perspective supported the agency‘s action to deny Olivares‘s application to attend a Federal Aviation Administration (FAA)-certified flight school in France and likewise lent support to the court‘s conclusion to defer to the agency‘s decision. Olivares is a foreign alien from Venezuela. He applied to attend flight school in France to obtain a pilot certification to fly large, U.S.-registered aircraft. After a background check, the Transportation Security Administration (TSA) determined that Olivares was a risk to national security and denied his application. Olivares sought a court‘s review of the agency‘s denial. The TSA provided the court with internal agency materials that included the findings of the background investigation. The TSA also provided a testimonial declaration by Andrea Vara, the official who denied Olivares‘s application. The declaration explained the grounds supporting the agency‘s determination that Olivares was a risk to national security. To the court, Vara‘s declaration confirmed, with the internal agency materials, that the agency had a reasonable explanation for its action. Because the court had this written statement explaining the grounds and rationale for the TSA‘s action—and because the declaration supported a finding that the agency‘s action on Olivares‘s application was not arbitrary, capricious, an abuse of discretion, or otherwise not in accord with law—the court concluded that there was no need to further review the case or to remand it for other considerations. The court denied the petition for review.‖

463

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Chapter Review Practice and Review Assume that the Securities and Exchange Commission (SEC) has a rule under which it enforces statutory provisions prohibiting insider trading only when the insiders make monetary profits for themselves. Then the SEC makes a new rule, declaring that it has the statutory authority to bring enforcement actions against individuals even if they did not personally profit from the insider trading. The SEC simply announces the new rule without conducting a rulemaking proceeding. A stock brokerage firm objects and says that the new rule was unlawfully developed without opportunity for public comment. The brokerage firm challenges the rule in an action that ultimately is reviewed by a federal appellate court. Using the information presented in the chapter, answer the following questions. 287. Is the SEC an executive agency or an independent regulatory agency? Does it matter to the outcome of this dispute? Explain. Solution The SEC is an independent regulatory agency, because the president does not have the power to appoint and remove federal officers at the SEC. Because federal officers at the SEC are not appointed by the president, serve for a fixed term, and cannot be removed from their positions without just cause, the SEC is an independent regulatory agency. Whether the SEC is an executive or independent regulatory agency has no bearing on the outcome of this dispute, though. 288. Suppose that the SEC asserts that it has always had the statutory authority to pursue persons for insider trading regardless of whether they personally profited from the transaction. This is the only argument the SEC makes to justify changing its enforcement rules. Would a court be likely to find that the SEC‘s action was arbitrary and capricious under the Administrative Procedure Act (APA)? Why or why not? Solution The new rule is likely arbitrary and capricious because little rationale was provided for a major change in a rule that should have been subject to notice-and-comment proceedings. 289. Would a court be likely to give Chevron deference to the SEC‘s interpretation of the law on insider trading? Why or why not? Solution The SEC will probably not get Chevron deference and the courts will give careful review to the new regulation. The new rule is a major expansion of regulatory power and it is not clear it was the intent of Congress to go this far. 290. Now assume that a court finds that the new rule is merely ―interpretive.‖ What effect would this determination have on whether the SEC had to follow the APA‘s rulemaking procedures? Solution Interpretive rules are not subject to the same level of judicial review as are new substantive rules.

464

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Practice and Review: Debate This 291. Because an administrative law judge (ALJ) acts as both judge and jury, there should always be at least three ALJs in each administrative hearing. Solution It is unfair to give an ALJ so much power within any administrative agency. After all, each ALJ works for the administrative agency that the ALJ is supposed to judge in any dispute. How can we assume that an ALJ will be unbiased? There will always be a tenancy for ALJs to favor the actions of administrative agencies. There is at least a chance of more unbiased decisions if at least three ALJs hear each case. The system of ALJs has worked well for decades, so now is not the time to change it. In any event, ALJs frequently rule against the agencies for whom they work. Besides, when a party to an ALJ‘s decision doesn‘t like the outcome, that party can always appeal the decision in federal court, which happens quite often. Finally, the cost of tripling the number of ALJs would be prohibitive, especially with the federal government running such huge budget deficits.

Issue Spotters 292. The U.S. Department of Transportation (DOT) sometimes hears an appeal from a party whose contract with the DOT has been canceled. An administrative law judge (ALJ), who works for the DOT, hears this appeal. What safeguards promote the ALJ‘s fairness? Solution Under the Administrative Procedure Act (APA), the administrative law judge (ALJ) must be separate from the agency‘s investigative and prosecutorial staff. Ex parte communications between the ALJ and a party to a proceeding are prohibited. Under the APA, an ALJ is exempt from agency discipline except on a showing of good cause. 293. Techplate Corporation learns that a federal administrative agency is considering a rule that will have a negative impact on the firm‘s ability to do business. Does the firm have any opportunity to express its opinion about the pending rule? Explain. Solution Yes. Administrative rulemaking starts with the publication of a notice of the rulemaking in the Federal Register. Among other details, this notice states where and when the proceedings, such as a public hearing, will be held. Proponents and opponents can offer their comments and concerns regarding the pending rule. After the agency reviews all the comments from the proceedings, it considers what was presented and drafts the final rule.

Business Scenarios and Case Problems 294. Rulemaking. For decades, the Federal Trade Commission (FTC) resolved fair trade and advertising disputes through individual adjudications. In the 1960s, the FTC began setting forth rules that defined unfair trade practices. In cases involving violations of these rules, the due process rights of participants were more limited and did not include cross-examination. This was because, although anyone found violating a rule would receive a full adjudication, the legitimacy of the rule itself could not be challenged in the adjudication. Any party charged with violating a rule was almost certain to lose the adjudication. Affected parties complained to a court, arguing that their rights before the FTC were unduly limited by the new rules. What will the court examine to determine whether to uphold the new rules? (See The Administrative Process.)

465

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

Solution The court will examine first whether the agency followed the procedures prescribed in the Administrative Procedure Act (APA). If so, the Federal Trade Commission (FTC) rules will likely be held legal. As long as an agency has both rulemaking and adjudicatory powers, the agency has great discretion in its choice of which power to use. Courts will not second-guess agencies on their choice of proceeding through rulemaking and adjudication. As long as the FTC followed prescribed rulemaking procedures, with notice and comment, the rules and subsequent adjudications will be legal. 295. Informal Rulemaking. Assume that the Food and Drug Administration (FDA), using proper procedures, adopts a rule describing its future investigations. This new rule covers all future circumstances in which the FDA wants to regulate food additives. Under the new rule, the FDA is not to regulate food additives without giving food companies an opportunity to crossexamine witnesses. Some time later, the FDA wants to regulate methylisocyanate, a food additive. After conducting an informal rulemaking procedure, without cross-examination, the FDA regulates methylisocyanate. Producers protest, saying that the FDA promised them the opportunity for cross-examination. The FDA responds that the Administrative Procedure Act does not require such cross-examination and that it is free to withdraw the promise made in its new rule. If the producers challenge the FDA in court, on what basis would the court rule in their favor? (See The Administrative Process.) Solution The court will consider first whether the agency followed the procedures prescribed in the Administrative Procedure Act (APA). Ordinarily, courts will not require agencies to use procedures beyond those of the APA. Courts will, however, compel agencies to follow their own rules. If an agency has adopted a rule granting extra procedures, the agency must provide those extra procedures, at least until the rule is formally rescinded. Ultimately, in this case, the court will most likely rule for the food producers. 296. Spotlight on the Environmental Protection Agency—Powers of the Agency. A welldocumented rise in global temperatures has coincided with a significant increase in the concentration of carbon dioxide in the atmosphere. Many scientists believe that the two trends are related, because when carbon dioxide is released into the atmosphere, it produces a greenhouse effect, trapping solar heat. Under the Clean Air Act (CAA), the Environmental Protection Agency (EPA) is authorized to regulate ―any‖ air pollutants ―emitted into . . . the ambient air‖ that in its ―judgment cause, or contribute to, air pollution.‖ A group of private organizations asked the EPA to regulate carbon dioxide and other ―greenhouse gas‖ emissions from new motor vehicles. The EPA refused, stating that Congress last amended the CAA in 1990 without authorizing new, binding limits on auto emissions. Nineteen states, including Massachusetts, asked a district court to review the EPA‘s denial. Did the EPA have the authority to regulate greenhouse gas emissions from new motor vehicles? If so, was its stated reason for refusing to do so consistent with that authority? Discuss. [Massachusetts v. Environmental Protection Agency, 549 U.S. 497, 127 S.Ct. 1438, 167 L.Ed.2d 248 (2007)] (See Agency Creation and Powers.) Solution The United States Supreme Court held that greenhouse gases fit within the Clean Air Act‘s (CAA‘s) definition of ―air pollutant.‖ Thus, the Environmental Protection Agency (EPA) has the authority under that statute to regulate the emission of such gases from new motor vehicles. According to

466

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

the Court, the definition, which includes ―any‖ air pollutant, embraces all airborne compounds ―of whatever stripe.‖ The EPA's focus on Congress‘s 1990 amendments (or their lack) indicates nothing about the original intent behind the statute (and its amendments before 1990). Nothing in the statute suggests that Congress meant to curtail the agency‘s power to treat greenhouse gases as air pollutants. In other words, the agency has a pre-existing mandate to regulate ―any air pollutant‖ that may endanger the public welfare. The EPA also argued that, even if it had the authority to regulate greenhouse gases, the agency would not exercise that authority because any regulation would conflict with other administration priorities. The Court acknowledged that the CAA conditions EPA action on the agency‘s formation of a ―judgment,‖ but explained that judgment must relate to whether a pollutant ―cause[s], or contribute[s] to, air pollution which may reasonably be anticipated to endanger public health or welfare.‖ Thus, the EPA can avoid issuing regulations only if the agency determines that greenhouse gases do not contribute to climate change (or if the agency reasonably explains why it cannot or will not determine whether they do). The EPA‘s refusal to regulate was thus ―arbitrary, capricious, or otherwise not in accordance with law,‖ The Court remanded the case for the EPA to ―ground its reasons for action or inaction in the statute.‖ 297. Judicial Deference. After Dave Conley died of lung cancer, his widow filed for benefits under the Black Lung Benefits Act. To qualify for benefits under the act, she had to show that exposure to coal dust was a substantial contributing factor to her husband‘s death. Conley had been a coal miner, but he had also been a longtime smoker. At the benefits hearing, a physician testified that coal dust was a substantial factor in Conley‘s death. No evidence was presented to support this conclusion, however. The administrative law judge awarded benefits. On appeal, should a court defer to this decision? Discuss. [Conley v. National Mines Corp., 595 F.3d 297 (6th Cir. 2010)] (See Judicial Deference to Agency Decisions.) Solution A court of appeals reviews the legal issues raised in an administrative appeal but accords deference to relevant factual finding. An ALJ‘s factual determinations must be upheld if they are supported by substantial evidence in the administrative record, and the decision as a whole must be affirmed if the ALJ‘s decision was rational, supported by substantial evidence on the record, and consistent with controlling law. When an ALJ has improperly characterized the evidence or failed to take into account relevant material, however, deference is inappropriate and remand is required. A failure by the ALJ to apply the correct legal standard presents a legal question over which the BRB and the court of appeals have plenary (unlimited) review. The appeals court reviews the BRB‘s decision reversing the ALJ, not the ALJ‘s decision itself. The question is if the BRB correctly concluded that the ALJ‘s decision was not supported by sufficient evidence based on established legal standards. Since the medical record did not support the conclusion that coal dust exposure hastened death from lung cancer caused by cigarette smoking, the reversal by the BRB was correct. 298. Business Case Problem with Sample Answer—Arbitrary and Capricious Test. Michael Manin, an airline pilot, was twice convicted of disorderly conduct, a minor misdemeanor. To renew his flight certification with the National Transportation Safety Board (NTSB), Manin filed an application that asked him about his criminal history. He did not disclose his two convictions. When these came to light more than ten years later, Manin argued that he had not known that he was required to report convictions for minor misdemeanors. The NTSB‘s policy was to consider an applicant‘s understanding of what information a question sought before determining whether an

467

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

answer was false. But without explanation, the agency departed from this policy, refused to consider Manin‘s argument, and revoked his certification. Was this action arbitrary or capricious? Explain. [Manin v. National Transportation Safety Board, 627 F.3d 1239 (D.C.Cir. 2011)] (See Agency Creation and Powers.) —For a sample answer to Problem 37–5, go to Appendix E. Solution Yes. The agency‘s decision to revoke Manin‘s certification was arbitrary and capricious. When reviewing an agency decision, a court considers whether the agency‘s actions were arbitrary, capricious, or an abuse of discretion. An action is arbitrary or capricious if, for example, the agency changed its prior policy without justification or entirely failed to consider a relevant factor. When an agency‘s action is arbitrary or capricious, a court can hold it to be unlawful and set it aside. In this problem, the agency departed from its prior policy without explanation. That policy was to consider an applicant‘s understanding of what information a question was asking for before determining whether the applicant‘s answer was false. Manin argued that he had not known he was required to report convictions for minor misdemeanors. For policy reasons, the agency should have allowed him to present evidence that he did not know the statements he made on his application were false. But the agency refused to consider this argument and revoked his certification. In the actual case on which this problem is based, the court held that the agency‘s action had been arbitrary and capricious. 299. Adjudication. Mechanics replaced a brake assembly on the landing gear of a CRJ–700 plane operated by GoJet Airlines, LLC. The mechanics installed gear pins to lock the assembly in place during the repair, but failed to remove one of the pins after they had finished. On the plane‘s next flight, a warning light alerted the pilots that the landing gear would not retract after takeoff. There was a potential for danger, but the pilots flew the plane safely back to the departure airport. No one was injured, and no property was damaged. The Federal Aviation Administration (FAA) cited GoJet for violating FAA regulations by ―carelessly or recklessly operating an unairworthy airplane.‖ GoJet objected to the citation. To which court can GoJet appeal for review? On what ground might that court decline to review the case? [GoJet Airlines, LLC v. F.A.A., 743 F.3d 1168 (8th Cir. 2014)] (See The Administrative Process.) Solution GoJet can appeal the decision of the Federal Aviation Administration (FAA) to the appropriate federal court of appeals. After a hearing before an administrative law judge (ALJ), the ALJ issues an initial order. Any party to the case can appeal this decision to the board or commission that governs the agency. If any party is further dissatisfied with the governing body‘s ruling, the party can appeal the decision to a federal appellate court. If the party appeals and a review is denied, the order of the ALJ or the governing body becomes the final order in the case. If the party appeals and the case is accepted for review, the final order will come from the reviewing court. In this problem, after the initial order in GoJet‘s case, the airline can appeal to the FAA‘s governing board or commission and, if further appeal is sought, to a federal appellate court. On the facts, GoJet might base its appeal from an adverse ruling on the pilots‘ successful attempt to avoid injury or damage—a warning light alerted that the landing gear would not retract, and the pilots safely flew the aircraft back to the departure airport. A ground on which the court might

468

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

deny review is that regardless of what actually occurred, the potential for danger and harm existed—one of the gear pins was not removed, and the landing gear would not retract after the plane had taken off. This is on its face a violation of FAA regulations by ―carelessly or recklessly operating an unairworthy airplane.‖ In the actual case on which this problem is based, the FAA imposed a civil penalty. GoJet petitioned the U.S. Court of Appeals for the Eighth Circuit for review. The court denied the petition. The court held that proof of actual danger is not required for the FAA‘s citation and imposition of a penalty—―the potential for danger is enough.‖ 300. Judicial Deference to Agency Decisions. Knox Creek Coal Corporation operates coal mines in West Virginia. The U.S. Department of Labor charged Knox‘s Tiller No. 1 Mine with ―significant and substantial‖ (S&S) violations of the Federal Mine Safety and Health Act. According to the charges, inadequately sealed enclosures of electrical equipment in the mine created the potential for an explosion. The Mine Act designates a violation as S&S when it ―could significantly and substantially contribute to the cause and effect of a coal or other mine safety or health hazard.‖ Challenging the S&S determination, Knox filed a suit against the secretary of labor. The secretary argued that ―could‖ means ―merely possible‖—if there is a violation, the existence of a hazard is assumed. This position was consistent with agency and judicial precedent and the Mine Act‘s history and purpose. Knox argued that ―could‖ requires proof of the likelihood of a hazard. When does a court defer to an agency‘s interpretation of law? Do those circumstances exist in this case? Discuss. [Knox Creek Coal Corp. v. Secretary of Labor, 811 F.3d 148 (4th Cir. 2016)] (See Judicial Deference to Agency Decisions.) Solution Yes. The court can defer to the Secretary‘s interpretation of the language in the Mine Act, but only if the court decides that the interpretation is reasonable. A court generally defers to an agency‘s analysis of facts that pertain to its area of expertise. A court also generally defers to an agency‘s interpretation of a statute if the interpretation is reasonable. Reasonableness is particularly important when the statute‘s language is ambiguous. An interpretation that meets the standards for notice-and-comment rulemaking is assured of deference. The Federal Mine Safety and Health Act—the statute at the center of this problem—designates a violation as ―significant and substantial‖ (S&S) when it ―could significantly and substantially contribute to the cause and effect of a coal or other mine safety or health hazard.‖ The U.S. Department of Labor charged Knox Creek with violations of the Mine Act that were determined to be S&S. In Knox Creek‘s challenge to this determination in a federal court, the Labor Secretary contended that the statute‘s language (―could‖) meant ―merely possible.‖ Knox Creek argued that the statute required evidence of at least some ―threshold level of probability.‖ Thus, in the citing of Knox Creek‘s mine for violations of the Mine Act, as to whether the reasonable likelihood of an explosion was required to determine that the violations were S&S, there were at least two plausible interpretations of the statutory language. As a result, the language can be considered ambiguous, and the court can determine whether the Secretary‘s interpretation is reasonable. As distinguished from an interpretation that results through notice-and-comment rulemaking, a position taken in the context of litigation does not arise out of a formal procedure intended to

469

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

foster ―fairness and deliberation,‖ and is not binding and precedential. Thus, it is owed deference to the extent that it has the ―power to persuade‖—i.e., that it is reasonable. Because the Secretary‘s position is consistent with agency and judicial precedent and the Mine Act‘s history and purpose, the court will likely conclude that it is persuasive and defer to it. In the actual case on which this problem is based, the court determined that the Secretary‘s position in the context of the litigation was not entitled to ―full Chevron‖ deference. But the court concluded that the position was persuasive—in part for the reasons noted here—deferred to it and denied Knox Creek‘s petition for review. 301. The Arbitrary and Capricious Test. The Sikh Cultural Society, Inc. (SCS), petitioned the United States Citizenship and Immigration Services (USCIS) for a special immigrant religious worker visa for Birender Singh. The USCIS denied the request for several reasons. Despite certain statutory requirements, there were discrepancies or inadequate evidence as to Singh‘s compensation, housing, and employment history. The SCS did not provide all of the requested information. In addition, the SCS did not show that Singh had worked continuously for the previous two years. The SCS filed a suit in a federal district court against the USCIS, arguing that the denial was arbitrary and capricious. In applying the arbitrary and capricious standard, what agency actions or omissions does a court typically consider? Does the denial of Singh‘s visa pass the test? Explain. [Sikh Cultural Society, Inc. v. United States Citizenship and Immigration Services, 720 Fed. Appx. 649 (2018)] (See Agency Creation and Powers.) Solution Yes. The denial of Singh‘s visa passes the arbitrary-and-capricious test. The Administrative Procedure Act provides that courts should set aside agency actions that are contrary to the law or so irrational as to be arbitrary or capricious. On a party‘s challenge to an action on this basis, a court may consider whether the agency did the following: • Failed to provide a rational explanation for its action. • Changed a prior policy without justification. • Considered legally inappropriate factors. • Failed to consider a relevant factor. • Acted plainly contrary to the evidence. In this problem, the Sikh Cultural Society (SCS) asked the United States Citizenship and Immigration Services (USCIS) for a special immigrant religious worker visa for Birender Singh. The USCIS denied the request. The SCS filed a suit in a federal district court against the USCIS, challenging the denial as arbitrary and capricious. As noted in the facts, despite certain statutory requirements, there were discrepancies or the evidence was inadequate as to Singh‘s compensation, housing, and employment history. The SCS did not provide all of the requested information. Additionally, the SCS did not show that Singh had worked continuously for the previous two years. The USCIS‘s review of these factors demonstrates that its action was not arbitrary or capricious. In the actual case on which this problem is based, the court issued a judgment in the agency‘s favor. The U.S. Court of Appeals for the Second Circuit affirmed. 302. The IDDR Approach and the Arbitrary and Capricious Test. The Delaware River Port Authority (DRPA) solicited bids to repaint the Commodore Barry Bridge, a mile-long structure

470

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

spanning the Delaware River between New Jersey and Pennsylvania. Alpha Painting & Construction Company, an experienced contractor that had previously worked for the DRPA, submitted the lowest bid. Under DRPA guidelines, a ―responsible‖ contractor has the ―capacity‖ and ―capability‖ to do a certain job. A ―responsive‖ contractor includes all required documents with its bid. Alpha‘s bid did not include certain required accident and insurance data. For this reason, and without checking further, the DRPA declared that Alpha was ―not responsible‖ and awarded the contract to the second-lowest bidder. [Alpha Painting & Construction Co. v. Delaware River Port Authority, 853 F.3d 671 (3d Cir. 2017)] (See Agency Creation and Powers.) 1.

Using the Inquiry step of the IDDR approach, identify the ethical issue the DRPA faced when deciding whether to accept or reject Alpha‘s bid. Solution The ethical issue the Delaware River Port Authority (DRPA) faced when deciding whether to accept or reject a bid by Alpha Painting and Construction Company concerned the extent to which the agency would follow its own guidelines in making this decision. The IDDR approach consists of four steps. The first is an Inquiry to identify the ethical issue, stakeholders, and governing standards. In this problem, the stakeholders included the Delaware River Port Authority (DRPA), the bidders on a DRPA contract to repaint a certain bridge, the taxpayers whose funds the DRPA would spend on the contract, and members of the public who use the bridge. Ethical standards included the DRPA‘s guidelines. The ethical issue focused on the degree to which the agency would follow its guidelines in awarding the contract. Under the DRPA‘s guidelines, a responsible contractor has the ―capacity‖ and ―capability‖ to do a certain job. A responsive contractor includes all required documents with its bid. In response to the DRPA‘s solicitation of bids to repaint a bridge, Alpha submitted the lowest bid. Alpha‘s bid omitted required accident and insurance data. Under the strictest interpretation of the DRPA‘s guidelines, this omission would define Alpha as unresponsive. This conclusion could serve as a ground to reject the painter‘s bid. But Alpha was an experienced contractor who had done previous work for the DRPA. Perhaps the omission was an unintentional oversight. With this in mind, the agency might have given the bidder an opportunity to supplement its bid. Or, the contractor might have believed that the government had the information, either as a consequence of the painter‘s previous work or as a result of other state-mandated filings (tax returns, or license or bonding requirements, for example). The DRPA could have searched its own files or asked other agencies for the missing information. In any event, the government, the taxpayers, and the public would benefit from an experienced painter doing contract work for the least amount of funds.

Using the Discussion step of the IDDR approach, consider whether the DRPA‘s rejection of Alpha was ethical. Solution The DRPA acted unethically in rejecting Alpha. The second step of the IDDR approach is a Discussion of possible actions to take to resolve an ethical issue, the strengths and

471

Solution and Answer Guide: Miller, Business Law Today, Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 37: Administrative Law

weaknesses of those actions, and the consequences and effects on the stakeholders. The ethical issue here involved the extent to which a government agency would follow its guidelines in deciding which bid to accept for a certain contract. An ethical person, business, or government agency will set standards and follow them. This is not only good from an ethical perspective—the predictability engendered by adherence to principles is good for doing business and good for governing. In this case, however, the agency—the Delaware River Port Authority (DRPA)—did not adhere to its own standards. Under the DRPA‘s guidelines, a responsible contractor has the ―capacity‖ and ―capability‖ to do a certain job. A responsive contractor includes all required documents with its bid. In response to the DRPA‘s solicitation of bids to repaint a bridge, Alpha Painting and Construction Company submitted the lowest bid. Alpha‘s bid did not include required accident and insurance data. For this reason, and without checking further, the agency declared that the painter was not responsible and rejected its bid. The DRPA faulted the ―responsiveness‖ of Alpha and relied on the contractor‘s failure to provide certain information to reject Alpha as not ―responsible.‖ But under the DRPA‘s own guidelines, the agency could reject a bidder as not ―responsible‖ only if the bidder did not have the ―capacity‖ or ―capability‖ to do the work. There does not seem to be any justifiable doubt about Alpha‘s ―capability‖ or ―capacity‖ to perform the job on which it bid—Alpha had previously worked for the DRPA and was an experienced contractor. The agency‘s faulty rejection of the contractor is underscored by its failure to seek clarification on the issue of the unremitted information. (The agency might have undertaken a public records review or a general online search, or might simply have asked the contractor.) In the actual case on which this problem is based, Alpha filed a suit in a federal district court against the DRPA. The court concluded that the agency acted arbitrarily and capriciously. The U.S. Court of Appeals for the Third Circuit affirmed this ruling.

Critical Thinking and Writing Assignments 303. Investigation. Maureen Droge was a flight attendant for United Air Lines, Inc. (UAL). After being assigned to work in Paris, France, she became pregnant. Because UAL does not allow its flight attendants to fly during their third trimester of pregnancy, Droge was placed on involuntary leave. She applied for temporary disability benefits through the French social security system. Her request was denied because UAL does not contribute to the French system on behalf of its U.S.based flight attendants. Droge filed a charge of discrimination with the U.S. Equal Employment Opportunity Commission (EEOC), alleging that UAL had discriminated against her and other Americans. The EEOC issued a subpoena, asking UAL to detail all benefits received by all UAL employees living outside the United States. UAL refused to provide the information on the ground that it was irrelevant and that compliance would be unduly burdensome. The EEOC filed a suit in a federal district court against UAL. (See The Administrative Process.) 1.

The first team will decide whether the court should enforce the subpoena and explain why. Solution The court should not order UAL to comply with the subpoena. The information sought goes far beyond an inquiry into whether and for whom UAL makes French social security payments. It is not limited to individuals who may be considered similarly situated to Droge either by

472

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

position (flight attendant) or by location (France). The subpoena requires extensive information with respect to all UAL employees residing abroad. Much of this information has little or no relevance to resolving Droge‘s charge against UAL. And even if it were relevant to the charge in some tangential way, the request is overly burdensome. The financial and administrative demand placed on UAL to comply would be significant and, in light of the tangential need for the information, an undue burden. 2.

The second team will discuss whether the EEOC should be able to force a U.S. company operating overseas to provide the same disability benefits to employees located there as it does to employees in the United States. Solution The Equal Employment Opportunity Commission (EEOC) does not have the authority to force a U.S. company that is operating oversees to provide the same (disability) benefits to employees located there as it does to employees in the United States. The major U.S. law regulating employment discrimination—Title VII of the Civil Rights Act of 1964—applies extraterritorially to all U.S. employees working for U.S. employers abroad. Generally, U.S. employers must abide by U.S. discrimination laws unless to do so would violate the laws of the country where their workplaces are located.

The EEOC monitors compliance with Title VII. An employee who alleges discrimination must file a claim with the EEOC before a lawsuit can be brought against the employer. The EEOC may investigate the dispute and attempt to obtain the parties‘ voluntary consent to an outof-court settlement. If a voluntary agreement cannot be reached, the EEOC may file a suit against the employer on the employee‘s behalf, but the agency itself cannot order a certain result. The third team should determine whether UAL should be required to contribute to the French social security system for employees who reside in France and explain why or why not. Solution As for whether UAL should be required to contribute to the French social security system for employees who reside in France, relevant factors include UAL‘s ―U.S.-based‖ and foreign assignment distinctions, which tax and social benefit system its overseas employees are subject to, and the requirements of French law with respect to such contributions.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

473

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Case 38.3 ............................................................................................................................................... 476 Chapter Review ........................................................................................................................................................... 478 Practice and Review .............................................................................................................................. 478 Practice and Review: Debate This ......................................................................................................... 479 Issue Spotters ........................................................................................................................................ 479 Business Scenarios and Case Problems ................................................................................................. 480 Critical Thinking and Writing Assignments ............................................................................................ 486

Critical Thinking Questions in Features Adapting the Law to the Online Environment 304. Given that consumers seem to benefit from free or low-cost services provided by Big Tech, do you agree that these companies are ―too big‖ and need to have limits placed on them by federal antitrust regulators? Explain your answer. Solution The arguments against taking drastic antitrust measures against companies such as Apple, Amazon, Facebook, and Google are fairly straightforward. Not only have these companies innovated at a historic pace over the past several decades, but they have also created products and services that are highly valued by consumers. Additionally, these products and services are often free or offered at dramatically lower costs than was the case previously. Therefore, Big Tech should be celebrated for developing such a successful business model rather than punished as a threat to American consumers. The counterargument, as detailed in the feature, focuses on competition. So, when Facebook, Instagram, and WhatsApp were three distinct entities, they were forced to compete with each other, which stimulates innovation, benefitting the consumer. Also, though it is not always evident, market concentration limits consumer choice. For example, Tile is a small company that makes Bluetooth trackers that help users find lost items such as wallets, keys, or smartphones. To function, the tracker needs to be paired with an app. Like almost every app developer, Tile needs to sell its product through the popular Apple app store. Tile also needs to be able to pair its product with Apple‘s iPhone, which dominates the smartphone market. Apple, however, has its own ―Find My‖ tracking app, which comes preloaded, at no cost, on Apple devices and cannot be deleted. By owning the platform—the Apple app store—and stocking it with its own products, Apple is in an enviable situation when it comes to competitors such as Tile. In the words of one Tile executive, Apple is like a sports team that owns the ball, the field, the stadium, and the league and can change the rules whenever it pleases.

Critical Thinking Questions in Cases Case 38.1 305. Could the defendants have successfully argued that their agreement to rig bids and allocate the market for public school bus transportation was reasonable, or that it could be justified on an economic or business basis? Explain.

474

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Solution No, the defendants in this case could not have argued successfully that their conspiracy was reasonable, or justifiable on an economic or business basis. The defendants‘ scheme involved deciding which company would submit the low bid for a given route. This conspiracy led to specific charges of bid rigging and market allocation. Bid rigging is a form of price fixing. Both price fixing and market allocation are per se violations of Section 1 of the Sherman Act, considered so blatantly anticompetitive as to be inherently illegal. In fact, a bidrigging scheme is sometimes thought to be more harmful than ordinary price fixing because it is easier for the participants to enforce against each other. To convict on those charges, a jury is not required to assess whether the defendants‘ conduct is somehow reasonable, justifiable, or cost-effective. Evidence of the supposed reasonableness of the conduct is arguably not even relevant. It would thus be within a court‘s discretion to exclude any evidence that, in this case, for example, the defendants‘ activity might not have cost the municipality much money. 306. Following the discovery of the bid-rigging scheme, Caguas held a presumably fair auction to award new school bus transportation contracts. Could the bids in the second auction provide a benchmark for the restitution amounts? Discuss. Solution Yes, the bids in the second, presumably fair, auction could provide a basis for setting the amounts of restitution that the defendants were ordered to pay. Of course, the amount of restitution for an offense must be based on an actual loss, not, for example, on a defendant‘s gain due to the offense. The amount must have a rational basis, but it does not have to be absolutely precise. In this case, the ostensibly fair prices paid after the second auction is an appropriate benchmark. Market conditions would have been similar, given the short time between the rigged and fair auctions, assuming there were no intervening events to alter the supply or demand for bus services. The routes and the numbers of students were not likely to have materially different. The court could reasonably presume that the two auctions were for approximately the same services in the same market.

Case 38.2 307. A California statute provides for the waiver of fees at state university campuses for senior citizens. What distinguishes this differential treatment from the discriminatory practice at issue in the Candelore case? Solution The situation described in the question differs from the discriminatory practice at issue in the Candelore case because the university-fee waiver, and other discounts for senior citizens (and others, in other circumstances) are independently justified by compelling social policy considerations expressed in, or at least evidenced by, legislative enactments. Many statutes in California and elsewhere provide for differential treatment of senior adults. As in the situation of the fee waiver, some specifically provide for price discounts (such as reduced

475

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

transit fares). In some instances, the limited earning capacities of seniors are cited as a justification for the price differential, but that, too, may reflect legislative limits on working conditions, hours, or opportunities for seniors. These statutes reflect the judgment of a legislature to advance certain social policy objectives by treating seniors differently from the rest of the public. This supports the use of class-based criteria in those cases, without requiring a court to generalize about age and income in a way that runs counter to the individual nature of the rights secured to all persons by civil rights statutes. 308. Instead of personal characteristics such as age, could a business like Tinder use economic distinctions to broaden its user base and increase profits? Discuss. Solution Yes. A business‘s interest in maximizing profits does not justify discrimination based on such personal characteristics as age. But this does not preclude a business like Tinder from employing economic distinctions to increase its user base and profitability. Those distinctions must be drawn in such a way that any customer could conceivably meet them, regardless of the customer‘s age or other personal characteristic. For example, Tinder could establish different membership levels for its Tinder Plus service that would allow more budget constrained customers, regardless of age, to access certain premium features at a lower price, while offering additional features to those less budget conscious users who are willing to pay more. Tinder could also offer discounts for buying several months of Tinder Plus in advance that would likewise allow budget constrained users cheaper access to its premium features, without arbitrarily discriminating against older users on the basis of age.

Case 38.3 309. How would TransWeb‘s injury have been ―shared by all consumers in the relevant markets‖ if TransWeb had not sued until after it had been driven out of those markets by 3M‘s actions? Solution If TransWeb, LLC had not proceeded with its suit until after 3M Innovative Products Co.‘s actions had excluded TransWeb from the relevant markets, TransWeb‘s injury would have been ―shared by all consumers‖ in those markets by the increased prices charged by 3M for its products. As the U.S. Court of Appeals for the Federal Circuit noted, ―TransWeb proved at trial that increased prices for fluorinated filter . . . respirators would have resulted had 3M succeeded in its suit.‖ TransWeb makes respirator filters made of nonwoven fibrous material to be worn at contaminated worksites. At an industry exposition, TransWeb‘s founder handed out samples of its filter material. 3M employees obtained the samples. At the time, 3M was experimenting with filter materials. Later, 3M obtained patents for its filter products and filed a suit against TransWeb, claiming infringement. 3M claimed that it had not obtained the TransWeb samples until after filing for its patents. The suit was dismissed. TransWeb filed a suit against 3M, seeking a declaratory judgment of non-infringement. A jury found that 3M obtained its patents through fraud, that its assertion of the patents against

476

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

TransWeb violated antitrust law, and that TransWeb was entitled to attorney fees as damages. The court trebled TransWeb‘s $7.7 million in fees accrued in defending against 3M‘s infringement suit to $23 million. The U.S. Court of Appeals for the Federal Circuit affirmed the trebled fees award. 3M‘s unlawful act—―the bringing of suit based on a patent known to be fraudulently obtained‖— was ―aimed at reducing competition and would have done so had the suit been successful. . . . TransWeb‘s attorney fees flow directly from this unlawful aspect of 3M‘s act. . . . The attorney fees are precisely the type of loss that the claimed violations would be likely to cause.‖ Why wasn‘t TransWeb required to wait to bring its suit until after it had been excluded from the market? Because ―the antitrust laws exist to protect competition. If we were to hold that TransWeb can seek antitrust damages only [by] forfeiture of competition, but not [by] defending the anticompetitive suit, then we would be incentivizing the former over the latter. . . . This is not in accord with the purpose of those very same antitrust laws.‖ And, of course, the injury would then have been suffered not by TransWeb alone ―but rather would be shared by all consumers in the relevant markets.‖

477

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

310.

What does 3M‘s conduct suggest about its corporate ethics?

Solution The conduct by 3M Innovative Products Company in the TransWeb case suggests greed and deception in the firm‘s fraudulent use of the patent system and its abuse of the legal system to obtain an unfair market advantage. TransWeb, LLC, makes respirator filters made of nonwoven fibrous material to be worn at dirty and polluted worksites. At an industry exposition, the company distributed samples of this material. 3M employees obtained some of the samples. At the time, 3M was experimenting with filter materials. Later, 3M obtained patents for filter products and filed a suit against TransWeb, claiming infringement. 3M claimed that it did not obtain the TransWeb samples until after it applied for its patents. The suit was dismissed. TransWeb then filed a suit against 3M, seeking a declaratory judgment of non-infringement. A jury found that the defendant obtained its patents through fraud, that its assertion of those patents against TransWeb violated antitrust law, and that the plaintiff was entitled to attorney fees as damages. The U.S. Court of Appeals for the Federal Circuit affirmed the award. ―No assertion of a patent known to be fraudulently obtained can be a proper use of legal process. No successful outcome of that litigation, regardless of how much the patentee subjectively desires it, would save that suit from being improper due to its tainted origin.‖

Chapter Review Practice and Review The Internet Corporation for Assigned Names and Numbers (ICANN) is a nonprofit entity that organizes Internet domain names. It is governed by a board of directors elected by various groups with commercial interests in the Internet. One of ICANN‘s functions is to authorize an entity to serve as a registrar for certain top-level domains (TLDs). ICANN entered into an agreement with VeriSign to provide registry services for the ―.com‖ TLD in accordance with ICANN‘s specifications. VeriSign complained that ICANN was restricting the services that VeriSign could make available as a registrar, blocking new services, imposing unnecessary conditions on those services, and setting the prices at which the services were offered. VeriSign claimed that ICANN‘s control of the registry services for domain names violated Section 1 of the Sherman Act. Using the information presented in the chapter, answer the following questions. 311. Should ICANN‘s actions be judged under the rule of reason or be deemed a per se violation of Section 1 of the Sherman Act? Explain. Solution Because ICANN is at a higher level of the distribution process than Verisign, it is imposing a vertical restraint. Since the vertical restraint that Verisign complains of involves restrictions on services that Verisign can offer (customer restrictions) and the setting of prices at which Verisign can sell its services (resale price maintenance agreement), ICANN‘s action should be judged under the rule of reason. 312.

Should ICANN‘s actions be viewed as a horizontal or a vertical restraint of trade? Explain.

478

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Solution Because ICANN and Verisign are firms at different levels in the distribution of top-level domain names, the actions that Verisign complains of are a vertical restraint. ICANN, which is Verisign‘s superior, is allegedly placing restrictions on what services Verisign can offer, and how much it can charge for its services. This amounts to a vertical restraint. 313. Does it matter that ICANN‘s directors are chosen by groups with commercial interests in the Internet? Why or why not? Solution Yes. If ICANN‘s leadership was chosen by those with a commercial interest in the Internet, the directors might represent commercial interests with significant market power and restrain trade in violation of the Sherman Act. 314. If the dispute is judged under the rule of reason, what might be ICANN‘s defense for having a standardized set of registry services that must be used? Solution ICANN‘s best defense is to assert that a standardized set of registry services is efficient and has the effect of promoting competition rather than suppressing it. Under the rule of reason, as long as an agreement is merely regulatory and does not unreasonably restrain trade, it should not be considered illegal.

Practice and Review: Debate This 315. The Internet and the rise of e-commerce have rendered our antitrust concepts and laws obsolete. Solution When our antitrust laws were written, the possibility of intense nationwide and even global competition was not possible. Today, in contrast, the Internet has increased competition to such a degree that few, if any, sellers of most products can maintain prices that are significantly higher than prices offered by other sellers anywhere in the country. The Internet has brought to the average consumer full information on prices, availability, and facts about most products—and at the speed of light. Also, anticompetitive behavior is readily denounced in blogs, websites, tweets, and social networking sites. While it may be true that the Internet has increased competitive forces throughout the world, we still need old-fashioned antitrust laws and enforcement of those laws. After all, big companies have become even bigger today. When an industry is highly concentrated, the relatively few sellers can still conspire to raise prices. When companies are worldwide in ownership and scope, they must be monitored to make sure that they are not using their market power to harm consumers with lower quality and/or higher prices. More than two hundred years ago in The Wealth of Nations, Adam Smith pointed out that whenever producers or sellers get together, they inevitably conspire to raise prices.

Issue Spotters 316. Under what circumstances would Pop‘s Market, a small store in a small, isolated town, be considered a monopolist? If Pop‘s is a monopolist, is it in violation of Section 2 of the Sherman Act? Why or why not?

479

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Solution Size alone does not determine whether a firm is a monopoly—size in relation to the market is what matters. A small store in a small, isolated town is a monopolist if it is the only store serving that market. Monopoly involves the power to affect prices and output. If a firm has sufficient market power to control prices and exclude competition, that firm has monopoly power. Monopoly power in itself is not a violation of Section 2 of the Sherman Act. The offense also requires an intent to acquire or maintain that power through anticompetitive means. 317. Maple Corporation conditions the sale of its syrup on the buyer‘s agreement to buy Maple‘s pancake mix. What factors would a court consider to decide whether this arrangement violates the Clayton Act? Solution This agreement is a tying arrangement. The legality of a tying arrangement depends the purpose of the agreement, the agreement‘s likely effect on competition in the relevant markets (the market for the tying product and the market for the tied product), and other factors. Tying arrangements for commodities are subject to Section 3 of the Clayton Act. Tying arrangements for services can be agreements in restraint of trade in violation of Section 1 of the Sherman Act.

Business Scenarios and Case Problems 318. Sherman Act. An agreement that is blatantly and substantially anticompetitive is deemed a per se violation of Section 1 of the Sherman Act. Under what rule is an agreement analyzed if it appears to be anticompetitive but is not a per se violation? In making this analysis, what factors will a court consider? (See Section 1 of the Sherman Act.) Solution Under what is called the rule of reason, anticompetitive agreements that allegedly violate Section 1 of the Sherman Act are analyzed with the view that they may, in fact, constitute reasonable restraints on trade. When applying this rule, the court considers the purpose of the arrangement, the powers of the parties to implement the agreement to achieve that purpose, and the effect or potential effect of the agreement on competition. Another possible factor that might be considered is whether the parties could have relied on less restrictive means to achieve their purpose. If the court deems that legitimate competitive benefits outweigh the anticompetitive effects of the agreement, it will be held lawful. 319. Tying Arrangement. John Sheridan owned a Marathon gas station franchise. He sued Marathon Petroleum Co. under Section 1 of the Sherman Act and Section 3 of the Clayton Act, charging it with illegally tying the processing of credit card sales to the gas station. As a condition of obtaining a Marathon dealership, dealers had to agree to let the franchisor process credit cards. They could not shop around to see if credit card processing could be obtained at a lower price from another source. The district court dismissed the case for failure to state a claim. Sheridan appealed. Is there a tying arrangement? If so, does it violate the law? (See The Clayton Act.) Solution Yes. There is a tying arrangement, but it is not illegal. To violate the law, the seller of the tying product must have monopoly power. Marathon Petroleum Company has no monopoly power in the retail gasoline market, which is the tying product in this case. Marathon Petroleum Company

480

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

has about 4 percent of the U.S. market. It tied credit-card processing to that, but it had no power in that market either. 320. Spotlight on Digital Music—Price Fixing. Together, EMI, Sony BMG Music Entertainment, Universal Music Group Recordings, Inc., and Warner Music Group Corp. produced, licensed, and distributed 80 percent of the digital music sold in the United States. The companies formed MusicNet to sell music to online services that sold the songs to consumers. MusicNet required all of the services to sell the songs at the same price and subject to the same restrictions. Digitization of music became cheaper, but Music- Net did not change its prices. Did MusicNet violate the antitrust laws? Explain. [Starr v. Sony BMG Music Entertainment, 592 F.3d 314 (2d Cir. 2010)] (See Section 1 of the Sherman Act.) Solution The participants in Music Net appear to have engaged in a conspiracy to fix the prices (and terms) under which their music would be sold online. This may have violated the Sherman Act. The antitrust laws, including the Sherman Act, are intended to limit restraints of trade—agreements between firms that have the effect of reducing competition in the marketplace. The underlying assumption of Section 1 of the Sherman Act is that society‘s welfare is harmed if rival firms are permitted to join in an agreement that restrains competition. Not all agreements between rivals, however, unreasonably restrain trade. Under the rule of reason, anticompetitive agreements that may violate the Sherman Act are analyzed with the view that they may, in fact, constitute reasonable restraints of trade. When applying this rule, a court considers the purpose of the arrangement, the powers of the parties, and the effect of their actions in restraining trade. In this problem, the music companies‘ conduct appeared to be the result of an agreement to fix prices, which would violate the Sherman Act. Parallel conduct—charging all of the online services the same price to obtain the songs in MusicNet‘s catalogs, for example—is not in itself a violation of the Act, but it can be part of a strategy to restrain trade. A rule of reason analysis could determine whether this was an anticompetitive price-fixing agreement among competitors. In other words, the combination formed by the music companies and represented by MusicNet must be shown to have been unreasonable and anticompetitive for it to violate the antitrust laws. In the actual case on which this problem is based, a coalition of consumers filed a suit against MusicNet‘s participants, alleging that the service violated the Sherman Act. The court ruled that the consumers could attempt to prove their claim.

481

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

321. Business Case Problem with Sample Answer— Price Discrimination. Dayton Superior Corp. sells its products in interstate commerce to several companies, including Spa Steel Products, Inc. The purchasers often compete directly with each other for customers. From 2005 to 2007, one of Spa Steel‘s customers purchased Dayton Superior‘s products from two of Spa Steel‘s competitors. According to the customer, Spa Steel‘s prices were always 10 to 15 percent higher for the same products. As a result, Spa Steel lost sales to at least that customer and perhaps others. Spa Steel wants to sue Dayton Superior for price discrimination. Which requirements for such a claim under Section 2 of the Clayton Act does Spa Steel satisfy? What additional facts will it need to prove? [Dayton Superior Corp. v. Spa Steel Products, Inc., 2012 WL 113663 (N.D.N.Y. 2012)] (See The Clayton Act.) —For a sample answer to Problem 38–4, go to Appendix E. Solution Spa Steel satisfies most of the requirements for a price discrimination claim under Section 2 of the Clayton Act. Dayton Superior is engaged in interstate commerce, and it sells goods of like grade and quality to at least three purchasers. Moreover, Spa Steel can show that, because it sells Dayton Superior‘s products at a higher price, it lost business and thus suffered an injury. To recover, however, Spa Steel will also need to prove that Dayton Superior charged Spa Steel‘s competitors a lower price for the same product. Spa Steel cannot recover if its prices were higher for reasons related to its own business, such as having a higher overhead or seeking a larger profit. 322. Section 1 of the Sherman Act. The National Collegiate Athletic Association (NCAA) and the National Federation of State High School Associations (NFHS), in an effort to enhance player safety and reduce technology-driven home runs and other big hits, set a standard for nonwood baseball bats to ensure that aluminum and composite bats performed like wood bats. Marucci Sports, LLC, makes nonwood bats. Under the new standard, four of Marucci‘s eleven products were decertified for use in high school and collegiate games. Marucci filed suit against the NCAA and the NFHS under Section 1 of the Sherman Act. At trial, Marucci‘s evidence focused on injury to its own business. Did the NCAA and NFHS‘s standard restrain trade in violation of the Sherman Act? Explain. [Marucci Sports, LLC v. National Collegiate Athletic Association, 751 F.3d 368 (5th Cir. 2014)] (See Section 1 of the Sherman Act.) Solution No. The standard set by the National Collegiate Athletic Association (NCAA) and the National Federation of State High School Associations (NFHS) for non-wood baseball bats did not violate Section 1 of the Sherman Act. Underlying this section is the assumption that society is harmed if rival firms join in an agreement that restrains competition. Under the rule of reason, the courts analyze anticompetitive agreements that allegedly violate Section 1 of the Sherman Act to determine whether they constitute reasonable—not unreasonable—restraints on trade. The test is whether the agreement ―merely regulates and thereby promotes competition‖ or whether it ―suppresses or even destroys competition.‖ Relevant factors include the purpose of the agreement and the effect of the agreement on competition. In this problem, the NCAA and NFHS‘s standard for non-wood bats was intended to ensure that aluminum and composite bats performed like wood bats in an effort to enhance player safety and reduce technology-driven homeruns and other big hits in high school and collegiate baseball games. Under this standard, four of the eleven bats made and sold by Marucci were decertified for use in the games. Seven of Marucci‘s products remained available for use, however. And

482

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Marucci‘s competitors did not drop out of the market, bat prices were not significantly changed, and bat quality was not affected. In the actual case on which this problem is based, Marucci filed a suit in a federal district court against the NCAA and NFHS, alleging that their standard violated the Sherman Act. The court dismissed the complaint, and the U.S. Court of Appeals for the Fifth Circuit affirmed, based partly on the reasoning stated above. 323. Mergers. St. Luke‘s Health Systems, Ltd., operated an emergency clinic in Nampa, Idaho. Saltzer Medical Group, P.A., had thirty-four physicians practicing at its offices in Nampa. Saint Alphonsus Health System, Inc., operated the only hospital in Nampa. St. Luke‘s acquired Saltzer‘s assets and entered into a five-year professional service agreement with the Saltzer physicians. This affiliation resulted in a combined share of two-thirds of the Nampa adult primary care provider market. Together, the two entities could impose a significant increase in the prices charged patients and insurers, and correspondence between the parties indicated that they would. Saint Alphonsus filed a suit against St. Luke‘s to block the merger. Did this affiliation violate antitrust law? Explain. [Saint Alphonsus Medical Center-Nampa Inc. v. St. Luke’s Health System, Ltd., 778 F.3d 775 (9th Cir. 2015)] (See The Clayton Act.) Solution Yes. The affiliation between St. Luke‘s and Saltzer violated antitrust law. Under Section 7 of the Clayton Act, a merger violates antitrust law ―where the effect . . . may be to substantially lessen competition.‖ This can occur when a merger results in a combination‘s obtaining monopoly power in the relevant market. An important consideration is market concentration. When a small number of companies control a large share of the market, the market is concentrated. A merger between firms that compete with each other in the same market is a horizontal merger. If a horizontal merger creates an entity with a significant market share, it increases market concentration and may be presumed illegal. But courts also consider other factors, including whether the apparent design of the merger is to establish market power. Here, in Nampa, Idaho, the market for adult primary care providers was highly concentrated— there are only three providers mentioned in the facts. St Luke‘s emergency clinic acquired the assets of Saltzer Medical Group and entered into a professional service agreement with its physicians. Together, through this horizontal merger, these entities gained a two-thirds share of the Nampa market. This meant that the two could impose a significant increase in the prices charged patients and insurers, and their correspondence indicated that they would. In other words, their combination increased market concentration and could therefore be presumed illegal. And because the entities‘ apparent design of the merger was to establish and use market power to increase prices, their merger violated antitrust law. In the actual case on which this problem is based, the court found that the ―huge market share‖ of the post-merger entity ―creates a substantial risk of anticompetitive price increases‖ and ordered divestiture. The U.S. Court of Appeals for the Ninth Circuit affirmed the order, based on the reasoning stated above. 324. Section 1 of the Sherman Act. Manitou North America, Inc., makes and distributes telehandlers (forklifts with extendable telescopic booms) to dealers throughout the United States. Manitou agreed to make McCormick International, LLC, its exclusive dealer in the state of

483

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Michigan. Later, Manitou entered into an agreement with Gehi Company, which also makes and sells telehandlers. The companies agreed to allocate territories within Michigan among certain dealers for each manufacturer, limiting the dealers‘ selection of competitive products to certain models. Under this agreement, McCormick was precluded from buying or selling Gehi telehandlers. What type of trade restraint did the agreement between Manitou and Gehi represent? Is this a violation of antitrust law? If so, who was injured, and how were they injured? Explain. [Manitou North America, Inc. v. McCormick International, LLC, 2016 WL 439354 (2016)] (See Section 1 of the Sherman Act.) Solution The agreement between Manitou North America Inc. and Gehi Co., both makers of telehandlers (a type of forklift), to allocate territories within Michigan among certain dealers for each manufacturer and to limit the dealers‘ selection of competitive products to certain models is a horizontal trade restraint. A territorial or market division such as this agreement is a violation of antirust law. As a result of the agreement, injured parties included the dealers and their customers, who were harmed by the reduced competition. Competitors who agree to divide territories—a horizontal market division—commit a per se violation of Section 1 of the Sherman Act. To recover for the violation, a party must suffer an injury attributable to it that flows from the anticompetitive aspect of the agreement and reduces competition. In this problem, the agreement between Manitou and Gehi provided for the division of territories among telehandler dealers at the same level of the market, thereby reducing competition. The agreement barred McCormick (and presumably other dealers) from buying and selling competitive Gehi telehandlers. This part of the agreement limited consumers‘ selection and must have had a negative impact on McCormick‘s sales and thereby its ability to survive in the market. This is inherently anticompetitive, a per se violation of antitrust law, and constitutes an antitrust injury, resulting in damages. In the actual case on which this problem is based, McCormick International, LLC, a Manitou dealer, complained about Manitou‘s arrangements with Gehi and other dealers. McCormick terminated its contract with Manitou, which then filed a suit in a Michigan state court against the dealer for breach. McCormick filed a counterclaim against the telehandler maker, alleging a violation of state antitrust law. (The state law and its controlling principles were based on federal antitrust law.) A jury found in favor of McCormick on both claims, and the court awarded $3.85 million in damages on the counterclaim. A state intermediate appellate court affirmed. 325. Tying Arrangements. PRC-Desoto International, Inc., makes and distributes more than 90 percent of the aerospace sealant used in military and commercial aircraft. Packaging Systems, Inc., buys the sealant in wholesale quantities, repackages it into special injection kits, and sells the kits on the retail market to aircraft maintenance companies. PRC-Desoto bought one of the two main manufacturing companies of injection kits and announced a new policy to prohibit the repackaging of its sealant for resale. Packaging Systems was forced to buy both the sealant and the kits from PRC-Desoto. Due to the anti-repackaging constraint, the reseller could no longer meet its buyers‘ needs for pre-filled injection kits. Does this policy represent an unlawful tying arrangement? Explain. [Packaging Systems, Inc. v. PRCDesoto International, Inc., 2018 WL 735978 (C.D.Cal. 2018)] (See The Clayton Act.)

484

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

Solution Yes. PRC-Desoto International, Inc.‘s new policy is an unlawful tying arrangement. A tying arrangement occurs when a seller conditions the sale of a product on the buyer‘s agreement to buy another product made or distributed by the seller. The legality depends on the purpose of the agreement and its likely effect on competition in the markets for the products. The injury caused by an unlawful tying arrangement is reduced competition in the market for the tied product. In this problem, PRC-Desoto made and distributed more than 90 percent of the aerospace sealant used in aircraft. Packaging Systems bought the sealant in wholesale quantities, repackaged it into injection kits, and sold the kits on the retail market to aircraft maintenance companies. PRCDesoto bought one of the main makers of the kits and prohibited the repackaging of its sealant for resale. This forced Packaging Systems to buy both the sealant and the kits from PRC-Desoto. Also, due to the anti-repackaging constraint, the reseller could no longer meet its buyers‘ needs for pre-filled injection kits. Here, there is a market for wholesale sealant and a separate market for sealant sold in injection kits. PRC-Desoto had significant leverage over its customers to dictate the terms on which they must buy sealant and kits. With its anti-repackaging policy, resellers were compelled to buy the injection kits to obtain the sealant when, without the prohibition, they could have bought the products separately. PRC-Desoto effectively foreclosed competition in the market for sealant sold in injection kits. In the actual case on which this problem is based, Packaging Systems filed a suit in a federal district court against PRC-Desoto, alleging the facts stated in the problem constituted antitrust violations. The court denied the defendant‘s motion to dismiss the claim. The allegations ―are sufficient to plead harm to competition.‖ 326. A Question of Ethics—The IDDR Approach and Section 2 of the Sherman Act. Apple, Inc., controls which apps—such as ringtones, instant messaging, and video—can run on iPhone software. Apple‘s App Store is a website where iPhone users can find, buy, and download the apps. Apple prohibits third-party developers from selling iPhone apps through channels other than the App Store, threatening to cut off sales by any developer who violates this prohibition. Apple also discourages iPhone owners from downloading unapproved apps, threatening to void iPhone warranties if they do. Seven iPhone app buyers filed a complaint in a federal district court against Apple. The plaintiffs alleged that the firm monopolized the market for iPhone apps. [In re Apple iPhone Antitrust Litigation, 846 F.3d 313 (9th Cir. 2017)] (See Section 2 of the Sherman Act.) 327. Using the Decision step of the IDDR approach, provide reasons why Apple might attempt to protect iPhone software by setting narrow boundaries on the sales of related apps and aggressively enforcing them. Solution The Decision is the third step of the IDDR approach, following an Inquiry to state the issue and a Discussion of possible actions to resolve it. The issue here is whether it is ethical for Apple to protect iPhone software? The stakeholders include Apple‘s owners, officers, and employees, and the vendors and buyers of iPhones, as well as the designers and distributors of the apps, and those who would create other products for use in all types of markets. Options to resolve this issue in the interests of all of these stakeholders include Apple‘s choice

485

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 38: Antitrust Law and Promoting Competition

to protect its software by setting narrow boundaries on the sales of related apps and aggressively enforcing those limits. This choice is the focus of the IDDR approach‘s Decision step. Apple is protecting its technology and intellectual property from theft. Companies that do not set boundaries and protect their property can easily have it copied by competitors, who can use it to gain an unfair advantage. Apple believes that the threat to its products is genuine. Restricting the sales of iPhone apps is a legitimate step grounded on this honest belief. In fact, Apple also uses other methods to accomplish this goal—suits against makers of competitive products charging patent infringement, for example. The final step of the IDDR approach is a Review of the success or failure of the action to resolve the issue and satisfy the stakeholders. In this case, were Apple to freely allow the copying or theft of its intellectual property, the company would be robbed of its success in the marketplace, with a consequent loss of market share, revenue, and profits. This result would ultimately satisfy none of the stakeholders. 328.

Explain why Apple‘s actions in this case might be considered unethical.

Solution Arguably, it is not ethical for Apple to protect iPhone software by setting narrow boundaries on the sales of related apps and enforcing them. Apple is being too aggressive. The company is not simply protecting its technology and intellectual property from theft. It is profiting from the efforts of competitors, whom it is casting in a bad light by imposing restrictions on their sales. Presumably, Apple‘s goal is to be the monopolist of its market. In addition, Apple‘s tight hold over its products and secrets could inhibit innovation and thereby eliminate any gain in market share against more open, collaborative competitors. In the actual case on which this problem is based, the iPhone app buyers filed their complaint under the Clayton Act, which allows a private party to sue based on an alleged violation of any of the antitrust laws except the Federal Trade Commission Act. The complaint alleged violations of the Sherman Act. The court dismissed the complaint on the ground that the plaintiffs lacked standing. The U.S. Court of Appeals for the Ninth Circuit reversed and remanded the case. The appellate court held that the plaintiffs were direct purchasers of the apps from Apple, and therefore had standing to sue.

Critical Thinking and Writing Assignments 329. Business Law Writing. Write two paragraphs explaining some ways in which antitrust laws might place too great a burden on commerce in the global marketplace. (See Section 2 of the Sherman Act.) Solution In the global marketplace, antitrust laws could arguably inhibit the combination of business firms that might otherwise be able to cooperate to do business in economically efficient ways. Ultimately, this restriction would make doing business more expensive, which would of course be more expensive to commerce in general than necessary, by shouldering business firms with the

486

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

burden of engaging in transactions in roundabout, needlessly complicated ways. The result would be higher prices in the markets in which consumers shop. 330. Time-Limited Group Assignment—Antitrust Violations. Residents of the city of Madison, Wisconsin, became concerned about overconsumption of liquor near the campus of the University of Wisconsin (UW). The city took action by imposing conditions on area bars to discourage reduced-price ―specials‖ that were believed to encourage high-volume and dangerous drinking. Later, the city began to draft an ordinance to ban all drink specials. Bar owners responded by announcing that they had ―voluntarily‖ agreed to discontinue drink specials on Friday and Saturday nights after 8:00 p.m. The city put its ordinance on hold. Several UW students filed a lawsuit against the local bar owners‘ association alleging violations of antitrust law. (See Section 1 of the Sherman Act.) 331. The first group will identify the grounds on which the plaintiffs might base their claim for relief and formulate an argument on behalf of the plaintiffs. Solution The plaintiffs could base a claim for damages and an injunction on an allegation that the taverns, in agreeing to eliminate drink specials on Friday and Saturday nights after 8:00 p.m., violated antitrust prohibitions against ―conspiracies in restraint of trade.‖ 332. The second group will determine whether the defendants are exempt from the antitrust laws. Solution The defendants might contend that they could not be held liable for anticompetitive conduct because their agreement was in direct response to the city's exercise of its legitimate regulatory authority over tavern operations. In other words, they could argue that they acted in response to a clearly articulated policy that was actively supervised by the state (through the city). 333. The third group will decide how the court should rule in this dispute and provide reasons for its answer. Solution The court should issue a judgment in the defendants‘ favor. Anticompetitive actions or agreements voluntarily undertaken by private entities can qualify for antitrust immunity if the private conduct is prompted or motivated by governmental regulatory authority and intent. Where the authority is a municipality, as in this problem, there is little or no danger that it is involved in a private price-fixing arrangement. Private parties who are regulated by a municipality are entitled to immunity as long as the effective decision maker is the municipality and not the private parties. Here, the city of Madison was the effective decision maker with respect to the bar owners‘ agreement to forego drink specials on Fridays and Saturdays after 8:00 p.m. The owners‘ private conduct was pursued under the city's supervision, and the conduct thus qualifies for exemption from the antitrust laws.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

487

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 488 Case 39.1 ............................................................................................................................................... 488 Case 39.2 ............................................................................................................................................... 489 Case 39.3 ............................................................................................................................................... 489 Chapter Review ........................................................................................................................................................... 491 Practice and Review .............................................................................................................................. 491 Practice and Review: Debate This ......................................................................................................... 492 Issue Spotters ........................................................................................................................................ 492 Business Scenarios and Case Problems ................................................................................................. 493 Critical Thinking and Writing Assignments ............................................................................................ 500

Critical Thinking Questions in Cases Case 39.1 334. POM claimed that, for ethical reasons, RTCs should not be required to substantiate disease-related claims about food products. It argued that, for instance, ―doctors cannot . . . ethically deprive a control group of patients of all Vitamin C for a decade to determine whether Vitamin C helps prevent cancer.‖ Is this a valid argument? Why or why not? Solution No. POM‘s argument that it is unethical to require RCTs to substantiate disease-related claims about food products because it is impossible to create a zero intake group for nutrients in an ethical manner is not a valid challenge to the FTC‘s findings, conclusion, and order in this case. There is no need for a study participant to undergo a decade-long deprivation of an essential nutrient. An ad can make a claim about the short-term benefits of consuming a certain product. This ad can be based on a short-term study. And whether or not it may be unethical to tell patients in a control group to stop consuming Vitamin C, there is no apparent reason to believe that it would be unethical to create a zero intake group for pomegranate juice.

488

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

Case 39.2 335. A fraud injury can be measured in two ways. As a loss of the benefit of the bargain, damages consist of the difference between the value of what was promised and the value of what was received. Under the out-of-pocket rule, the measure is the difference between the price paid and the market value of what was received. If Haywood had established her claim, which of these methods would have applied? Why? Solution If Haywood had established her claim under the ICFA, the applicable measure of damages would have been the benefit-of-the-bargain method. Under this measure, her damages would have consisted of the difference between the value of what was promised and the value of what was received. Massage Envy promised a one-hour (sixty-minute) massage. Haywood did not receive the benefit of her bargain—she received a fifty-minute massage. According to the relative lengths of time, the value of what was promised was greater than the value of what was received. Applying the out-of-pocket rule to Haywood‘s claim would not show an injury. Under this method, the measure would have been the difference between the price Haywood paid and the market value of what she received. In her complaint, Haywood did not assert that she overpaid for a fifty-minute massage. 336. Suppose that reliance was not an element of a consumer fraud claim under the ICFA. Would the result in this case have been different? Explain. Solution Yes. It is likely that the result in this case would have been different on the facts stated in the question. In the Haywood case, the court found that she failed to allege Massage Envy‘s promise of a one-hour massage induced her to make her appointment. This finding was fatal to her claim. If reliance were not an element of a consumer fraud claim under the ICFA, however, whether Haywood actually relied on Massage Envy‘s deceptive promise when she booked her massage would have been irrelevant. Or, in other words, it would not have been necessary for Haywood to prove that Massage Envy‘s allegedly deceptive promise induced her to buy a massage. It would have been sufficient to allege the following: 337. Massage Envy‘s website was deceptive (because it advertised a one-hour massage on one page and ―hid‖ through a link to another page that a one-hour session consisted of less than sixty minutes of massage time). 338. Haywood viewed the website with the deceptive ad before making her appointment. 339. Massage Envy gave her something less (fifty minutes of massage time) than what she expected. These are the elements that Haywood alleged in her complaint. (The court pointed out, ―There is no allegation in the complaint that her belief about the length of the massage caused Haywood to make the appointment.‖) In effect, she would have made her case.

Case 39.3 340. How might Merchants have phrased its debt collection letters to meet the standards of the FDCPA? Explain.

489

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

Solution Merchants might have avoided the result in the Manuel case simply by adding a sentence to inform the debtor that there was a statute of limitations. For example, in Texas, after the lower court‘s decision in the Manuel case, the state began to require that all first collection letters sent by debt buyers, on debt for which the limitations period has run, must contain one of three variations of the following notice: THE LAW LIMITS HOW LONG YOU CAN BE SUED ON A DEBT. BECAUSE OF THE AGE OF YOUR DEBT, WE WILL NOT SUE YOU FOR IT. THIS NOTICE IS REQUIRED BY LAW. Other states requiring similar notices include California, Connecticut, Massachusetts, New Mexico, New York, North Carolina, Vermont, and West Virginia. The U.S. Court of Appeals for the Ninth Circuit, in Stimpson v. Midland Credit Management, Inc., 944 F.3d 1190 (9th Cir. 2019), reversed a grant of summary judgment to the plaintiffs for a letter that included the following warning: The law limits how long you can be sued on a debt and how long a debt can appear on your credit report. Due to the age of this debt, we will not sue you for it or report payment or nonpayment of it to a credit bureau. In 2020, the Consumer Financial Protection Bureau issued a proposed rule that would require a debt collector ―who knows or should know that a debt is time barred when the debt collector makes the initial communication‖ to clearly and conspicuously disclose (1) that the law limits how long the consumer can be sued for a debt and that, because of the age of the debt, the debt collector will not sue the consumer to collect it and (2) if, under applicable law, the debt collector‘s right to bring a legal action against the consumer can be revived, the fact that revival can occur and the circumstances in which it can occur. A model form included in the proposed rule would provide: The law limits how long you can be sued for a debt. If you do nothing or speak to us about this debt, we will not sue you to collect it. This is because the debt is too old. BUT if you acknowledge in writing that you owe this debt, then we can sue you to collect it. 341. Why would a debt collector use carefully crafted, ambiguous language in an attempt to collect an old debt? Discuss. Solution In the Manuel case, the U.S Court of Appeals for the Fifth Circuit stated, ―The only reason to use such carefully ambiguous language is the expectation that at least some unsophisticated debtors will misunderstand and will choose to pay on the ancient, time-barred debts because they fear the consequences of not doing so.‖ Of course, some persons might consider full debt repayment to be a moral obligation, even though the legal remedy for the debt has been extinguished under a statute of limitations. But in the view of the Federal Trade Commission and Consumer Financial Protection Bureau, most consumers do not understand their legal rights regarding time-barred debt. Gullible consumers

490

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

who make partial payments on old debts could inadvertently reset limitations periods and thereby make themselves vulnerable to a suit on the full amount.

Chapter Review Practice and Review Residents of Lake Caliopa, Minnesota, began noticing an unusually high number of lung ailments among the local population. Several concerned citizens pooled their resources and commissioned a study to compare the frequency of these health conditions in Lake Caliopa with national averages. The study concluded that residents of Lake Caliopa experienced four to seven times the rate of frequency of asthma, bronchitis, and emphysema as the population nationwide. During the study period, citizens began expressing concerns about the large volume of smog emitted by the Cotton Design apparel manufacturing plant on the outskirts of town. The plant had a production facility two miles east of town beside the Tawakoni River and employed seventy workers. Just downstream on the Tawakoni River, the city of Lake Caliopa operated a public waterworks facility, which supplied all city residents with water. After conducting its own investigation, the Minnesota Pollution Control Agency ordered Cotton Design to install new equipment to control air and water pollution. Later, citizens brought a lawsuit in a Minnesota state court against Cotton Design for various respiratory ailments allegedly caused or compounded by smog from Cotton Design‘s factory. Using the information presented in the chapter, answer the following questions. 342. Under the common law, what would each plaintiff be required to identify in order to be given relief by the court? Solution To establish a common law cause of action for nuisance, each plaintiff would have to identify a distinct harm caused by the pollution that was separate from that affecting the general public. In other words, they would need to show how each of them was individually harmed by Cotton Design‘s emissions. 343. What standard for limiting emissions into the air does Cotton Design‘s pollution-control equipment have to meet? Solution Major stationary sources of air pollution are required to use the maximum achievable control technology to reduce emissions. The EPA issues guidelines as to what equipment meets this standard, and the guidelines may vary depending on whether the source is new or existing and whether the area is clean or polluted. 344. If Cotton Design‘s emissions violated the Clean Air Act, how much can the EPA assess in fines per day? Solution For violations of the Clean Air Act in these circumstances, the EPA can assess fines of about $100,000 per day. 345.

What information must the city send to every household that it supplies with water?

491

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

Solution Under the Safe Drinking Water Act, as amended, suppliers of drinking water are required to send an annual statement describing the source of its water, the level of contaminants contained in the water, and any possible health concerns associated with the contaminants. Thus, the city must send a statement that includes this information every year to every household it provides with water.

Practice and Review: Debate This 346. Laws against bait-and-switch advertising should be abolished because no consumer is ever forced to buy anything. Solution Just because an advertised item is not available when a consumer goes to buy it does not mean that sellers should be prevented from ―up-selling.‖ That is to say, sellers should be free to offer higher-priced version of unavailable lower-priced advertised items. After all, in a free society, consumers can just say no. If sellers want to dupe consumers, they can always offer low-priced items but only have in stock higher-priced versions of the same items. Consumers take time to visit stores that advertise items, so once in the stores, these consumers may end up paying for higher-priced versions of the same products. Retailers must be prevented from using such unethical tactics.

Issue Spotters 347. United Pharmaceuticals, Inc., has developed a new drug that it believes will be effective in the treatment of patients with AIDS. The drug has had only limited testing, but United wants to make the drug widely available as soon as possible. To market the drug, what must United show the Food and Drug Administration? Solution Under an extensive set of procedures established by the U.S. Food and Drug Administration, which administers the federal Food, Drug and Cosmetic Act, drugs must be shown to be effective, as well as safe before they may be marketed to the public. In general, manufacturers are responsible for ensuring that the drugs they offer for sale are free of any substances that could injure consumers.

492

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

348. ChemCorp generates hazardous wastes from its operations. Disposal Trucking Company transports those wastes to Eliminators, Inc., which owns a site for hazardous waste disposal. Eliminators sells the property on which the disposal site is located to Fluid Properties, Inc. If the Environmental Protection Agency cleans up the site, from whom can it recover the cost? Solution The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) regulates the cleanup of hazardous waste disposal sites. Any potentially responsible party can be charged with the entire cost of cleaning up a site. Potentially responsible parties include the party that generated the waste (ChemCorp) the party that transported the waste to the site (Disposal), the party that owned or operated the site at the time of the disposal (Eliminators), and the current owner or operator of the site (Fluid). A party held responsible for the entire cost may be able to recoup some of it in a lawsuit against other potentially responsible parties.

Business Scenarios and Case Problems 349. Environmental Laws. Fruitade, Inc., is a processor of a soft drink called Freshen Up. Fruitade uses returnable glass bottles, which it cleans with a special acid to allow for further beverage processing. The acid is diluted with water and then allowed to pass into a navigable stream. Fruitade crushes its broken bottles and throws the crushed glass into the stream. Discuss fully any environmental laws that Fruitade may have violated. (See Air and Water Pollution.) Solution Fruitade has violated a number of federal environmental laws if such actions are being taken without a permit. First, because the dumping is in a navigable waterway, the Rivers and Harbors Appropriations Act, has been violated. Second, the Clean Water Act, as amended, has been violated. This act is designed to make the waters safe for swimming, to protect fish and wildlife, and to eliminate discharge of pollutants into the water. Both the crushed glass and the acid violate this act. Third, the Toxic Substances Control Act was passed to regulate chemicals that are known to be toxic and could have an effect on human health and the environment. The acid in the cleaning fluid or compound could come under this act. 350. Credit Protection. Maria Ochoa receives two new credit cards on May 1. She has solicited one of them from Midtown Department Store, and the other arrives unsolicited from High-Flying Airlines. During the month of May, Ochoa makes numerous credit card purchases from Midtown Department Store, but she does not use the High-Flying Airlines card. On May 31, a burglar breaks into Ochoa‘s home and steals both credit cards, along with other items. Ochoa notifies Midtown Department Store of the theft on June 2, but she fails to notify HighFlying Airlines. Using the Midtown credit card, the burglar makes a $500 purchase on June 1 and a $200 purchase on June 3. The burglar then charges a vacation flight on the High-Flying Airlines card for $1,000 on June 5. Ochoa receives the bills for these charges and refuses to pay them. Discuss Ochoa‘s liability in these situations. (See Credit Protection.) Solution The Truth in Lending Act (TILA) deals specifically with lost or stolen credit cards and the unauthorized use of credit cards. For credit cards solicited by the cardholder and then lost or

493

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

stolen, the act limits the liability of the cardholder to $50 for unauthorized charges made before the card issuer is notified. There is no liability for any unauthorized charges made after the date of notice. Therefore, for the Midtown Department Store credit card stolen on May 31, Ochoa is liable for $50 of the $500 charge made on June 1, which occurred before Ochoa notified the card issuer. Ochoa has no liability for the $200 charge on June 3 because it was made after the issuer was notified. TILA prohibits the issuance of unsolicited credit cards. Unless an individual accepts an unsolicited card (such as by using it), that person is not liable for any unauthorized charges if the card is lost or stolen. The person does not have to notify the issuer of an unsolicited, unaccepted card to be relieved of all liability for unauthorized charges. Therefore, Ochoa owes $50 to Midtown Department Store and nothing to High-Flying Airlines. 351. Spotlight on McDonald’s—Food Labeling. A McDonald‘s Happy Meal® consists of an entrée, a small order of French fries, a small drink, and a toy. In the early 1990s, McDonald‘s Corp. began to aim its Happy Meal marketing at children aged one to three. In 1995, McDonald‘s began making nutritional information for its food products available in documents known as ―McDonald‘s Nutrition Facts.‖ The documents list the food items that the restaurant serves and provide a nutritional breakdown, but the Happy Meal is not included. Marc Cohen filed a suit in an Illinois state court against McDonald‘s. Cohen alleged, among other things, that McDonald‘s had violated a state law prohibiting consumer fraud and deceptive business practices by failing to follow the Nutrition Labeling and Education Act (NLEA). The NLEA generally requires that standard nutrition facts be listed on food labels. The act, however, sets out different, less detailed requirements for products specifically intended for children under the age of four. Does it make sense to have different requirements for children of this age? Why or why not? Should a state court impose regulations when the NLEA has not done so? Explain. [Cohen v. McDonald’s Corp., 347 Ill.App.3d 627, 808 N.E.2d 1, 283 Ill.Dec. 451 (1 Dist. 2004)] (See Advertising, Marketing, Sales, and Labeling.) Solution Parents are often aware that doses of medicine are smaller for young children and that portion sizes of restaurant items, as well as clothing and other things, are differently sized for children. It may be only common sense to conclude that daily nutritional requirements would be different, too, especially for children under four. With that in mind, it could be argued that it would be unethical not to post the requirements differently for children under four. A consumer who is not familiar with nutrition standards, however, would likely not understand the NLEA‘s different percentage requirements for products specifically intended for children under the age of four. A state court should not impose regulations under the NLEA for establishing nutritional requirements for children under four. A state cannot impose obligations that are different from those mandated by federal law, because non-uniformity among the states would result. In this case, too, the plaintiff was asking a state court to interpret a federal statute, which the court did not have the authority to do. 352. Environmental Impact Statements. The U.S. Forest Service (USFS) proposed a travel management plan (TMP) for the Beartooth Ranger District in the Pryor and Absaroka Mountains

494

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

in the Custer National Forest of southern Montana. The TMP would convert unauthorized usercreated routes within the wilderness to routes authorized for motor vehicle use. It would also permit off-road ―dispersed vehicle camping‖ within 300 feet of the routes, with some seasonal restrictions. The TMP would ban cross-country motorized travel outside the designated routes. Is an environmental impact statement required before the USFS implements the TMP? If so, what aspects of the environment should the USFS consider in preparing it? Discuss. [Pryors Coalition v. Weldon, 551 Fed.Appx. 426 (9th Cir. 2014)] (See Protecting the Environment.) Solution Yes. An environmental impact statement (EIS) is required before the U.S. Forest Service (USFS) implements its proposed travel management plan (TMP). An EIS must be prepared for every major federal action that significantly affects the quality of the environment. An action is ―major‖ if it involves a substantial commitment of resources. An action is ―federal‖ if a federal agency has the power to control it. An EIS must analyze (1) the impact on the environment that the action will have, (2) any adverse effects on the environment and alternative actions that might be taken, and (3) irreversible effects that the action might generate. Here, the resources committed to the implementation of the USFS‘s TMP could include the resources within the wilderness and the time and effort dedicated by the agency. The wilderness resources would include the soil, the vegetation, the wildlife, the wildlife habitat, any threatened or endangered species, and other natural assets impacted by the TMP. The agency‘s resources would include its funds and its staff—to design, map, maintain, and enforce the TMP. These resources seem substantial. Of course, the implementation of the TMP is federal because the USFS has the power to control it. As for the aspects of the environment that the agency might consider in preparing the EIS, some of the important factors are listed above—the soil, vegetation, wildlife, wildlife habitat, and threatened or endangered species. Other aspects of the environment impacted by the TMP might include cultural resources, historical resources, and wilderness suitability, and on other authorized uses of the wilderness. There is a potential for impact by every route that is designed to be part of the system, as well as the ―dispersed vehicle camping‖ to be permitted on the terrain. In the actual case on which this problem is based, the USFS considered all of the factors listed above. The agency then issued an EIS and a decision implementing the TMR. On a challenge to the EIS, a federal district court issued a judgment in the USFS‘s favor. The U.S. Court of Appeals for the Ninth Circuit affirmed. ―The Forest Service took the requisite hard look at the environmental impacts.‖ 353. Business Case Problem with Sample Answer— Deceptive Advertising. Innovative Marketing, Inc. (IMI), sold ―scareware‖—computer security software. IMI‘s Internet ads redirected consumers to sites where they were told that a scan of their computers had detected dangerous files—viruses, spyware, and ―illegal‖ pornography. In fact, no scans were conducted. Kristy Ross, an IMI cofounder and vice president, reviewed and edited the ads. She was also aware of the many complaints that consumers had made about them. An individual can be held liable under the Federal Trade Commission Act‘s prohibition of deceptive acts or practices if the person (1) participated directly in the deceptive practices or had the authority to control them and (2) had or should have had knowledge of them. Were IMI‘s ads deceptive? If so, can Ross be held liable? Explain. [Federal Trade Commission v. Ross, 743 F.3d 886 (4th Cir. 2014)] (See Advertising, Marketing, Sales, and Labeling.) —For a sample answer to Problem 39–5, go to Appendix E.

495

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

Solution Yes. Ross can be held personally liable for a violation of the Federal Trade Commission (FTC) Act‘s prohibition of deceptive acts or practices. Generally, deceptive advertising occurs if a reasonable consumer would be misled by the advertising claim. Advertising that appears to be based on factual evidence but that in fact cannot be supported will be deemed deceptive. An individual can be held personally liable under the FTC Act if the person (1) participated directly in the deceptive practices or had the authority to control them, and (2) had or should have had knowledge of them. In this problem, the facts indicate that IMI‘s ads were deceptive. Consumers were misled by the ads that appeared to be based on factual evidence but were not actually supportable—the ads claimed that a scan of the consumers‘ computers had detected dangerous files, such as viruses, when in fact no scans were conducted. The issue is whether Ross can be held individually liable for these violations. She was an IMI co-founder and vice president, reviewed and edited the ads, and was aware of the many complaints about them. Thus, under the FTC Act, Ross met the standard for personal liability—she knew of the deceptive practices, she had the authority to control them, and she participated directly in them. In the actual case on which this problem is based, in the FTC‘s suit against Ross, a federal district court held her jointly and severally liable. On her appeal, the U.S. Court of Appeals for the Fourth Circuit affirmed. 354. The Clean Water Act. ICG Hazard, LLC, operated the Thunder Ridge surface coal mine in Leslie County, Kentucky, under a National Pollutant Discharge Elimination System permit issued by the Kentucky Division of Water (KDOW). As part of the operation, ICG discharges selenium into the surrounding water. Selenium is a naturally occurring element that endangers aquatic life at a certain concentration. KDOW knew when it issued the permit that mines in the area may produce selenium but did not specify discharge limits for the element in ICG‘s permit. Instead, the agency imposed a one-time monitoring requirement, which ICG met. Does ICG‘s discharge of selenium violate the Clean Water Act? Explain. [Sierra Club v. ICG Hazard, LLC, 781 F.3d 281 (6th Cir. 2015)] (See Air and Water Pollution.) Solution No. ICG‘s discharge of selenium into the water surrounding ICG‘s coal mining operation does not violate the Clean Water Act (CWA). The CWA established a permit system—the National Pollutant Discharge Elimination System (NPDES)—to regulate discharges from point sources of pollution. Under the NPDES system, a polluter must obtain a permit before discharging wastes into surface waters. An authorized state agency can issue an NPDES permit for a discharge that will not violate water-quality standards. In this problem, KDOW, an authorized state agency, issued an NPDES permit to ICG for the operation of a surface coal mine. KDOW knew when it issued the permit that mines in the area could produce selenium but did not specify effluent limits for the element in ICG‘s permit. Instead, the agency included a one-time monitoring requirement, which ICG met. In these circumstances, ICG obtained the required permit from an authorized agency before discharging selenium and complied with the permit‘s monitoring condition, which qualifies as a ―water-quality standard.‖ In the actual case on which this problem is based, Sierra Club filed a suit in a federal district court against ICG, alleging that the discharge of selenium violated the CWA. The court issued a

496

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

judgment in ICG‘s favor. The U.S. Court of Appeals for the Sixth Circuit affirmed. ICG‘s permit shielded the company from liability for the discharge. 355. Debt Collection. Zakia Mashiri owns a home in San Diego, California. She is a member of the Westwood Club Homeowners‘ Association (HOA), which charges each member an annual fee. When Mashiri failed to pay the fee, the law firm of Epsten Grinnell & Howell sent her a letter demanding payment. The letter read, ―Failure to pay your . . . account in full within thirty-five days from the date of this letter will result in a lien . . . against your property.‖ Mashiri asked for validation of the debt. Within two weeks of receiving it, she sent the HOA a check for the fee. Meanwhile, the law firm filed a lien against her property. Mashiri filed a lawsuit in a federal district court against the law firm, alleging a violation of the Fair Debt Collection Practices Act. On what provision of the act did Mashiri likely base her allegation? Will she succeed in her lawsuit against the law firm? Explain your answer. [Mashiri v. Epsten Grinnell & Howell, 845 F.3d 984 (9th Cir. 2017)] (See Credit Protection.) Solution The Fair Debt Collection Practices Act (FDCPA) requires debt collection agencies to include a validation notice whenever they initially contact a debtor for payment of a debt or within five days of that initial contact. The notice must state that the debtor has thirty days within which to dispute the debt and to request a written verification of the debt from the collection agency. These are the provisions of the act on which Mashiri most likely based her allegation. In this problem, homeowner Zakia Mashiri owed a homeowners‘ association (HOA) an annual fee. When she failed to pay it, the law firm of Epsten Grinnell & Howell sent her a letter demanding payment. The letter stated, ―Failure to pay your . . . account in full within thirty-five (35) days from the date of this letter will result in a lien . . . against your property.‖ Mashiri later received validation of the debt and, within two weeks, sent HOA a check. Meanwhile, however, Epsten Grinnell filed a lien against her property. Mashiri filed a suit in a federal district court against the Epsten Grinnell, alleging a violation of the FDCPA. Epsten Grinnell is a debt collection agency. The letter demanding payment within thirty-five days of its date violates a debtor‘s right to dispute a debt within thirty days of receipt of the letter. By the time a debtor receives the letter, there may be fewer than thirty days before payment is due. This infringement of the debtor‘s right to thirty days in which to dispute the debt violates the FDCPA‘s notice and validation provision. In the actual case on which this problem is based, the court dismissed Mashiri‘s complaint. On appeal, the U.S. Court of Appeals for the Ninth Circuit reversed the dismissal and remanded the case, in part on the reasoning stated above. 356. False Advertising. Rainbow School, Inc., has run a childcare facility in Fayetteville, North Carolina, for over twenty years. In addition to using the word ―rainbow‖ in its name, the school uses rainbow imagery on its logo. Rainbow Early Education Holding, LLC, operates child-care facilities in several states. Early Education opened a branch in Fayetteville near the school under the name ―Rainbow Child Care Center‖ that also used rainbow imagery on its logo. The school filed a suit in a federal district court against Early Education, alleging a violation of the Lanham Act. The parties entered into a settlement agreement that required Early Education to stop using the word ―rainbow‖ in connection with its Fayetteville facility. The court issued an injunction to enforce the agreement. Early Education continued to use the word ―rainbow‖ in domain names,

497

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

links, and meta tags associated with its Fayetteville facility‘s website. Rainbow imagery was used in a mailer inviting residents to the ―nearest Rainbow Child Care Center.‖ Did Early Education violate the Lanham Act? Explain. [Rainbow School, Inc. v. Rainbow Early Education Holding LLC, 887 F.3d 610 (4th Cir. 2018)] (See Advertising, Marketing, Sales, and Labeling.) Solution Yes. The conduct of Early Education violates the Lanham Act. This act covers trademark infringement, as well as false advertising claims. To state a successful claim for false advertising under the act, a business must prove the following: 357. 358. 359.

An injury to a commercial interest in reputation or sales. Direct causation of the injury by false or deceptive advertising. A loss of business from buyers who were deceived by the advertising.

In this problem, Early Education opened a ―Rainbow Child Care Center‖ in Fayetteville that used rainbow imagery on its logo. This facility was located near a childcare facility that had been operated by Rainbow School for more than twenty years. The School had long used the word ―rainbow‖ and rainbow imagery on its logo. To avoid a suit involving a claim for false advertising under the Lanham Act, Early Education agreed to stop using the word ―rainbow‖ in connection with its facility. A court issued an injunction to enforce the agreement. Nevertheless, Early Education continued to use the word ―rainbow‖ in domain names, links, and meta tags associated with its facility‘s website, and rainbow imagery in a mailer inviting residents to the ―nearest Rainbow Child Care Center.‖ On these facts, an injury to the School‘s commercial interest would consist of a loss of childcare clients. The direct cause of this injury could be attributed to Early Education‘s advertising and online use of the word ―rainbow‖ and use of rainbow imagery on its logo. These uses would have confused and thereby deceived buyers. By entering into the settlement agreement to avoid litigation, Early Education admitted its initial violation. By breaching this agreement, Early Education also violated the injunction. In the actual case on which this problem is based, the School filed a motion with the court, asserting that Early Education violated the injunction. The court held Early Education in contempt. The U.S. Court of Appeals for the Fourth Circuit affirmed. 9.

A Question of Ethics—The IDDR Approach and Consumer Protection. In Richland, Washington, Robert Ingersoll planned his wedding to include about a hundred guests, a photographer, a caterer, a wedding cake, and flowers. Ingersoll had been a customer of Arlene‘s Flowers and Gifts for more than nine years and had spent several thousand dollars at the shop. When he approached Arlene‘s owner, Baronelle Stutzman, to buy flowers for his wedding, she refused because Ingersoll and his fiancé, Curt Freed, were a same-sex couple. Deeply offended, Ingersoll and Freed dropped their wedding plans and married in a modest ceremony. [Arlene’s Flowers, Inc. v. State of Washington, __U.S.__, 138 S.Ct. 2671, 201 L.Ed.2d 1067 (2018)] (See Advertising, Marketing, Sales, and Labeling.) 10. Federal and state laws attempt to protect consumers from unfair trade practices, including discriminatory requirements, related to consumer transactions. Using the Review step of the

498

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

IDDR approach, consider whether it would be ethically fair to hold Stutzman personally liable for a violation of these laws. Solution Yes. In the circumstances, it would be ethically fair to hold Stutzman personally liable for a violation of consumer protection law. Federal and state laws attempt to protect consumers from unfair trade practices, including discriminatory requirements, in consumer transactions. Consumer protection statutes generally authorize actions against ―any person‖ for violations, with ―person‖ defined to include business entities and ―natural‖ persons. Here, Stutzman owned Arlene‘s Flowers and Gifts. Ingersoll had been a customer of Arlene‘s for more than nine years and had spent several thousand dollars at the shop. Through Stutzman, however, Arlene‘s refused to sell wedding flowers to Ingersoll because his betrothed, Freed, was a man. Offended by Stutzman‘s refusal, the couple dropped their wedding plans and married in a modest ceremony. The ethical focus is on whom to fairly sanction to punish and deter an ―unfair practice.‖ Individuals may be personally liable for a violation of a law if they participate in the wrongful conduct, or knowingly approve of it. This is not only legal, of course, but ethical, and would be more likely to resolve the issue with success than not holding violators personally liable. It would be unethical, and fail to successfully address the issue, to allow a business owner to avoid liability for such conduct behind the veil of a business entity. This is especially true here, when Stutzman, the owner of Arlene‘s, committed the violation herself. If such unfair practices were effectively deterred, the stakeholders—Ingersoll, Freed, and other consumers—would benefit. Other business owners, and the American public, generally, could also benefit from a more open market. 11. Using the Discussion step of the IDDR approach, consider actions that Ingersoll and Freed as consumers might take in response to Arlene‘s—Stutzman‘s—discriminatory rejection of their offer to do business. Solution Actions that Ingersoll and Freed as consumers might take in response to Arlene‘s— Stutzman‘s—discriminatory rejection of their offer to do business include filing complaints with private and government agencies, filing a suit, and doing nothing. A Discussion is the second step in the IDDR approach, after an Inquiry to define the ethical issue. In this question, the issue is whether Ingersoll and Freed should act in response to Stutzman‘s conduct. The stakeholders include Ingersoll and Freed‘s relatives and others with a personal interest in their lives, as well as other consumers—especially those who might be refused products or services on the basis of any bias by any merchant—other businesses, and society generally. The Discussion step posits actions to address the issue, their strengths and weaknesses, and consequences and effects. As stated above, Ingersoll and Freed might opt to do nothing. This would have the advantage of putting the incident quickly behind them. If it satisfies them, it would also likely satisfy their friends and families. But other consumers could be similarly

499

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 39: Consumer and Environmental Law

discriminated against with immediate impunity by Arlene‘s and other merchants. This would not benefit those stakeholders nor society generally. Ingersoll and Freed might choose to file complaints with private and government agencies or to file a suit against Arlene‘s and its owner. Either of these actions could vindicate the couple‘s rights and those of other consumers to engage in commerce free of the discrimination practiced by Stutzman. A successful suit could deter other merchants from discrimination. This could contribute to a more vibrant and prosperous economy, which would ultimately inure to the profit of society generally. In the actual case on which this problem is based, Ingersoll and Freed filed a suit in a Washington state court against Stutzman, alleging a violation of the state‘s Consumer Protection Act (CPA). The CPA prohibits ―unfair practices,‖ which include discriminating against customers on the basis of their sexual orientation. The court granted a summary judgment and awarded damages to the plaintiffs, holding Stutzman personally liable. The Washington Supreme Court affirmed the rulings. On a petition for a writ of certiorari, however, the United States Supreme Court vacated the judgment and remanded the case for further consideration. By this action, the Court directed the state supreme court to take into consideration Stutzman‘s religious objections to samesex marriage.

Critical Thinking and Writing Assignments 12. Time-Limited Group Assignment—Consumer Protections. Many states have enacted laws that go even further than federal laws to protect consumers against deceptive and false advertising. These laws vary tremendously from state to state. (See Advertising, Marketing, Sales, and Labeling.) 13. The first group will decide whether having different laws is fair to sellers, who may be prohibited from engaging in a practice in one state that is legal in another. Solution Sellers in one state may be prohibited from engaging in a certain practice that is permissible in another. This may seem unfair in individual cases. But there are greater considerations— imposing uniform consumer legislation on all of the states would extend national control over an area that has traditionally been within the states‘ prerogative, and could be unconstitutional. 14. The second group will consider how these different laws might affect a business. Solution A business must comply with the laws of the jurisdiction in which it does business. Of course, doing business in more than one jurisdiction means complying with different sets of laws. A business would have to adjust its methods accordingly. 15. A third group will determine whether it is fair that residents of one state have more protection than residents of another. Solution

500

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

Inequitable regulation can lead to inequitable results in similar cases in different states. This can mean that the citizens of one state are subject to more chicanery on the part of some unscrupulous merchants and creditors than in other states. But forcing uniform federal consumer legislation on all of the states would be to extend federal control into an area that has traditionally been within the states‘ prerogative and could be argued to be unconstitutional.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 501 Case 40.1 ............................................................................................................................................... 501 Case 40.2 ............................................................................................................................................... 502 Case 40.3 ............................................................................................................................................... 503 Chapter Review ........................................................................................................................................................... 504 Practice and Review .............................................................................................................................. 504 Practice and Review: Debate This ......................................................................................................... 505 Issue Spotters ........................................................................................................................................ 505 Business Scenarios and Case Problems ................................................................................................. 506 Critical Thinking and Writing Assignments ............................................................................................ 512

Critical Thinking Questions in Cases Case 40.1 16. In light of the fact that Suarez did not respond to Fernandez‘s complaint at the trial level, should any restrictions be placed on his appeal? Discuss. Solution Yes, there should be, and there are, restrictions placed on an appeal from a default judgment. In Texas, a default judgment is proper when a plaintiff‘s petition states a cause of action, recites the court‘s jurisdiction, provides ―fair notice‖ of the claim, and ―does not disclose any invalidity of the claim on its face,‖ according to the appellate court in the Suarez case. The entry of a default judgment operates as an admission of all allegations of fact set out in the plaintiff‘s petition. To succeed in an appeal, appellants (defendants at the trial level) must establish: • • •

They were parties to the underlying suit. They did not participate in the hearing that resulted in the judgment. They filed a notice of appeal within six months after the judgment.

501

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

•

―Error is apparent on the face of the record.‖

In the Suarez case, the appellate court found that the complaint met the requirements of stating a cause, invoking the trial court‘s jurisdiction, providing fair notice, and not otherwise invalidating the claim. Suarez‘s appeal was filed within six months of the judgment and established that he was a party and did not participate in the hearing in the lower court. Thus, the only element at issue on appeal was whether there was error on the record. In determining that issue, the appellate court was limited to considering only the face of the record, which consisted of all of the documents on file in the appeal, including the court reporter‘s record of the proceedings in the trial court. 17. What might Fernandez and El Hoyo have done to thwart Suarez‘s fraud? Explain. Solution To thwart Suarez‘s fraud, and consequently avoid the resulting losses in this case, Fernandez and El Hoyo might have established checks on the conduct and recording of the restaurant‘s finances and transactions. Presumably, Suarez was allowed to set up the procedures for the business of the restaurant and the corporation and trusted to carry out those processes without review. To frustrate attempts at theft and fraud, a third party might have been given the responsibility of overseeing those transactions and accounts. Bravo and Montoya seem to have been implicated in the fraud perpetrated on Fernandez. This indicates that the party practicing oversight in the circumstances of this case should have been Fernandez, or perhaps someone entirely neutral, with no interest or stake in the business.

Case 40.2 18. If the board were to open a new disciplinary proceeding against Laccetti and re-interview him, what would it have to do to comply with the court‘s decision? Solution If the Public Company Accounting Oversight Board were to open a new disciplinary proceeding against Laccetti and re-interview him, to comply with the court‘s decision in this case the board must allow him to be accompanied by counsel and an accounting expert who would assist his counsel. Under the court‘s decision, the right to counsel—which is guaranteed by the board‘s rules in this context—encompasses the right to have the assistance of an accounting expert during an investigative interview. At the interview at the center of this case, as the court stated, ―The Board infringed [Laccetti‘s] right to counsel by unreasonably barring the accounting expert from assisting his counsel at the interview.‖ Infringement of the right to counsel is a serious transgression. Opening a new proceeding for Laccetti might be the only reasonable remedy in this case.

502

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

19. Suppose that the board‘s rules guaranteed a witness‘s right to counsel but expressly excluded ―technical consultants and experts‖ during an investigative interview. Would the result have been different? Explain. Solution Yes. It is likely that the result in this case would have been different the board‘s rules guaranteed a witness‘s right to counsel but expressly excluded ―technical consultants and experts‖ during an investigative interview. In the Laccetti case, the court concluded that the board failed to follow its own rules when it refused to allow Laccetti to be accompanied by his counsel and an accounting expert who would assist his counsel at an investigative interview. The board‘s rules guaranteed the right to counsel for those who were compelled to testify and the board directed its staff to permit the presence of ―a technical consultant.‖ The court held that the right to counsel encompassed experts who could be considered ―an extension of counsel‖ such as Laccetti‘s accounting expert. Of course, the board is free to set and change its rules. Had those rules provided as expressed in the question, assuming there were no constitutional violations, the board could have properly denied Laccetti‘s request for an accounting expert. In other words, in the actual facts of the case and under the different facts in the question, the board must follow its rules.

Case 40.3 20. Suppose that a hearing had been held on the question of the attorney-client privilege before Baldwin testified. Would the result have been different? Solution Most likely, yes. As indicated by the opinion of the state intermediate appellate court in this case, preliminary questions regarding the existence and extent of an attorney-client privilege are to be decided by an appropriate court. At a hearing on the question of attorney-client privilege held before the testimony of parties to whom the privilege may apply, questions regarding the extent to which those parties could testify would be considered and answered, and thereby determined by the court. In fact, at the time of the actual events in this case, Pennsylvania Rules of Professional Conduct and Pennsylvania Rules of Evidence provided for such a hearing. But, as noted in the excerpt, the state trial court failed to hold a hearing on the issue of attorney-client privilege before Baldwin testified. In the words of the appellate court, without a hearing ―the Commonwealth assumed the risk of proceeding without a clear determination regarding the privilege concerns at play, which is precisely the risk that has now borne fruit in the form of a challenge to the charges flowing in part from such foul blows. Since the obstruction of justice and related conspiracy charges in this matter relied extensively on a presentment from an investigating grand jury privy to impermissible privileged communications, we quash the counts of obstruction of justice and the related conspiracy charge.‖ This would not likely have occurred if a hearing had been held.

503

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

Chapter Review Practice and Review Superior Wholesale Corporation planned to purchase Regal Furniture, Inc., and wished to determine Regal‘s net worth. Superior hired Lynette Shuebke, of the accounting firm Shuebke Delgado, to review an audit that had been prepared by Norman Chase, the accountant for Regal. Shuebke advised Superior that Chase had performed a high-quality audit and that Regal‘s inventory on the audit dates was stated accurately on the general ledger. As a result of these representations, Superior went forward with its purchase of Regal. After the purchase, Superior discovered that the audit by Chase had been materially inaccurate and misleading, primarily because the inventory had been grossly overstated on the balance sheet. Later, a former Regal employee who had begun working for Superior exposed an e-mail exchange between Chase and former Regal chief executive officer Buddy Gantry. The exchange revealed that Chase had cooperated in overstating the inventory and understating Regal‘s tax liability. Using the information presented in the chapter, answer the following questions. 21. If Shuebke‘s review was conducted in good faith and conformed to generally accepted accounting principles, could Superior hold Shuebke Delgado liable for negligently failing to detect material omissions in Chase‘s audit? Why or why not? Solution Shuebke could be liable if her failure to detect the impropriety is attributable to negligence. Complying with GAAP and acting in good faith are defenses to a prima facie case, but liability may exist otherwise. If it does, in this problem, possible defenses include Shuebke‘s alleged negligence not being the proximate cause of Superior‘s losses and Superior‘s potential contributory negligence. Neither of these defenses is indicated in the facts, however. 22. According to the rule adopted by the majority of courts to determine accountants‘ liability to third parties, could Chase be liable to Superior? Explain. Solution The majority of courts apply the principles set out in the Restatement (Second) of Torts, which hold an accountant liable for negligent acts that harm a third party if the accountant knew the third party would use the accountant‘s statements. It does not require that the third party be in privity of contract with the accountant. Chase apparently intended to misstate Regal‘s financial status, in violation of GAAP and GAAS, which would indicate negligence. On this theory, the question is whether Chase prepared the audit, knowing that Superior would ultimately rely on it. If so, Chase could be liable under the Restatement rule. 23. Generally, what requirements must be met before Superior can recover damages under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? Can Superior meet these requirements? Solution To be liable for fraud under the 1934 act and Rule 10b-5, an accountant must make untrue statements or omissions of material facts that render financial statements misleading in connection with a purchase or sale of securities. In this problem, the financial statement prepared by Chase was materially misleading in violation of Section 10(b). Chase failed to apply GAAP,

504

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

intentionally creating an inaccurate financial picture. Superior relied on the misrepresentations in purchasing Regal. Therefore, Chase could be liable on this theory. 24. Suppose that a court determined that Chase had aided Regal in willfully understating its tax liability. What is the maximum penalty that could be imposed on Chase? Solution Aiding or assisting in the preparation of a false tax return is a felony punishable by a fine of up to $100,000 in the case of an individual ($500,000 in the case of a corporation) and imprisonment of up to three years. A penalty of $250 per return may be assessed for negligent understatement of tax liability. For a willful understatement, the penalty may be $1,000. Additional penalties of up to $10,000 may apply for aiding and abetting an understatement.

Practice and Review: Debate This 25. Only the largest publicly held companies should be subject to the Sarbanes-Oxley Act. Solution All U.S. publicly held companies, other than the very largest, are at a competitive advantage compared to similar countries in Europe and Asia. Why? Because they have to spend, in total, billions a year satisfying Sarbanes-Oxley reporting requirements. The United States used to be the preferred country to list a foreign company on one of the stock exchanges. Today, we are no longer in this formerly enviable position because foreign companies don‘t want to pay the huge cost of complying with the Sarbanes-Oxley Act. Accounting scandals occur not only with the largest U.S. publicly held companies, but with smaller ones, too. If we exempted all but this country‘s largest publicly held corporations from SarbanesOxley, we would see increased accounting irregularities throughout the country. After all, the Act was passed in an attempt to reduce accounting irregularities that caused millions of investors to lose huge sums.

Issue Spotters 26. Dave, an accountant, prepares a financial statement for Excel Company, a client, knowing that Excel will use the statement to obtain a loan from First National Bank. Dave makes negligent omissions in the statement that result in a loss to the bank. Can the bank successfully sue Dave? Why or why not? Solution Yes. In these circumstances, when the accountant knows that the bank will use the statement, the bank is a foreseeable user. A foreseeable user is a third party within the class of parties to whom an accountant may be liable for negligence. 27. Nora, an accountant, prepares a financial statement as part of a registration statement that Omega, Inc., files with the Securities and Exchange Commission before making a public offering of securities. The statement contains a misstatement of material fact that is not attributable to Nora‘s fraud or negligence. Pat relies on the misstatement, buys some of the securities, and suffers a loss. Can Nora be held liable to Pat? Explain. Solution

505

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

No. In the circumstances described, the accountant will not be held liable to a purchaser of the securities. Although an accountant may be liable under securities laws for including untrue statements or omitting material facts from financial statements, due diligence is a defense to liability. Due diligence requires an accountant to conduct a reasonable investigation and have reason to believe that the financial statements were true at the time. The facts say that the misstatement of material fact in Omega‘s financial statement was not attributable to any fraud or negligence on Nora‘s part. Therefore, Nora can show that she used due diligence and will not be held liable to Pat.

Business Scenarios and Case Problems 28. The Ultramares Rule. Larkin, Inc., retains Howard Perkins to manage its books and prepare its financial statements. Perkins, a certified public accountant, lives in Indiana and practices there. After twenty years, Perkins has become a bit bored with generally accepted accounting principles (GAAP) and has adopted more creative accounting methods. Now, though, Perkins has a problem. He is being sued by Molly Tucker, one of Larkin‘s creditors. Tucker alleges that Perkins either knew or should have known that Larkin‘s financial statements would be distributed to various individuals. Furthermore, she asserts that these financial statements were negligently prepared and seriously inaccurate. What are the consequences of Perkins‘s failure to follow GAAP? Under the traditional Ultramares rule, can Tucker recover damages from Perkins? Explain. (See Potential Liability to Third Parties.) Solution Perkins's decision to become creative in his accounting, and hence to abandon generally accepted accounting principles, will be considered prima facie evidence of negligence on his part. Under the traditional Ultramares rule, an accountant did not owe any duty to a third person with whom that accountant had no direct contractual relationship. Thus, Tucker could not hold Perkins liable for negligence because there was no direct contractual relationship between the two parties. The recent tendency, however, is to hold an accountant liable to a third party, such as Tucker, with whom the accountant is not in privity. 29. The Restatement Rule. The accounting firm of Goldman, Walters, Johnson & Co. prepared financial statements for Lucy‘s Fashions, Inc. After reviewing the financial statements, Happydays State Bank agreed to loan Lucy‘s Fashions $35,000 for expansion. When Lucy‘s Fashions declared bankruptcy under Chapter 11 six months later, Happydays State Bank filed an action against Goldman, Walters, Johnson & Co., alleging negligent preparation of financial statements. Assuming that the court has abandoned the Ultramares approach, what is the result? What are the policy reasons for holding accountants liable to third parties with whom they are not in privity? (See Potential Liability to Third Parties.) Solution Assuming that the circuit court has abandoned the Ultramares rule, it is likely that the accounting firm of Goldman, Walters, Johnson & Co. will be held liable to Happydays State Bank for negligent preparation of financial statements. As a side note, this hypothetical question is partially derived from the case, Citizens State Bank v. Timm, Schmidt & Co. In that case, the Supreme Court of Wisconsin enunciated various policy reasons for holding accountants liable to third parties even in the absence of privity. The court suggested that this potential liability would make accountants more careful in preparing financial statements. Moreover, in some situations the accountants may be the only solvent defendants. Hence, unless liability is imposed on the accountants, third parties who reasonably rely on financial statements may go unprotected. The court also observed that if

506

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

third parties, such as banks, have to absorb the costs of bad loans made as a result of negligently prepared financial statements, then the cost of credit to the public in general will increase. The court suggested that accountants are in a better position to absorb the risk by purchasing liability insurance. 30. Accountant’s Liability under Rule 10b-5. In early 2018, Bennett, Inc., offered a substantial number of new common shares to the public. Harvey Helms had a long-standing interest in Bennett because his grandfather had once been president of the company. On receiving Bennett‘s prospectus, Helms was dismayed by the pessimism it embodied, so he decided to delay purchasing stock in the company. Later, Helms asserted that the prospectus prepared by the accountants had been overly pessimistic and had contained materially misleading statements. Discuss fully how successful Helms would be in bringing a suit under Rule 10b-5 against Bennett‘s accountants. (See Liability of Accountants under Federal Laws.) Solution Harvey Helms may not bring a cause of action against the accountants of Bennett, Inc., under Rule 10b-5 because Helms is neither a purchaser nor a seller of securities. Standing to commence an action under Rule 10b-5 is limited to actual purchasers or sellers of securities. 31. Professional’s Liability. Soon after Teresa DeYoung‘s husband died, her mother-in-law also died, leaving an inheritance of more than $400,000 for DeYoung‘s children. DeYoung hired John Ruggiero, an attorney, to ensure that her children would receive it. Ruggiero advised her to invest the funds in his real estate business. She declined. A few months later, $300,000 of the inheritance was sent to Ruggiero. Without telling DeYoung, he deposited the $300,000 in his account and began to use the funds in his real estate business. Nine months later, $109,000 of the inheritance was sent to Ruggiero. He paid this to DeYoung. She asked about the remaining amount. Ruggiero lied to hide his theft. Unable to access these funds, DeYoung‘s children changed their college plans to attend less expensive institutions. Nearly three years later, DeYoung learned the truth. Can she bring a suit against Ruggiero? If so, on what ground? If not, why not? Did Ruggiero violate any standard of professional ethics? Discuss. [DeYoung v. Ruggiero, 2009 VT 9, 971 A.2d 627 (2009)] (See Potential Liability to Clients.) Solution Among the grounds for professional liability discussed in this chapter, DeYoung might file a suit against Ruggerio for breach of contract, or fiduciary duty; malpractice (professional negligence); and fraud. She might also file a criminal complaint against him for fraud. He has also violated the attorney‘s duty of care and other professional responsibility and ethical standards. By surreptitiously diverting the children‘s inheritance to his own account, Ruggerio failed to perform as he agreed in his contract with DeYoung. For this breach, DeYoung might recover the funds (compensatory damages), the expense to secure another professional to secure the funds (incidental damages), and other reasonable and foreseeable losses, including interest. Ruggerio failed to exercise reasonable care and professional judgment, thereby breaching the duty of care that all attorneys owe their clients. For this breach, Ruggerio can be held liable for malpractice. Liability for fraud requires the misrepresentation of a material fact, an intent to deceive, an innocent party‘s justifiable reliance on the misrepresentation, and for damages an injury. Each of these elements is present in this set of facts. In violation of the professional responsibility and ethical standards, as noted above, Ruggerio failed to exercise reasonable care and professional judgment, breaching his duty of care. An award of punitive damages might also be possible.

507

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

In the case on which this problem is based, DeYoung filed a suit in a Vermont state court against Ruggerio for breach of fiduciary duty, misrepresentation, misappropriation, negligence, and breach of contract. She was awarded compensatory damages and attorney‘s fees. On appeal, the Vermont Supreme Court upheld the award and remanded for a determination of punitive damages. Meanwhile, the state professional responsibility board disbarred Ruggerio, and he paid DeYoung $300,000, with interest. 32. Professional Malpractice. Jeffery Guerrero hired James McDonald, a certified public accountant, to represent him and his business in an appeal to the Internal Revenue Service. The appeal concerned audits that showed Guerrero owed more taxes. When the appeal failed, McDonald assisted in preparing materials for an appeal to the Tax Court, which was not successful. Guerrero then sued McDonald for professional negligence in the preparation of his evidence for the court. Specifically, Guerrero claimed that he would have won the case if McDonald had adequately prepared witnesses and had presented all the arguments that could have been made on his behalf. Guerrero contended that McDonald was liable for all of the additional taxes he was required to pay. Is Guerrero‘s claim likely to result in liability on McDonald‘s part? What factors would the court consider? [Guerrero v. McDonald, 302 Ga.App. 164, 690 S.E.2d 486 (2010)] (See Potential Liability to Clients.) Solution The trial court rejected these claims and the appeals court affirmed. Since the matter concerned malpractice in litigation, the standard is the same as is applied in cases of legal malpractice. To prevail on a claim of professional malpractice, a client must show that: (1) he employed an attorney; (2) the attorney failed to exercise ordinary care, skill, and diligence; and (3) the attorney‘s negligence was the proximate cause of damage to client. Guerrero‘s affidavit was insufficient to show that alleged negligence by McDonald, who represented him in the Tax Court challenging corporate tax rulings of the IRS, proximately caused, as an element of the professional negligence claim, damages to Guerrero. The affidavit listed topics that client believed could have been addressed in underlying trial, but failed to explain how the introduction of such evidence, witness testimony, and argument would have resulted in an outcome favorable to client. There can be no negligence liability for acts and omissions by an attorney in the conduct of litigation, which are based on an honest exercise of professional judgment. A court will not hold an attorney (or CPA in this case) liable for malpractice based merely on the choice of trial tactics or strategy or the good faith exercise of professional judgment. 33. Business Case Problem with Sample Answer—Potential Liability to Third Parties. In 2006, twenty-seven parties became limited partners in two hedge funds that had invested with Bernard Madoff and his investment firm. The partners‘ investment adviser gave them various investment information, including a memorandum indicating that an independent certified public accountant, KPMG, LLP, had audited the hedge funds‘ annual reports. Since 2004, KPMG had also prepared annual reports addressed to the funds‘ ―partners.‖ Each report stated that KPMG had investigated the funds‘ financial statements, had followed generally accepted auditing principles, and had concluded that the statements fairly summarized the funds‘ financial conditions. Moreover, KPMG used the information from its audits to prepare individual tax statements for each fund partner. In 2008, Madoff was charged with securities fraud for running a massive Ponzi scheme. In a 2009 report, the Securities and Exchange Commission identified numerous ―red flags‖ that should have been discovered by investment advisers and auditors. Unfortunately, they were not, and the hedge funds‘ partners lost millions of dollars. Is KPMG potentially liable to the funds‘ partners

508

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

under the Restatement (Third) of Torts? Why or why not? [Askenazy v. Tremont Group Holdings, Inc., 2012 WL 440675 (Mass.Super. 2012)] (See Potential Liability to Third Parties.) —For a sample answer to Problem 40–6, go to Appendix E. Solution KPMG is potentially liable to the hedge funds‘ partners under the Restatement (Second) of Torts. Under Section 552 of the Restatement, an auditor owes a duty to ―persons for whose benefit and guidance the accountant intends to supply . . . information.‖ In this case, KPMG prepared annual reports on the hedge funds and addressed them to the funds‘ ―Partners.‖ Additionally, KPMG knew who the partners were because it prepared individual tax forms for them each year. Thus, KPMG‘s annual reports were for the partners‘ benefit and guidance. The partners relied on the reports, including their representations that they complied with generally accepted accounting principles. As a result, they lost millions of dollars, which exposes KPMG to possible liability under Section 552. 34. Attorney’s Duty of Care. Luis and Maria Rojas contracted to buy a house in Westchester County, New York, from Andrew and Karen Paine. The house was on property designated as ―Lot No. 8‖ on a subdivision map filed in the county clerk‘s office. The Paines had acquired the property in two parts by the transfer of two separate deeds. At the closing, they delivered a deed stating that it covered ―the same property.‖ In fact, however, the legal description attached to the deed covered only the portion of Lot No. 8 described in one of the two previous deeds. Attorney Paul Herrick represented the Rojases in the deal with the Paines. When the Rojases sought to sell the property two years later, the title search revealed that they owned only part of Lot No. 8, and the buyer refused to go through with the sale. Is Herrick liable for malpractice? Explain. [Rojas v. Paine, 125 A.D.3d 745, 4 N.Y.S.3d 223 (2 Dept. 2015)] (See Potential Liability to Clients.) Solution Yes. Herrick is liable for malpractice. An attorney owes a duty to provide a client with competent and diligent representation. This requires the attorney to investigate and discover facts that could materially affect the client‘s legal rights. Normally, an attorney‘s performance is expected to be that of a reasonably competent general practitioner of ordinary skill, experience, and capacity. When an attorney fails to exercise reasonable care and professional judgment, that attorney breaches the duty of care owed to the client and can be held liable for malpractice, or professional negligence. In this problem, the Rojases contracted to buy a house from the Paines. The house was on property designated as ―Lot No. 8‖ on a subdivision map filed with the county. The Paines had acquired the property by the transfer of two separate deeds, and at the closing, they delivered a deed that stated this was ―the same property.‖ But the legal description attached to the deed covered only the portion of Lot No. 8 described in one of the two previous deeds. When the Rojases sought to sell the property later, the title search revealed that they owned only part of Lot No. 8, and the buyer refused to go through with the sale. Herrick represented the Rojases in the deal with the Paines. He failed to comply the standards stated above when he did not investigate and discover the discrepancy among the various deeds. This materially affected the Rojases‘ legal rights.

509

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

In the actual case on which this problem is based, the Rojases filed a suit in a New York state court against the Paines and Herrick, alleging malpractice by the attorney. The court entered a judgment in the Rojases‘ favor. A state intermediate appellate court affirmed. Herrick ―failed to exercise the ordinary reasonable skill and knowledge commonly possessed by a member of the legal profession.‖ 35. Attorney Misconduct. Solomons One, LLC, was formed to develop waterfront property in Maryland. Vernon Donnelly was a member of the LLC and served as the company‘s counsel. The state denied Solomons‘s request for a permit to build a pier. Donnelly appealed the denial. Meanwhile, he assigned Solomons‘s potential right to build a pier to a trust, appointed himself trustee, and changed his fee arrangement with the company. These steps were taken without Solomons‘s authorization, but there was no financial harm to the LLC and no additional evidence that Donnelly engaged in dishonesty or deceit. On learning of Donnelly‘s actions, however, a majority of the LLC members voted to terminate his representation. Despite the vote, he pursued the pier case until the LLC ultimately gained the right to build a pier. Donnelly had not previously been disciplined for misconduct. Should he be disciplined in this case? Why or why not? [Attorney Grievance Commission of Maryland v. Donnelly, 458 Md. 237, 182 A.3d 743 (2018)] (See Potential Liability to Clients.) Solution Yes. Donnelly should be disciplined in this case. A state‘s rules of professional conduct provide a basis for the discipline of an attorney for many types of misconduct. For example, the rules define professional misconduct to include criminal acts that reflect adversely on the professional‘s ―honesty or trustworthiness, or fitness as a lawyer in other respects,‖ as well as conduct involving ―dishonesty, fraud, deceit, or misrepresentation.‖ The rules also proscribe the following: • • • •

Acting on a client‘s behalf without the client‘s authorization. Failing to communicate with a client. Failing to withdraw from a client‘s case after the lawyer‘s representation is terminated. Engaging in conduct that would negatively affect the public‘s perception of the legal profession.

In this problem, Donnelly was a member of, and designated counsel for, Solomons One, LLC. Formed to develop waterfront property, the company asked the state for a permit to build a pier. When this was denied, Donnelly appealed. He also assigned Solomons‘s potential right to build a pier to a trust, appointed himself trustee, and altered his fee arrangement with the company. Solomons did not authorize these actions, and on learning of them, a majority of the members voted to terminate Donnelly‘s representation. Despite the vote, Donnelly pursued the pier case. Donnelly violated a number of proscriptions in the state‘s rules of professional conduct. There are mitigating factors—he had not previously been disciplined, and there was no additional evidence that he committed any criminal acts, that he otherwise engaged in dishonesty or deceit, or that Solomons suffered substantial financial harm. In sum, however, Donnelly should be disciplined to underscore for him and other members of the bar in the state the need to act in compliance with the state‘s rules, particularly with respect to communicating with clients and obtaining their authorization before acting on their behalf.

510

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

In the actual case on which this problem is based, the Attorney Grievance Commission of Maryland filed a petition in the state‘s highest court for disciplinary action against Donnelly. The court considered the evidence, weighed the mitigating factors, concluded that Donnelly violated the state‘s rules, and suspended him from the practice of law for thirty days. 36. A Question of Ethics—The IDDR Approach and Attorney Misconduct. Brandy Sutton was the sole owner of the law firm Pendleton & Sutton in Lawrence, Kansas. Sutton offered a retirement plan as a benefit to the members of her staff. Employees could contribute up to 3 percent of their salaries. Sutton withheld the contributions from the employees‘ paychecks, which indicated that the amounts were deposited into the plan. For a period of years, however, she failed to make the deposits, using the funds to cover her professional expenses instead. An associate attorney with the firm discovered the discrepancy and filed a complaint with the state disciplinary office. In response, Sutton argued that the misconduct was caused by financial difficulties, including ―several items‖ involving the associate who filed the complaint. Sutton expressed remorse, and within sixteen months properly funded all of the employees‘ accounts. [In the Matter of Sutton, 307 Kan. 95, 405 P.3d 1205 (2017)] (See Potential Liability to Clients.) 37. When a business experiences financial difficulties, can it withhold amounts owed to its employees to pay more immediate obligations? Consider this question from an ethical perspective, using the IDDR approach. Solution From an ethical perspective, a business that is experiencing financial difficulties cannot withhold amounts owed to its employees to pay more immediate obligations. The first step of the IDDR approach is the Inquiry, which involves a statement of the ethical issue, its stakeholders, and the relevant standards. The issue here is whether a business can forego the payment of amounts owed to its employees in favor of other obligations. The stakeholders include the business, its employees, its creditors, and others who may depend on the continuance of the business for contributions to their livelihood—suppliers, customers or clients, and the like. The standards include applicable business, trade, or professional codes, as well as state licensing and occupational practice laws, and the ethical precept to act honestly. The second and third steps of the IDDR approach are the Discussion and the Decision. These steps consider actions to resolve the issue, their strengths and weaknesses, and their consequences and effects, and include a choice of action. Confronting the issue stated above, a business might prioritize the payment of debts without regard to ethical considerations, or with some slight awareness of its impact. Or the business might honor its obligations with complete attention to the ethical effects. For example, in this problem, an attorney facing financial difficulties opted to withhold her employees‘ contributions from their retirement accounts. The attorney used those funds to pay other obligations. Could this have been done ethically? Possibly—say, if the attorney had obtained the employees‘ consent and promised to repay the loans with interest. Here, however, the attorney chose to conceal her actions from the employees. This deceit violated all of the relevant ethical standards.

511

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 40: Liability of Accountants and Other Professionals

The fourth, and final, step of the IDDR approach is a Review of the success or failure of the selected action to resolve the issue and satisfy the stakeholders. The attorney‘s choice to withhold payments to her employees without their knowledge breached all of the applicable legal and ethical principles. This exposed the attorney and her firm to potential litigation, dissolution, and other sanctions. These consequences would have satisfied none of the stakeholders, except perhaps those creditors who were paid in lieu of the employees. A better choice of action might have been to borrow the funds from the employees, as noted above. Or the attorney might have contacted the other creditors to renegotiate her firm‘s debts or a financial institution to obtain a loan. 38. Should a sanction be imposed on Sutton in this case? If so, what should it be? Possibilities include suspension from the practice of law for a limited time or an indefinite period, and probation. Explain. Solution In this case, a sanction should be imposed on Sutton. She withheld her employees‘ contributions from their retirement accounts in order to pay her business‘s expenses without the employees‘ knowledge. This continued for years. When her actions were reported to the state disciplinary authority, her defense was to blame others, in particular, the party who filed the complaint. Among the possibilities for sanctions indicated in the question is probation. This could be imposed with any number of terms and conditions. In the actual case on which this problem is based, the panel that heard Sutton‘s case recommended that she be placed on probation for three years. This would have allowed her to continue practicing law. The panel recommended nine conditions, including supervision by an appointed attorney who would have access to all of her firm‘s files and financial records. Those financial records would have to be maintained with the assistance of professional accountants. In Kansas, the state supreme court decides on the sanctions to be imposed on attorneys for violations of the state‘s code of professional ethics. At Sutton‘s hearing before the court, the state disciplinary administrator recommended that Sutton be indefinitely suspended. In the court‘s opinion, Sutton‘s conduct was ―in effect‖ conversion, which ―warrants more severe discipline than probation.‖ The court imposed a three-year suspension. Sutton could petition to have the suspension lifted after six months. But this would require the approval of the state disciplinary authority of a subsequent thirty-month probation, which would be subject to the conditions referred above. Sutton was also ordered to pay all of the expenses of these proceedings.

Critical Thinking and Writing Assignments 39. Time-Limited Group Assignment—Attorney- Client Privilege. Napster, Inc., offered a service that allowed its users to browse digital music files on other users‘ computers and download selections for free. Music industry principals sued Napster for copyright infringement, and the court ordered Napster to remove files that were identified as infringing from its service. When Napster failed to comply, it was shut down. A few months later, Bertelsmann, a German corporation, loaned Napster $85 million to fund its anticipated transition to a licensed digital music distribution system. The terms allowed Napster

512

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

to spend the loan on ―general, administrative and overhead expenses.‖ In an e-mail, Napster‘s chief executive officer referred to a ―side deal‖ under which Napster could use up to $10 million of the loan to pay litigation expenses. Napster failed to launch the new system before declaring bankruptcy. The plaintiffs filed a suit against Bertelsmann, alleging that its loan had prolonged Napster‘s infringement. The plaintiffs asked the court to order the disclosure of all attorney-client communications related to the loan. (See Confidentiality and Privilege.) 40. The first group will identify the principle that Bertelsmann could assert to protect these communications and outline the purpose of this protection. Solution The attorney-client privilege protects the confidentiality of attorney-client communications. Under this principle, an attorney cannot discuss a client‘s case without the client‘s permission or the client‘s waiver of this privilege, even by court order. The purpose for this protection is to encourage the client‘s full disclosure to the attorney of the facts of the client‘s case. 41. The second group will decide whether this principle should protect a client who consults an attorney for advice that will help the client commit fraud. Solution The confidentiality of attorney-client communications is protected from disclosure without the client‘s permission by the attorney-client privilege. But there is an exception—the ―crimefraud‖ exception—under which a client who consults an attorney for advice that will help the client commit fraud cannot avoid disclosure. 42. A third group will determine whether the court should grant the plaintiffs‘ request. Solution In this problem, considering the evidence, the court should not order the disclosure of the attorney-client communications relating to the Bertelsmann-Napster loan under the crimefraud exception. The plaintiffs‘ evidence does not establish an intentional, material misrepresentation aimed at the court. Litigation expenses could fall under the ―general, administrative and overhead expenses‖ clause in the loan documents. Even if the court concluded that the written terms of the loan misrepresented the parties‘ agreement to allow some of the funds to be used for litigation expenses, the plaintiffs‘ evidence does not suggest that Bertelsmann selected these terms with the intent to defraud the court. The fact that a party has taken steps to structure a business transaction to limit its liability is not enough to establish that the crime-fraud exception applies. Even assuming for the sake of argument that Bertelsmann's failure to spell out in the loan documents that ―overhead costs‖ included litigation expenses was an intentional misrepresentation, it could not have deceived a court into concluding that Bertelsmann provided no financial support to, or had no financial stake in, the existing Napster company. If funding Napster's litigation may have helped to prolong Napster's existence, so, too, did injecting any cash into Napster.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

513

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

Table of Contents Critical Thinking Questions in Features ............................................................................................................. 514 Adapting the Law to the Online Environment ....................................................................................... 514 Critical Thinking Questions in Cases ................................................................................................................... 514 Case 41.1 ............................................................................................................................................... 514 Case 41.2 ............................................................................................................................................... 514 Case 41.3 ............................................................................................................................................... 516 Chapter Review ........................................................................................................................................................... 516 Practice and Review .............................................................................................................................. 516 Practice and Review: Debate This ......................................................................................................... 517 Issue Spotters ........................................................................................................................................ 518 Business Scenarios and Case Problems ................................................................................................. 518 Critical Thinking and Writing Assignments ............................................................................................ 527

Critical Thinking Questions in Features Adapting the Law to the Online Environment 43. How might a couple who enjoy purchasing digital goods together avoid property division issues in the event of a divorce? Solution Couples can specify in pre-nuptial agreements which party gets what if divorce occurs. As they add new digital property, they can create addenda to their existing agreements.

Critical Thinking Questions in Cases Case 41.1 44. Suppose that Gladys Piper had told Clara Kaufmann that she was giving the rings to Clara but wished to keep them in her possession for a few more days. Would this have affected the court‘s decision in this case? Explain. Solution Whether a gift would exist would depend on whether Clara had acquired the unconditional right to remove the rings whenever she chose. In other words, the court would ask whether Gladys had given up complete control of the rings before it would rule that Clara was entitled to claim them as gifts. In such a situation, however, the fact that the rings remained in Gladys‘s possession would suggest that there was no effective delivery even though Clara might argue that she was given the power to remove the rings whenever she chose.

Case 41.2 45. Suppose someone else‘s snow blower is left in your garage for an extended period of time. Under the statute applied in the Zephier case, could you become the owner of the snow blower? Explain.

514

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

Solution Yes, under the Minnesota statute applied in the Zephier case, you could become the owner of a snow blower that is left in your garage for an extended period by its original owner. To obtain the ownership rights, you would have to meet the requirements of the statute. As the appellate court stated in the case, Minnesota Statutes Section 345.75 ―lays out a clear, concise process to obtain ownership of abandoned tangible personal property.‖ It specifies that six months must pass before property may be deemed abandoned. The possessor of the property must give its owner thirty days‘ notice before the rights to ownership can transfer to the possessor. And the notice must be personal service or certified. By following these steps, you could obtain the ownership rights to the snow blower. In the Zelphier case, of course, Agate, Oliver‘s possessor, did not provide the requisite notice to Zelphier, Oliver‘s owner, which led the appellate court to conclude that she could reclaim the dog. 46. Why is a possessor of abandoned property allowed to obtain ownership rights to it? Discuss. Solution Property is a fiscal resource. Its use has economic benefits. These facts provide the policy to support the transfer of ownership rights to abandoned property from its prior owner to its possessor. By transferring the ownership rights to abandoned property, its possessor can put it to use, in contrast to the apparent disuse or non-use by its prior owner. If this use generates income, the transfer of rights may also support the collection of revenue by the state in the form of taxes from an ascertainable, asserted, and locatable owner. Or its new owner may sell the property, which is another way to generate income (and taxes). And if there is no declared owner, the state can acquire the property and sell it. For example, if the ownership rights to an abandoned car were transferred to its possessor, the new owner could drive it or sell it. Either activity would likely result in income to the state, in the form of personal property, gas, or sales taxes. And if the state became the possessor, and subsequent owner, the car could be sold with the proceeds going into the state‘s coffers.

515

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

Case 41.3 47. Suppose that instead of putting the Zissus‘ personal property outside, IH2 had taken it to a storage facility. Would the result have been different? Why or why not? Solution The conclusion of the court in the Zissu case would likely have been the same even if IH2 had taken the Zissus‘ personal property to a storage facility rather than leaving it outside on a curb. But the facts might have been sufficiently different to result in no litigation—the goods might not have been damaged or stolen in a storage facility. If so, there would have been no basis for the ground on which the Zissus brought this suit. In the actual facts of the case, IH2 Property Illinois, L.P., obtained an order from an Illinois state court for possession of an apartment IH2 owned in Chicago, allowing the owner to evict its current occupants—the Zissus. A county sheriff executed the order. IH2‘s agents then put the Zissus‘ personal property on the curb. The property was stolen or damaged. The Zissus filed a suit against IH2 in a federal district court. IH2 filed a motion to dismiss. The court denied the motion, after determining that the plaintiffs sufficiently alleged claims for the existence of a bailment and negligence. Neither the statutes of Illinois nor the Illinois Supreme Court had addressed the question of a landlord‘s duty under Illinois law with respect to a tenant‘s personal property after an eviction, so the court in which the Zissus brought their suit had to ―divine‖ how the state supreme court would rule. After reviewing cases addressing the issue, the court found that there generally was no duty except when the landlord chooses to care for the property. Because IH2 chose to care for the Zissus‘ property—by taking possession of it after the eviction—the landlord was liable for the Zissus‘ loss. If IH2 had moved the property to a storage facility, it would likewise have chosen to care for the property, and the same principles would have applied, making the landlord liable for its damage or loss.

Chapter Review Practice and Review Vanessa Denai owned forty acres of land in rural Louisiana. On the property were a 1,600-square-foot house and a metal barn. Denai met Lance Finney, who had been seeking a small plot of rural property to rent. After several meetings, Denai invited Finney to live on a corner of her land in exchange for Finney‘s assistance in cutting wood and tending her property. Denai agreed to store Finney‘s sailboat in her barn. With Denai‘s consent, Finney constructed a concrete and oak foundation on Denai‘s property and purchased a 190-square-foot dome from Dome Baja for $3,395. The dome was shipped by Doty Express, a transportation company licensed to serve the public. When it arrived, Finney installed the dome frame and fabric exterior so that the dome was detachable from the foundation. A year after Finney installed the dome, Denai wrote Finney a note stating, ―I‘ve decided to give you four acres of land surrounding your dome as drawn on this map.‖ This gift violated no local land-use restrictions. Using the information presented in the chapter, answer the following questions.

516

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

48. Is the dome real property or personal property? Explain. Solution Real property is land and its fixtures (everything permanently attached to it). Intent that an item be a fixture can be assumed from its permanent installation. Personal property encompasses all other types of property. A key distinction between personal and real property is that real property is not movable. Here, the dome was movable because it was detachable from its foundation, which indicates an intent that it not be a fixture. 49. Is Denai‘s gift of land to Finney a gift causa mortis or a gift inter vivos? Solution Denai‘s gift of the land was a gift inter vivos—that is, a gift made during one‘s lifetime and not in contemplation of imminent death. 50. What type of bailment relationship was created when Denai agreed to store Finney‘s boat? What degree of care was Denai required to exercise in storing the boat? Solution Finney was the bailor, and Denai was the bailee in an ordinary, voluntary, gratuitous bailment for the sole benefit of the bailor. It is ordinary because it is not special—Denai is not a common carrier, a warehouse company, or an innkeeper. It is voluntary because the property was voluntarily delivered with the knowledge of both parties. It is gratuitous because the facts do not indicate consideration. It is for the sole benefit of the bailor because it exists for his convenience and benefit alone. The duty of care required of Denai (the bailee) is to exercise reasonable care to preserve the sailboat (the bailed property) but the degree of that care is slight, because the bailment is for the sole benefit of the bailor. 51. What standard of care applied to the shipment of the dome by Doty Express? Solution Doty was a common carrier (a publicly licensed transportation service, such as a trucking company). A common carrier is held to a standard of care based on strict liability, rather than reasonable care, in relation to bailed personal property. The carrier is thus liable, regardless of care, for all loss or damage to goods, except damage caused by: (1) an act of God, (2) an act of a public enemy, (3) an order of a public authority, (4) an act of the shipper, or (5) the inherent nature of the goods. Common carriers cannot contract away this liability, but they can limit their dollar liability to an amount stated on the shipment contract.

Practice and Review: Debate This 52. Common carriers should not be able to limit their liability. Solution Those who use common carriers for shipping should not have to worry about what happens if a parcel is lost or damaged. After all, customers of common carriers do not control in what manner their parcels are handled during shipping. Liability should be shouldered uniquely by the carrier. If common carriers had unlimited liability, they would have to purchase much more expensive insurance to cover their increased liability. Consequently, common carriers would have to raise

517

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

their rates, thereby hurting all customers. Customers should simply buy more insurance themselves for their shipments.

Issue Spotters 53. While walking to work, Bill finds an expensive ring lying on the curb. Bill gives the ring to his son, Hunter. Two weeks later, Martin Avery, the true owner of the ring, discovers that Bill had found the ring and demands that Hunter return it. Who is entitled to the ring, and why? Solution The ring is classified as lost property because it was discovered under circumstances indicating that the owner had not voluntarily placed it where it was found. The general rule is that the finder of the lost property has the right to possession (and eventual title) over all others except the true owner of the lost property. Therefore, Martin, as the true owner of the ring, is entitled to repossess the ring from Hunter. 54. Rosa de la Mar Corporation ships a load of goods via Southeast Delivery Company. The load of goods is lost in a hurricane in Florida. Who suffers the loss? Explain your answer. Solution Rosa de la Mar Corporation, the shipper, suffers the loss. A common carrier is liable for damage caused by the willful acts of third persons or by an accident. Other losses must be borne by the shipper (or the recipient, depending on the terms of their contract). In this situation, this shipment was lost due to an act of God.

Business Scenarios and Case Problems 55. Duties of the Bailee. Discuss the standard of care traditionally required of the bailee for the bailed property in each of the following situations, and determine whether the bailee breached that duty. (See Bailments.) 56. Ricardo borrows Steve‘s lawn mower because his own lawn mower needs repair. Ricardo mows his front yard. To mow the backyard, he needs to move some hoses and lawn furniture. He leaves the mower in front of his house while doing so. When he returns to the front yard, he discovers that the mower has been stolen. Solution This gratuitous bailment was created primarily for the benefit of the bailee, Ricardo. Under such circumstances the bailee is required to use great care to protect the bailed property from loss or damage. Many courts would require a greater degree of care than one would expect if the bailee owned the property. Whether leaving the mower in the front yard under these circumstances is a breach of the care required here is questionable. The discussion could go either way, but the best answer is that no breach of care occurred and that therefore there is no liability to Steve.

518

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

57. Alicia owns a valuable speedboat. She is going on vacation and asks her neighbor, Maureen, to store the boat in one stall of Maureen‘s double garage. Maureen consents, and the boat is moved into the garage. Maureen needs some grocery items for dinner and drives to the store. She leaves the garage door open while she is gone, as is her custom, and the speedboat is stolen during that time. Solution Maureen‘s bailment was created primarily for the benefit of the bailor, Alicia. Under these circumstances the bailee can be expected to use only slight care in the protection of the bailed property from loss or damage. Because Maureen‘s custom was to leave the garage door open on short trips, her failure to close and lock the garage door might not necessarily be a breach of the care required here. Thus, Maureen may have no liability to Alicia. One could reasonably argue, however, that Maureen should have at least closed her garage door so as not to make Alicia‘s boat obvious to any potential thief who walked by. 58. Gifts. Jaspal has a severe heart attack and is taken to the hospital. He is aware that he is not expected to live. Because he is a bachelor with no close relatives nearby, Jaspal gives his car keys to his close friend Friedrich, telling Friedrich that he is expected to die and that the car is Friedrich‘s. Jaspal survives the heart attack, but two months later he dies from pneumonia. Sam, Jaspal‘s uncle and the executor of his estate, wants Friedrich to return the car. Friedrich refuses, claiming that the car was a gift from Jaspal. Discuss whether Friedrich will be required to return the car to Jaspal‘s estate. (See Acquiring Ownership of Personal Property.) Solution Jaspal has made a gift causa mortis of the car to Friedrich. The gift meets all three tests to be effective: delivery (symbolic by car keys), donative intent, and donee acceptance. A gift causa mortis is revocable at any time prior to Jaspal‘s death and is automatically revoked if Jaspal survives the illness that initiated the gift. Thus, for the gift to be absolute, Jaspal would have had to die from the illness contemplated—the heart attack. Because Jaspal survived the heart attack, the gift to Friedrich was revoked, and the car passed back to Jaspal. It now belongs to Jaspal‘s estate, and Uncle Sam is correct in demanding its return. 59. Lost Property. Sara Simon misplaced her Galaxy cell phone in Manhattan, Kansas. Days later, Shawn Vargo contacted her, claiming to have bought the phone from someone else. He promised to mail it to Simon if she would wire $100 to him through a third party, Mark Lawrence. When Simon spoke to Lawrence about the wire transfer, she referred to the phone as hers and asked, ―Are you going to send my phone to me?‖ Simon paid, but she did not get the phone. Instead, Lawrence took it to a Best Buy store and traded it in for credit. Charged with the theft of lost property, Lawrence claimed that he did not know Simon was the owner of the phone. Was Simon‘s phone lost, mislaid, or abandoned? What is the finder‘s responsibility with respect to this type of property? Can Lawrence successfully argue that he did not know the phone was Simon‘s? Explain. [State of Kansas v. Lawrence, 347 P.3d 240 (Kan.App. 2015)] (See Mislaid, Lost, and Abandoned Property.)

519

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

Solution Simon‘s cell phone was lost. Property that is involuntarily left is lost property. Property that has voluntarily been placed somewhere by the owner and then inadvertently forgotten is mislaid property. Property that has been discarded by the true owner, who has no intention of reclaiming title to it, is abandoned property. The finder‘s responsibility with respect to lost property is to return it. A finder of the property can claim title to the property against the whole world, except the true owner. If the owner demands its return, the finder must return it. Lawrence cannot successfully argue that he did not know the phone was Simon‘s. When a finder of lost property knows the true owner and fails to return the property to that person, the finder has committed the tort of conversion—the wrongful taking of another‘s property—and the crime of theft. In this problem, Simon misplaced her phone. Shawn Vargo contacted her, claiming to have it, and promising to send it to her if she would wire $100 to him through Mark Lawrence. She spoke to Lawrence about the wire, referring to the phone as hers and indicating the she wanted it to be returned. Instead of returning it, however, Lawrence traded it for credit at a Best Buy store. Based on these facts, Simon‘s phone was lost property—involuntarily left, not voluntarily placed and forgotten or discarded with no intent to reclaim it. Lawrence could not successfully contend that he did not know the phone was Simon‘s because she told him it was hers and he was working with Vargo, who clearly knew who the owner of the phone was. In the actual case on which this problem is based, Lawrence was convicted in a Kansas state court of theft of lost property. A state intermediate appellate court affirmed. ―A rational factfinder could find beyond a reasonable doubt that Lawrence possessed actual knowledge that [Vargo] was not the owner.‖ 60. Bailments. Christie‘s Fine Art Storage Services, Inc. (CFASS), is in the business of storing fine works of art at its warehouse in Brooklyn, New York. The warehouse is next to the East River in a flood zone. Boyd Sullivan owns works of art by Alberto Vargas, including Beauty and the Beast and Miss Universe. Sullivan contracted to store the works at CFASS‘s facility under an agreement that limited the warehouser‘s liability for damage to the goods to $200,000. A few months later, as Hurricane Sandy approached, CFASS was warned, along with the other businesses in the flood zone, of the potential for damage from the storm. CFASS e-mailed its clients that extra precautions were being taken. Despite this assurance, Sullivan‘s works were left exposed on a ground floor and sustained severe damage in the storm. Who is most likely to suffer the loss? Why? [Sullivan v. Christie’s Fine Art Storage Services, Inc., 2016 WL 427615 (Sup. N.Y. County 2016)] (See Bailments.) Solution Most likely, under the facts in the problem, CFASS is fully liable for the damage to Sullivan‘s artworks. The warehouser appears to have been negligent in failing to protect the property from damage by the storm, and the limitation-to-liability clause in the parties‘ agreement is not likely to apply. A bailment is created when a party delivers personal property into the possession of another who is to be responsible for the care and custody of the property. If bailed property is returned damaged, a court will presume that the bailee was negligent. The bailee can rebut this

520

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

presumption by showing the exercise of due care. For example, the bailee‘s obligation will be excused if the property was destroyed through no fault of the bailee. In an ordinary bailment, a bailee has the right to limit liability for damage to the property. But a limit for a party‘s own wrongful acts, such as an exculpatory clause may provide, is often held to be illegal. In this problem, Sullivan delivered his artworks to CFASS for storage. Based on the terms of their agreement, it is clear that a bailor-bailee relationship arose between them. As a bailee, CFASS was required to exercise reasonable care to prevent damage to Sullivan‘s property. With the approach of the hurricane, the warehouser was warned, along with the other businesses in the flood zone next to the East River, of the potential for damage from the storm. CFASS told its clients that it would take extra precautions with their property. But with Sullivan‘s artworks, it appears this was not done—the items were left exposed on a ground floor and sustained significant damage from the storm. Thus, the severity of the weather was foreseeable, and despite its assurance to the contrary, CFASS could not point to any apparent act it took to show it exercised ordinary care with Sullivan‘s goods. The limitation-to-liability clause in the bailment agreement is not likely to apply. The proximate cause of the damage was the warehouser‘s negligence. If the limit to liability were applied, it would thus operate as a potentially illegal exculpatory clause. In the actual case on which this problem is based, Sullivan filed a suit in a New York state court against CFASS, alleging breach of the storage agreement and negligence, and seeking more than $11 million in damages. The defendant filed a motion to dismiss, which the court denied. Sullivan‘s complaint sufficiently stated a cause of action for negligence. 61. Duties of the Bailee. James Heal owned a vehicle salvage yard in Homestead, Iowa. Brian Anderson contracted with Heal to run the business. Anderson cleaned up the property, removed trash, installed heat and fixed the plumbing in the buildings, and brought in tools and equipment. He used his own resources to rebuild the aging inventory. Anderson reinvested all of the profits in the business. When Anderson sold a 2004 Ford F-150 that he had bought with his own money for his own use, however, Heal pocketed the proceeds and locked Anderson out of the business. Heal filed a suit in an Iowa state court against Anderson, alleging breach of contract, and obtained an injunction to keep him off the property. Do these circumstances create a bailment? What is the appropriate standard of care if there is a bailment? Discuss. [Heal v. Anderson, 900 N.W.2d 617 (Iowa App. 2017)] (See Bailments.) Solution Yes. These circumstances create a bailment. A bailment has three elements—a bailor‘s personal property, in the possession of a bailee, and an agreement or obligation for its return or disposal. In this problem, James Heal owned the land on which was situated a vehicle salvage yard. Brian Anderson contracted to run the business. Anderson brought in tools and equipment and used his own resources to rebuild the inventory. When he sold a truck that he had bought with his own money for his own use, Heal kept the proceeds and locked Anderson out of the business. Heal then obtained an injunction to keep Anderson off the property. Pursuant to the injunction, Heal became a bailee of Anderson‘s property. A bailee is responsible for taking reasonable care of the bailed property and, at the end of the bailment, returning it to the bailor or disposing of it in accord with the bailor‘s instructions. What constitutes reasonable care depends on the nature of the bailment. In a bailment for the sole

521

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

benefit of the bailor, the bailee needs to exercise only a slight degree of care and will be liable for damage to, or the loss of, the bailed property only if grossly negligent. Here, the bailment was arguably for Anderson‘s benefit. Heal had a duty to exercise reasonable care with respect to Anderson‘s tools, equipment, and inventory that remained on the property and an obligation to return it once the injunction was lifted. Heal would be liable for damage to, or the loss of, Anderson‘s property if Heal was grossly negligent. In the actual case on which this problem is based, the court found that Heal had converted Anderson‘s property and awarded Anderson its full value. A state intermediate appellate court reversed as to the undamaged items that could be returned and remanded the case. 62. The Nature of Personal Property. American Multi-Cinema, Inc. (AMC), owns movie theaters. To determine the amount of taxes it owed to Texas, AMC subtracted its cost of goods sold (COGS) from its total revenue. AMC included the cost of showing movies in its COGS. In other words, it treated showing movies as a ―good.‖ Texas, however, refused to allow AMC to claim this cost. AMC protested, arguing it was in the business of showing movies. Specifically, AMC sold its ―product‖— the right to watch films in its theaters—to moviegoers. The state countered that this right is intangible ―non-property,‖ arguing that an AMC customer exits a theater with memories but not a copy of the film. Thus, AMC‘s product is not considered a ―good‖ for the purpose of COGS. Does the right to watch a film in a movie theater constitute property? Discuss. [American Multi-Cinema, Inc. v. Hegar, 2017 WL 74416 (Tex.App.— Austin 2017)] (See Personal Property versus Real Property.) Solution Yes. The right to watch a movie in a theater is property. Property consists of the legally protected rights and interests a person has in anything with an ascertainable value that is subject to ownership. Personal property can be tangible or intangible. Tangible personal property, such as a flat-screen TV or a car, has physical substance. Intangible personal property represents some set of rights and interests but has no real physical existence. Stocks and bonds, patents, and copyrights are intangible personal property. In this problem, AMC calculated the amount of taxes that it owed the state of Texas by subtracting the cost of goods sold (COGS) from revenue. AMC included the cost of showing movies in its COGS. Texas disallowed the inclusion of this cost as COGS. AMC protested, arguing that it sold to moviegoers a ―product‖—the right to watch films in theaters. The state classified this right as intangible ―non-property.‖ The purchase of a movie ticket to experience the content of a film is a purchase of a license—the right to watch the film in the theater to which the ticket entitles its holder to admission. A license is intangible personal property. In the actual case on which this problem is based, AMC filed a suit in a Texas state court against the state, challenging the assessment of taxes that did not allow the inclusion of the cost of showing movies as COGS. The court ruled in AMC‘s favor. A state intermediate appellate court affirmed, holding that AMC‘s product fell within the definition of ―property‖ in the applicable state tax statute. 63. Business Case Problem with Sample Answer—Duties of the Bailee. KZY Logistics, LLC, transported a load of Mrs. Ressler‘s Food Products from New Jersey to California. When KZY‘s driver delivered the cargo, the customer rejected it—its temperature was higher than expected,

522

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

making it unsafe. Mrs. Ressler‘s filed a suit against KZY in a federal district court. KZY contended that the temperature in its refrigerated trailer was proper and that Mrs. Ressler‘s had delivered a ―hot‖ product for transport. KZY supplemented its allegations with temperature readings from the unit during the time in question. In transporting the cargo, what level of care did KZY owe Mrs. Ressler‘s? Did KZY meet this standard? Explain. [Mrs. Ressler’s Food Products v. KZY Logistics, LLC, 675 Fed.Appx. 136 (3d Cir. 2017)] (See Bailments.) —For a sample answer to Problem 41–7, go to Appendix E. Solution KZY owed Mrs. Ressler‘s a duty to exercise reasonable care. From an ethical perspective, KZY appears to have met this standard. A bailee must exercise reasonable care in preserving bailed property. What constitutes reasonable care depends on the nature and circumstances of the bailment. A bailment for the mutual benefit of the bailee and the bailor involves compensation. The bailee must exercise ordinary care—the care that a reasonably careful person would use under the circumstances. A bailee who fails to exercise reasonable care will be liable for ordinary negligence. If bailed property is returned damaged, a bailee will be presumed to have been negligent. The bailee is excused, however, if the property was damaged through no fault of the bailee. In this problem, transported a load of Mrs. Ressler‘s Food Products. When KZY delivered the cargo, the customer rejected it because its temperature was higher than expected, making it unsafe. In Mrs. Ressler‘s suit against KZY, the defendant asserted that the temperature in its trailer was proper and that Mrs. Ressler‘s delivered a ―hot‖ product for transport. KZY provided temperature readings from the refrigerated unit during the time in question. This would be a complete defense to a claim that the bailee was negligent in failing to maintain a proper temperature during the transport. KZY‘s ethical duty was the same as the bailee‘s legal duty of care. In handling Mrs. Ressler‘s cargo, KZY was ethically bound to exercise the care that a reasonably careful person would use under the circumstances. If the temperature readings from the refrigerated unit would absolve the bailee from liability for negligence, the proof would also refute any charge that KZY had acted unethically. In the actual case on which this problem is based, KZY failed to file a timely response to Mrs. Ressler‘s suit, and the court entered a default judgment against the defendant. The U.S. Court of Appeals for the Third Circuit reversed the lower court‘s decision. ―KZY alleged a prima facie meritorious defense to the action‖ and ―there was no direct evidence that KZY acted in bad faith.‖ 64. Bailor’s Duty to Reveal Defects. Anastasio Guerra agreed to loan his pick-up truck to Gina Mandujano so that she could go grocery shopping in exchange for her making him lunch. When Mandujano drove out of the store‘s parking lot, the truck‘s power steering failed. Her wrist was caught in the spokes of the steering wheel, and she was severely injured. Guerra knew that there was a problem with his truck‘s steering, but he thought he had fixed the problem by replenishing the steering fluid. He did not believe that the issue was dangerous and had not told Mandujano. What type of bailment existed between Guerra and Mandujano? What standard of care did the bailor owe the bailee? Was the duty breached? Who is liable for the cost of Mandujano‘s injury? Explain. [Mandujano v. Guerra, 2018 WL 1611458 (Md. 2018)] (See Bailments.)

523

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

Solution The bailment of the truck between Guerra and Mandujano was a bailment for the mutual benefit of the parties. As the bailor, Guerra owed a duty to exercise reasonable care in advising Mandujano of the truck‘s defects. He breached this duty and is therefore liable in negligence for the cost of her injury resulting from the breach. In this problem, Guerra agreed to loan his truck to Mandujano for her shopping in exchange for his lunch. While Mandujano was driving the truck, its power steering failed, causing her to be injured. Guerra knew that there was a problem with the steering, but he had not told Mandujano. There are three types of ordinary bailments, distinguished by who receives a benefit from the bailment. This distinction determines the rights and liabilities of the parties, and the standard of care required of each. Guerra might argue that the bailment of his truck to Mandujano was an arrangement for the sole benefit of the bailee. There was no promise to pay cash or even to buy gas to borrow the truck to go shopping. But Mandujano said that she would make Guerra lunch in exchange for the use of his truck. This categorizes the trade as a bailment for the mutual benefit of both parties. In a mutual-benefit bailment, the bailee owes a duty to exercise a reasonable degree of care towards the bailed property. If the property is returned damaged, the bailee‘s failure to have exercised appropriate care can result in tort liability. This obligation is excused if the property is damaged through no fault of the bailee—i.e., if the bailee shows that she exercised due care. In this problem, assuming that the truck was returned damaged, Guerra might contend that Mandujano failed to drive it with appropriate care and that consequently her injury was her fault. By showing that the truck was damaged as a consequence of the defective steering, Mandujano could refute this contention. A bailor has the duty to provide property that is free of known defects that could cause injury to the bailee. In a mutual-benefit bailment, the bailor must reveal all of the property‘s known defects, which include defects the bailor could have discovered with reasonable diligence. A bailor who fails to give this notice can be liable in negligence to the bailee for resulting injuries. Here, Guerra did not tell Mandujano about the truck‘s defective power steering. Thus, he is likely liable in negligence for her resulting injuries. In the actual case on which this problem is based, Mandujano filed a suit in a Michigan state court against Guerra to recover for her injury. The court denied Guerra‘s motion for summary judgment. A state intermediate appellate court affirmed the denial because ―there is a triable issue regarding whether defendant fulfilled his duty to warn plaintiff of any known defects.‖ 65. A Question of Ethics—The IDDR Approach and Abandoned Property. Mansoor Akhtar lived rent-free in the basement of Anila Dairkee‘s duplex in Minneapolis, Minnesota, for more than a year. When Dairkee asked Akhtar to move out, he refused. She changed the locks and advised him to remove his property from the duplex. But he did not. About a year later, while Dairkee was staying in New York, her father had the basement cleaned out. When Dairkee returned four months later, she learned that her father had disposed of Akhtar‘s property. Akhtar filed a suit in a Minnesota state court against Dairkee, alleging that she had wrongfully disposed of his property.

524

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

[Akhtar v Dairkee, 2017 WL 1210140 (Minn.App. 2017)] (See Mislaid, Lost, and Abandoned Property.) 66. Dairkee contended that Akhtar had abandoned his property. Is she correct? Explain. Solution Yes. Anila Dairkee is correct that Mansoor Akhtar had abandoned his property. Property that has been discarded by its true owner, who has no intention of reclaiming title to it, is abandoned property. Someone who finds abandoned property acquires title to it, and this title is good against the whole world, including the original owner. An owner of property who shows no attempt to claim it can be held to have abandoned it. In this problem, Akhtar lived in the basement of Dairkee‘s duplex. She asked him to move out, but he refused. She changed the locks on the duplex and told him to remove his property. He did not. About a year later, while she was gone, her father had the basement cleaned without her knowledge or consent. Months later, Akhtar filed a suit against Dairkee, alleging that she had wrongfully disposed of his property. She responded that he had abandoned it. Here, Dairkee notified Akhtar to remove his property before she exercised rights of ownership over it. He did not reclaim it within a reasonable time. The property could justifiably be considered abandoned. Dairkee‘s father disposed of it, arguably on her behalf and in her best interest. Akhtar does not have a supportable claim against her. In the actual case on which this problem is based, the court concluded that Akhtar had abandoned his property and therefore was not entitled to damages. A state intermediate appellate court affirmed this judgment. 67. Using the Review step of the IDDR approach, consider whether Dairkee‘s handling of Akhtar‘s property was ethical. Solution Anila Dairkee acted ethically with respect to Mansoor Akhtar‘s property. Property that has been discarded by its true owner, who has no intention of reclaiming title to it, is abandoned property. Someone who finds abandoned property acquires title to it, and this title is good against the whole world, including the original owner. The IDDR approach begins with an Inquiry to identify the ethical dilemma, the stakeholders, and the relevant standards in a set of facts. Dairkee‘s dilemma was what to do with Akhtar‘s property. He lived in her duplex until she asked him to move out. He refused. She changed the locks and asked him to remove his property. He did not—in fact, for about a year, he also made no claim to it. The stakeholders included Dairkee, Akhtar, and potential tenants or buyers of Dairkee‘s duplex. The relevant standard might be identified as a duty to take reasonable care of the property. In the IDDR approach, the Inquiry is followed with a Discussion of actions to address the issue, the actions‘ strengths and weaknesses, and their consequences and effects. Dairkee might have left the property locked in her duplex indefinitely. She might have removed it immediately. Or she might have disposed of it after a reasonable time that would have evidenced Akhtar‘s abandonment of it. The first action would have inconvenienced all of the stakeholders, except perhaps Akhtar who, however, appeared to have abandoned his

525

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 41: Personal Property and Bailments

property. To be rid of the property immediately would have ignored the possibility that Akhtar might yet soon retrieve it. This would have been in complete derogation of any standard of care. Disposing of the property after a reasonable time would give due consideration to the interests of all of the stakeholders. The IDDR step after the Discussion is a Decision on the actions and a statement of its reasons. About a year after Akhtar was locked out of the duplex, Dairkee‘s father removed Akhtar‘s property. By that time, Akhtar could reasonably be thought to have abandoned the property. Dairkee‘s father acted without her knowledge or consent, but likely on her behalf and in her interest. The final step of the IDDR approach is a Review of the success or failure of the actions to resolve the issue and satisfy the stakeholders. Because Dairkee notified Akhtar to remove his property and kept it available for his retrieval for about a year, her conduct with respect to the property was unquestionably ethical. Once the property was removed, she regained full use of her duplex, which could also be enjoyed by any other stakeholders.

526

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Critical Thinking and Writing Assignments 68. Time-Limited Group Assignment—Bailments. On learning that Sébastien planned to travel abroad, Roslyn asked him to deliver $25,000 in cash to her family in Mexico. During a customs inspection at the border, Sébastien told the customs inspector that he carried less than $10,000. The officer discovered the actual amount of cash that Sébastien was carrying, seized it, and arrested Sébastien. Roslyn asked the government to return what she claimed were her funds, arguing that the arrangement with Sébastien was a bailment and that she still held title to the cash. (See Bailments.) 69. The first group will argue that Roslyn is entitled to the cash. Solution Roslyn is entitled to the return of the cash. There was a bailment between her and Sébastien. A bailment is formed by the delivery of personal property without the transfer of title by one person, the bailor, to another, the bailee, usually under an agreement for a particular purpose. On the completion of the purpose, the bailee is obligated to deliver the property to the bailor or a third person, or to otherwise dispose of it. Here, Roslyn delivered the cash to Sébastien for the purpose of further delivering it to her family in Mexico. She did not transfer title to the money to Sébastien. Thus, she had the right to assert her title to it against any person, including the government. 70. The second group will take the position of the government and develop an argument that Roslyn‘s agreement with Sébastien does not qualify as a bailment. Solution The government‘s best argument that the arrangement between Roslyn and Sébastien was not a bailment is that whoever possesses cash has title to it. On that ground, Roslyn transferred title to the cash when she gave it to Sébastien. There was thus no bailment, and Sébastien had title to the cash when the customs inspector found it. 71. The third group will assume that a bailment was created, identify what type of bailment it was, and explain the degree of care required of the bailee. Solution Assuming that the arrangement in this problem created a bailment between Roslyn and Sebastien for the cash ($25,000), the bailment was for the sole benefit of the bailor (Roslyn). In this type of bailment, the bailee must exercise only a slight degree of reasonable care in preserving the bailed property. Determining whether the bailee met this standard is a question of fact. The bailee‘s failure to meet this standard, and a consequent loss of or damage to the property, can result in tort liability.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Table of Contents Critical Thinking Questions in Cases ................................................................................................................... 528

527

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Case 42.1 ............................................................................................................................................... 528 Case 42.2 ............................................................................................................................................... 528 Case 42.3 ............................................................................................................................................... 529 Chapter Review ........................................................................................................................................................... 530 Practice and Review .............................................................................................................................. 530 Practice and Review: Debate This ......................................................................................................... 531 Issue Spotters ........................................................................................................................................ 532 Business Scenarios and Case Problems ................................................................................................. 532 Critical Thinking and Writing Assignments ............................................................................................ 540

Critical Thinking Questions in Cases Case 42.1 72. Suppose that Sydney Solberg had disposed of his entire estate in fee simple before his death. Would the result have been different? Discuss. Solution Yes. If Sydney had disposed of his entire estate in fee simple before his death, the result would have been different. Fee simple is the most complete form of ownership. To dispose of an estate in fee simple is to transfer a complete interest in the property. If Sydney had affected such a transfer of all of his property before his death, there would have been no interest in any of the property to pass to Lillian or their children. There would have been no property for Lillian to possess for life, no remainder interest for Glenn and his siblings to inherit, and no property to which Glenn could assert even the thinnest of claims. Of course, Lillian could not make such a transfer of the property in her life estate. No owner of property can transfer a greater right in or to the property than the owner holds. In the circumstance of a life estate, the transfer of an interest in the property of the estate that would exceed the life measuring its duration would be in disregard of the rights of the owner or owners of the remainder in the property. As a violation of those rights, the transfer would be invalid.

Case 42.2 73. Assuming that Ackley‘s behavior was unethical, was it unethical because she failed to tell Stambovsky something about the house that he did not know, or was it unethical because of the nature of the information that she omitted? What if Ackley had failed to mention that the roof leaked or that the well was dry—conditions that a buyer would normally investigate? Explain your answer. Solution Yes. Using a values-based ethical approach, it would be wrong for Ackley to withhold information that she knew—or should have known—would potentially impact Stambovsky‘s decision to purchase the house. Ethically, a party should disclose all material facts to the other party in

528

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

negotiating contracts. [This answer could go either way depending on the ethical models and theories discussed in class.].

Case 42.3 74. Would an adverse possessor satisfy the element of ―exclusive‖ on showing only that disputed property was not jointly possessed with the previous owner? Explain. Solution Yes, the element of ―exclusive‖ is satisfied, for the purposes of a claim of adverse possession, on showing only that the disputed property was not jointly possessed with the previous owner. It is not necessary to show more. In this case, for example, to prove that its possession of the disputed tract along the stonewall was ―exclusive,‖ A2 was required to show that it, and its predecessors, possessed the land for themselves, and not for others, and that they wholly excluded the true owner, Anderson, from possession of the property. The sporadic use, temporary presence, or visit to the property by others, including Anderson, is not enough to defeat such a claim. A2 had only to show that the disputed land was not jointly possessed with Anderson. And, according to the appellate court, A2 succeeded. ―Maintenance of a residential yard such that it appears to be part of the property on which the residence is situated is evidence from which a trier of fact can infer that the possession of the property was exclusive.‖ 75. Suppose that for a year during the Wordens‘ ownership of the Inn, they closed it for remodeling. Would the result in this case have been different? Discuss. Solution No. If, for a year during the Wordens‘ ownership of the Inn, they had closed it for remodeling, the result in this case would not have been different. To satisfy a claim of adverse possession, continuous possession of the disputed property does not require its continuous occupation and use. Even temporary absences, without an intent to abandon the property, will not break continuity. The Wordens owned the Inn for eleven years. During that time, both they and Anderson, the neighboring owner, believed that a stonewall that ran the length of their properties marked the boundary. Only after Anderson commissioned a survey of her property did she dispute the Wordens‘ possession of a tract on their side of the wall. Within that disputed tract, a driveway and walkway had been used to access the service entrance to the Inn to deliver supplies and equipment. The Wordens had maintained the landscaping in the space. They had cut the grass, planted flowers, put down a weed mat, mulched, laid paver and edging stones, and removed dying trees. When they had asked Anderson to remove overgrowth coming over the fence, she had told them ―it was on their side and therefore their responsibility.‖ In this case, the appellate court concluded, these activities evidenced ―occupancy, upkeep, and no intent to abandon the disputed property.‖ A temporary closure of the Inn for any reason would not have changed this result.

529

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Chapter Review Practice and Review Vern Shoepke bought a two-story home in Roche, Maine. The warranty deed did not specify what covenants would be included in the conveyance. The property was adjacent to a public park that included a popular Frisbee golf course. (Frisbee golf is a sport similar to golf but using Frisbees.) Wayakichi Creek ran along the north end of the park and along Shoepke‘s property. The deed allowed Roche citizens the right to walk across a five-foot-wide section of the lot beside Wayakichi Creek as part of a two-mile public trail system. Teenagers regularly threw Frisbee golf discs from the walking path behind Shoepke‘s property over his yard to the adjacent park. Shoepke habitually shouted and cursed at the teenagers, demanding that they not throw the discs over his yard. Two months after moving into his Roche home, Shoepke leased the second floor to Lauren Slater for nine months. The lease agreement did not specify that Shoepke‘s consent would be required to sublease the second floor. After three months of tenancy, Slater sublet the second floor to a local artist, Javier Indalecio. Over the remaining six months, Indalecio‘s use of oil paints damaged the carpeting in Shoepke‘s home. Using the information presented in the chapter, answer the following questions. 76. What is the term for the right of Roche citizens to walk across Shoepke‘s land on the trail? Solution Here, the right conveyed by the deed is nonpossessory and gives citizens a limited right to travel on a trail over Shoepke‘s land. Therefore, it is an easement. 77. What covenants would most courts infer were included in the warranty deed that Shoepke received when he bought his house? Solution A warranty deed conveys the most covenants, or promises of any other deed. The seller promises title to the property, the power to convey it, that there are no encumbrances against the property, and that the buyer‘s possession will not be disturbed (i.e., quiet enjoyment).

78. Can Shoepke hold Slater financially responsible for the damage to the carpeting caused by Indalecio? Explain. Solution When Slater sublet the apartment, she remained liable under the lease agreement. If a subtenant fails to pay the rent or causes damage to the premises, the landlord can still hold the original tenant financially responsible for the rent payments or cost of repairing the damage. Hence, Slater can be held liable for the damage Indalecio caused (beyond ordinary wear and tear). 79. Could the fact that teenagers continually throw Frisbees over Shoepke‘s yard outside the secondfloor windows arguably be a breach of the covenant of quiet enjoyment? Why or why not? Solution Under the covenant of quiet enjoyment, the landlord promises that neither the landlord nor anyone having a superior title to the property will disturb the tenant‘s use and enjoyment of the property. If the covenant is breached, the tenant can terminate the lease and sue for damages. In

530

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

this problem, by habitually demanding that teenagers stop throwing Frisbees over the leased property, the landlord assumed a duty to stop them and, because they did not stop, the duty has not been fulfilled. This failure might arguably constitute a breach of the covenant of quiet enjoyment. But a breach of this covenant normally consists of a more serious transgression—not the flight of a Frisbee, which is brief and temporary, but a leaning building, a failure to provide an essential utility, or something else of a similarly long-lasting nature and more damaging or injurious encroachment.

Practice and Review: Debate This 80. Under no circumstances should a local government be able to condemn property in order to sell it later to real estate developers for private use. Solution The Constitution‘s Fifth Amendment is clear about giving the power of condemnation to government. Such power can only be used to take private property for public use (and with appropriate compensation, of course). When a local government uses this taking power to condemn property that it later sells to private developers for a shopping mall development or nicer houses and apartments, that government is acting in violation of our Constitution. Sometimes, local governments face tough economic times and must do what they can to raise more taxes. If a blighted area is never going to ―upgrade‖ itself, then local governments should be able to step in and speed up the process by a taking, as provided for in the Fifth Amendment to the U.S. Constitution. The public good will be served in two ways: the blighted area will be transformed for the better and the local government will obtain more taxes revenues from the businesses located in this area.

531

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Issue Spotters 81. Bernie sells his house to Consuela under a warranty deed. Later, Delmira appears, holding a better title to the house than Consuela has. Delmira wants Consuela off the property. What can Consuela do? Solution This is a breach of the warranty deed‘s covenant of quiet enjoyment. Consuela can sue Bernie and recover the purchase price of the house, plus any damages. 82. Grey owns a commercial building in fee simple. Grey transfers temporary possession of the building to Haven Corporation. Can Haven transfer possession for even less time to Idyll Company? Explain. Solution Yes. Owners of fee simples have the most rights possible—they can give the property away, sell it, transfer it by will, use it for almost any purpose, possess it to the exclusion of all the world, or, as in this case, transfer possession for any period of time. The party to whom possession is transferred can also transfer this interest (usually only with the owner‘s permission) for any lesser period of time.

Business Scenarios and Case Problems 83. Property Ownership. Twenty-two years ago, Lorenz was a wanderer. At that time, he decided to settle down on an unoccupied, three-acre parcel of land that he did not own. People in the area told him that they had no idea who owned the property. Lorenz built a house on the land, got married, and raised three children while living there. He fenced in the land, installed a gate with a sign above it that read ―Lorenz‘s Homestead,‖ and removed trespassers. Lorenz is now confronted by Joe Reese, who has a deed in his name as owner of the property. Reese, claiming ownership of the land, orders Lorenz and his family off the property. Discuss who has the better ―title‖ to the property. (See Transfer of Ownership.) Solution As a general rule, the deed holder has the right to possess and use the property. This right allows the deed holder to evict others from the property as if they were trespassers. There is an exception to this rule when the person occupying the premises is able to claim title by adverse possession. Adverse possession gives the person in possession better title than the deed title holder, and thus the person in possession cannot be removed from the land by the original deed owner. In this case, Lorenz has met all of the four requirements for adverse possession: (1) he has occupied the property solely and exclusively and fenced it in; (2) he has openly claimed the property as his, as indicated by the sign above the gate; (3) he has occupied the land uninterruptedly for twenty-two years (most states require uninterrupted possession for ten years); and (4) his occupation was hostile and adverse—that is, he lived on the land without the owner‘s permission and exerted dominion over it (had trespassers removed). Lorenz thus has title to the land by adverse possession. Reese has lost his property and cannot evict Lorenz and his family.

532

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

84. Deeds. Wiley and Gemma are neighbors. Wiley‘s lot is extremely large, and his present and future use of it will not involve the entire area. Gemma wants to build a single-car garage and driveway along the present lot boundary. Because the placement of her existing structures makes it impossible for her to comply with an ordinance requiring buildings to be set back fifteen feet from an adjoining property line, Gemma cannot build the garage. Gemma contracts to purchase ten feet of Wiley‘s property along their boundary line for $3,000. Wiley is willing to sell but will give Gemma only a quitclaim deed, whereas Gemma wants a warranty deed. Discuss the differences between these deeds as they would affect the rights of the parties if the title to this ten feet of land later proves to be defective. (See Transfer of Ownership.) Solution Wiley understandably wants a general warranty deed, as this type of deed will give him the most extensive protection against any defects of title claimed against the property transferred. The general warranty deed would have Gemma warranting the following covenants: 1. That she has good title to, and the power to convey, the property. 2. A covenant of quiet enjoyment (a warranty that the buyer will not be disturbed in his possession of the land). 3. That transfer of the property is made without knowledge of adverse claims of third parties. Gemma, however, is conveying only ten feet along a property line that may not even be accurately surveyed. Therefore, she does not wish to make these warranties. Consequently, Gemma is offering a quitclaim deed, which does not convey any warranties but conveys only whatever interest, if any, the grantor owns. Although title is passed by the quitclaim deed, the quality of the title is not warranted. Because Wiley really needs the property, it appears that he has three choices: he can accept the quitclaim deed; he can increase his offer price to obtain the general warranty deed he wants; or he can offer to have a title search made, which should satisfy both parties. 85. Implied Warranty of Habitability. Sarah has rented a house from Frank. The house is only two years old, but the roof leaks every time it rains. The water that has accumulated in the attic has caused stucco to fall off ceilings in the upstairs bedrooms, and one ceiling has started to sag. Sarah has complained to Frank and asked him to have the roof repaired. Frank says that he has caulked the roof, but the roof still leaks. Frank claims that because Sarah has sole control of the leased premises, she has the duty to repair the roof. Sarah insists that repairing the roof is Frank‘s responsibility. Discuss fully who is responsible for repairing the roof and, if the responsibility belongs to Frank, what remedies are available to Sarah. (See Landlord-Tenant Relationships.) Solution At common law the landlord was under no duty to repair the leased premises or to warrant that the premises were habitable. The tenant took the property ―as is‖ and assumed the obligation to make repairs. Today, the common law has been replaced by the implied warranty of habitability. The implied warranty of habitability requires the landlord to furnish to the tenant premises that are in a habitable condition and to maintain them in that condition for the duration of the lease. A roof that seriously leaks when it rains causes the premises to be uninhabitable. In addition, once the landlord starts to make repairs, the repairs must be done properly. The failure to complete or perform repairs properly subjects the landlord to liability based on negligence. Thus, in absence of agreement, Frank has the responsibility to repair the roof and make the premises habitable. Sarah basically has four remedies available if Frank refuses to repair the roof: 1. Withhold rent and place the amount in escrow.

533

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

2. 3. 4.

Repair the roof and deduct the cost of repairs from the rent. Claim constructive eviction and terminate the lease without liability for rental payments. Sue the landlord for damages based on the cost of repair or the difference between the defective and repaired property‘s rental values. In addition, should Sarah be injured due to the dangerous condition to the premises, Frank would be liable for Sarah‘s injuries.

86. Rent. Flawlace, LLC, leased unfinished commercial real estate in Las Vegas, Nevada, from Francis Lin to operate a beauty salon. The lease required Flawlace to obtain a ―certificate of occupancy‖ from the city to commence business. This required the installation of a fire protection system. The lease did not allocate responsibility for the installation to either party. Lin voluntarily undertook to install the system. After a month of delays, Flawlace moved out. Three months later, the installation was complete, and Lin leased the premises to a new tenant. Did Flawlace owe rent for the three months between the time that it moved out and the time that the new tenant moved in? Explain. [Tri-Lin Holdings, LLC v. Flawlace, LLC, 2014 WL 1101577 (Nev. Sup.Ct. 2014)] (See Landlord-Tenant Relationships.) Solution Yes. Flawlace owes rent for the three months between the time that it moved out and the new tenant moved in. A lease typically indicates the amount of the rent and the length of the term. Normally, tenants must pay rent even if they refuse to occupy the property or move out, as long as the refusal is unjustified and the lease is in force. In this problem, Flawlace leased unfinished commercial property from Francis Lin to operate a beauty salon. The lease required Flawlace to obtain a ―certificate of occupancy‖ from the city to commence business. This required the installation of a fire protection system. The lease did not state whether the landlord or the tenant was to install the system. Lin voluntarily undertook to do so. After a month, Flawlace abandoned the premises. Three months later, the installation was finished, and Lin leased the premises to a new tenant. Nothing in these facts indicates that Flawlace‘s moving out was justified—as the tenant, Flawlace remained liable for the rent. In the actual case on which this problem is based, Flawlace filed a suit against Lin in a Nevada state court to rescind the lease and Lin counterclaimed to recover the unpaid rent. The court ruled in Lin‘s favor on the counterclaim. On appeal, the Nevada Supreme Court affirmed the lower court‘s ruling on this point. 87. Landlord-Tenant Relationships. Bhanmattie Kumar was walking on a sidewalk in Flushing, New York, when she tripped over a chipped portion of the sidewalk and fell. The defective sidewalk was in front of a Pretty Girl store—one of a chain of apparel stores headquartered in Brooklyn— on premises leased from PI Associates, LLC. Kumar filed a claim in a New York state court against PI, seeking to recover damages for her injuries. PI filed a cross-claim against Pretty Girl. On what basis would the court impose liability on PI? In what situation would Pretty Girl be the liable party? Is there any circumstance in which Kumar could be at least partially responsible for her injury? Discuss. [Bhanmattie Rajkumar Kumar v. PI Associates, LLC, 125 A.D.3d 609, 3 N.Y.S.3d 372 (2 Dept. 2015)] (See Landlord- Tenant Relationships.) Solution The court could impose liability on PI based on its ownership of the premises on which the injury occurred. Depending on the provisions of the lease, Pretty Girl could be the liable party. Kumar might be at least partially responsible for her injury if it was a result of her own negligence.

534

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Landlords must comply with any applicable state statutes and city ordinances regarding maintenance and repair of buildings. Generally, a landlord is required to maintain the premises in good repair. Tenants are responsible for any damage to the premises that they cause, intentionally or negligently. Unless the parties have agreed otherwise, however, the tenant is not responsible for ordinary wear and tear. State statutes often allow tenants and landlords flexibility negotiating the terms of a commercial lease. The liability of either a landlord or a tenant for injury to a third person by the condition of the premises may be reduced by the third party‘s own comparative negligence. In this problem, Pretty Girl leased certain premises from PI to operate an apparel store. Kumar tripped over a defective portion of the sidewalk in front of the store, suffering an injury, and sought to recover from PI. The landlord filed a cross-claim against its tenant. Depending on the terms of the lease, and the parties‘ negligence, if any, liability could be imposed on the tenant, the landlord, or both, and could be reduced proportionately by the third party‘s actions. In the actual case on which this problem is based, the lease between PI and Pretty Girl provided that the ―Tenant, shall, at Tenant's own expense, make all repairs and replacements to the sidewalks and curbs adjacent thereto.‖ The lease also provided that Pretty Girl would indemnify PI for all claims incurred as a result of the tenant‘s breach of the lease. Despite these provisions, the court issued a judgment against PI on all claims. A state intermediate appellate court reversed, however, and remanded for a new determination of liability, taking into consideration Kumar‘s negligence, if any. 88. Business Case Problem with Sample Answer— Joint Tenancies. Arthur and Diana Ebanks

owned three properties in the Cayman Islands in joint tenancy. With respect to joint tenancies, Cayman law is the same as U.S. law. When the Ebanks divorced, the decree did not change the tenancy in which the properties were held. On the same day as the divorce filing, Arthur executed a will providing that ―any property in my name and that of another as joint tenants … will pass to the survivor, and I instruct my Personal Representative to make no claim thereto.‖ Four years later, Arthur died. His brother Curtis, the personal representative of his estate, asserted that Arthur‘s interest in the Cayman properties was part of the estate. Diana said that the sole interest in the properties was hers. To whom do the Cayman properties belong? Why? [Ebanks v. Ebanks, 41 Fla. L. Weekly D291, 198 So.3d 716 (2 Dist. 2016)] (See Ownership Interests and Leases.) —For a sample answer to Problem 42–6, go to Appendix E. Solution Under the law of the Cayman Islands, and according to Arthur‘s will, the three disputed Cayman properties became Diana‘s sole property when Arthur died. In a joint tenancy, each of two or more persons owns an undivided interest in the property. A deceased joint tenant‘s interest passes to the surviving joint tenant or tenants. The right of a surviving joint tenant to inherit a deceased joint tenant‘s ownership interest is referred to as a right of survivorship. In this problem, Arthur and Diana owned three properties in the Cayman Islands in a joint tenancy. (For this purpose, Cayman law is the same as U.S. law.) When the couple divorced, the decree did not change the tenancy. Later, Arthur died. His will provided that any property he held in joint tenancy ―will pass to the survivor, and I instruct my Personal Representative to make no claim thereto.‖ Despite this provision, his brother Curtis, personal representative of his estate, asserted that Arthur‘s interest in the properties were part of the estate. Diana said that the

535

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

properties were entirely hers. Clearly, Diana is correct. Under the applicable principles of ownership of property by joint tenancy, as the sole surviving joint tenant, Arthur‘s interest in the properties passed to her. And under the terms of Arthur‘s will, his interest passed to her (and Curtis was ―to make no claim thereto.‖) A joint tenant can transfer any personal rights to the property without the consent of the other joint tenants. The new owner becomes a tenant in common, however, not a joint tenant. Or a joint tenant‘s interest can be levied against to satisfy the tenant‘s judgment creditors. In either case, the joint tenancy terminates, and the remaining owners hold the property as tenants in common. Neither of these situations occurred in the facts of this problem, however. In the actual case on which this problem is based, Curtis asked the Florida state court that issued the couple‘s divorce to declare that Arthur‘s interest in the Cayman properties were part of his estate. The court ruled in the estate‘s favor and ordered Diana to sell the properties or buy Arthur‘s interest in them. A state intermediate appellate court reversed the order. 89. Eminent Domain. In Tarrytown, New York, Citibank operated a branch that included a building and a parking lot with thirty-six spaces. Tarrytown leased twenty-one of the spaces from Citibank for use as public parking. When Citibank closed the branch and decided to sell the building, the public was denied access to the parking lot. After a public hearing, the city concluded that it should exercise its power of eminent domain to acquire the twenty-one spaces to provide public parking. Is this an appropriate use of the power of eminent domain? Suppose that Citibank opposes the plan and alternative sites are available. Should Tarrytown be required to acquire those sites instead of Citibank‘s property? In any event, what is Tarrytown‘s next step? Explain. [Citibank, N.A. v. Village of Tarrytown, 149 A.D.3d 931, 52 N.Y.S.3d 398 (2 Dept. 2017)] (See Transfer of Ownership.) Solution Yes. It is an appropriate use of the power of eminent domain for Tarrytown to acquire property to provide public parking. If the property owner objects, and alternate sites are available, Tarrytown is not required to acquire those sites instead. Tarrytown‘s next step is to bring a proceeding to obtain title to the property. In a second proceeding, a court will determine the fair value of the land. The government can exercise its right of eminent domain to take land. After the government determines that a particular parcel of land is necessary for public use—property may be taken only for public use—a judicial proceeding is brought to obtain title to the land. In another proceeding, the court determines the land‘s fair value (generally equal to its market value). Here, Citibank owned land that included a building and a parking lot with thirty-six parking spaces. Tarrytown leased twenty-one of the spaces for use as public parking. When Citibank decided to sell the building, the public was denied access to the parking lot. After a public hearing, Tarrytown concluded that it should exercise its power of eminent domain to acquire the twenty-one spaces to provide public parking. The determination to take, or condemn, a portion of Citibank‘s property is rationally related to the stated public purpose. That other sites may be available is not basis to stop the taking—the government has broad discretion to decide which land fulfills its purpose. In the actual case on which this problem is based, Citibank filed a suit in a New York state court

536

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

against Tarrytown, seeking a review of the determination to take Citibank‘s property. The court confirmed the determination. 90. Transfer of Ownership. Craig and Sue Shaffer divided their real property into two lots. They enclosed one lot with a fence and sold it to the Murdocks. The other lot was sold to the Cromwells. All of the parties orally agreed that the fence marked the property line. Over the next three decades, each lot was sold three more times. Houses were built, and the lots were landscaped, including lilac bushes planted against the fence. Later, one of the owners removed the fence, and another built a shed next to where it had been. On the lot with the shed, the Talbots erected a carport abutting the lilac bushes. The Nielsons bought the adjacent lot from the Parkers and measured it according to the legal description in the deed. They discovered that the Talbots‘ carport encroached on the Nielsons‘ property by about thirteen feet. Are the Nielsons entitled to damages for their ―lost‖ property from any party? Explain. [Nielson v. Talbot, 163 Idaho 480, 415 P.3d 348 (2018)] (See Transfer of Ownership.) Solution The Nielsons might be entitled to damages from the Parkers. A sale of real estate involves a transfer of ownership, often with specific warranties. Possession and title to land are passed from person to person by means of a deed. A deed must include a legally sufficient description of the land. Different types of deeds provide different levels of protection against defects of title, such as occurs when a third person has an interest in the property. In this problem, the Shaffers divided their property into two lots, enclosed one with a fence, and sold both. The Shaffers and their buyers orally agreed that the fence marked the property line. Over the next three decades, through successive owners, houses were built on the lots, and landscaping was added, including lilac bushes planted against the fence. One owner removed the fence. Another built a shed next to where it had been. On the lot with the shed, the Talbots erected a carport abutting the lilac bushes. The Nielsons bought the lot with the bushes from the Parkers and measured it, following the legal description in the deed. This revealed that the Talbots‘ carport encroached on the Nielsons‘ property by about thirteen feet. The Shaffers and their buyers intended the fence—which was later replaced by the lilac bushes, and still later by the shed and carport—to be the boundary line of the lots. All of the ensuing owners maintained this line. Under these circumstances, it would have been unreasonable for a buyer to assume the purchase of part of a shed or a carport on a neighbor‘s lot. In other words, the original oral agreement about the property line came to be evidenced by landmarks on the ground, and the landmarks provided the subsequent buyers with notice of the location of the line. Thus, the Nielsons would not be entitled to damages from the Talbots for the encroachment of the carport onto the Nielsons‘ lot. Of course, as part of each sale, a legal description was included in the deed, which the sellers and buyers believed reflected the fence or landscaping line as the property line. There was a discrepancy between the descriptions and the beliefs, however, which the Nielsons discovered when they measured their lot. This discrepancy could serve as the basis for a breach of warranty claim against the Parkers, from whom the Nielsons bought their lot. In the actual case on which this problem is based, the Nielsons filed a suit in an Idaho state court against the Talbots and the Parkers to recover the value of the property ―lost.‖ The court issued a summary judgment in favor of the Talbots, and ordered them to prepare new and accurate legal

537

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

descriptions of both lots. The Idaho Supreme Court affirmed the judgment and order, and remanded the case for a determination of the Nielsons‘ breach of warranty claim against the Parkers. 91. A Question of Ethics—The IDDR Approach to Easements. Two organizations, Class A Investors Post Oak, LP, and Cosmopolitan Condominium VP, L.P., owned adjacent pieces of property in Houston, Texas. Each owner organization planned to build a high-rise tower on its lot. The organizations signed an agreement that granted each of them an easement in the other‘s property to ―facilitate the development.‖ Cosmopolitan built its residential high-rise first. Later, Class A began moving forward with its plan for a mixed-use high-rise. Cosmopolitan objected that the proposed tower would ―be vastly oversized for its proposed location; situated perilously close to [Cosmopolitan‘s] building; create extraordinary traffic hazards; impede fire protection and other emergency vehicles in the area, and substantially interfere with the use and enjoyment of [Cosmopolitan‘s] property.‖ [Cosmopolitan Condominium Owners Association v. Class A Investors Post Oak, LP, 2017 WL 1520448 (Tex.App.—Houston 2017)] (See Ownership Interests.) 1.

On what basis can Class A proceed with its plan? Explain, using the IDDR approach. Solution Class A can proceed with its plan on at least two legal bases—it is the owner of the property that it plans to develop and it is a party to the agreement in which its neighbor expressed knowledge of the plan and granted necessary easements to see it through. Ethically, Class A can be seen to owe a duty to its owners and investors, and their stakeholders, as well as contractors and suppliers who may be anticipating the project, to proceed with the plan. Of course, this may not be to the liking of Class A‘s neighbors, who could also be identified as stakeholders. In this problem, Class A and Cosmopolitan owned adjacent property. Each planned to build a high-rise tower on its lot. They signed an agreement that granted each an easement in the other‘s property to ―facilitate the development.‖ Cosmopolitan built a residential high-rise. Later, Class A began to execute its plan for a mixed-use high-rise. Cosmopolitan objected. Presumably, Class A‘s building would be permissible under environmental and zoning laws, and the local building codes. In the face of Cosmopolitan‘s challenge, Class A might opt to forego its development plan. This might maintain a good relation with its neighbors and enhance their enjoyment of their own property. But it might not be the best use of Class A‘s property—certainly not in the view of the other stakeholders who are more likely to be satisfied by development. A decision to proceed would thus be the most likely to satisfy the greatest number of stakeholders in an optimal manner.

On what ethical ground might Cosmopolitan continue to oppose its neighbor‘s project? Discuss. Solution One ethical ground on which Class A‘s neighbor, Cosmopolitan, might continue to oppose the new development project is to champion the residents of its tower. These persons are stakeholders in Class A‘s decision to proceed, postpone, redesign, or cancel its project. They are also stakeholders in Cosmopolitan‘s decision to oppose or support that development.

538

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Here, Class A and Cosmopolitan owned adjacent property, and each agreed to ―facilitate the development‖ of the other‘s planned high-rise tower on its lot. Cosmopolitan built first. When Class A began its project, Cosmopolitan protested. Cosmopolitan‘s objections focused on concern for its tower‘s occupants and the value of their property. This indicates that Cosmopolitan was championing these residents, perhaps believing that a different use of Class A‘s property would be in their best interests. Even if a challenge did not succeed in discouraging Class A from proceeding with its plan, the protest might cause Class A to reconsider specific aspects of its project—the exact location of the high-rise on the property, for example, or the mixed-use character of the plan. This result might satisfy some of Cosmopolitan‘s stakeholders. In the actual case on which this problem is based, Class A filed a suit in a Texas state court, seeking a declaratory judgment that Cosmopolitan was bound by their agreement. Cosmopolitan filed a motion to dismiss, which the court denied. A state intermediate appellate court affirmed the dismissal.

539

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 42: Real Property and Landlord-Tenant Law

Critical Thinking and Writing Assignments 92. Time-Limited Group Assignment—Adverse Possession. The Wallen family owned a cabin on Lummi Island in the state of Washington. A driveway ran from the cabin across their property to South Nugent Road. Floyd Massey bought the adjacent lot and built a cabin on it in 1985. To gain access to his property, Massey used a bulldozer to extend the driveway, without the Wallens‘ permission but also without their objection. In 2010, the Wallens sold their property to Wright Fish Company. Massey continued to use and maintain the driveway without permission or objection. In 2016, Massey sold his property to Robert Drake. Drake and his employees continued to use and maintain the driveway without permission or objection, although Drake knew it was located largely on Wright‘s property. In 2018, Wright sold its lot to Robert Smersh. The next year, Smersh told Drake to stop using the driveway. Drake filed a suit against Smersh, claiming an easement by prescription (which is created by meeting the same requirements as adverse possession). (See Transfer of Ownership.) 1.

The first group will decide whether Drake‘s use of the driveway meets all of the requirements for adverse possession (easement by prescription). Solution An easement arises by prescription when one person exercises an easement, such as a rightof-way, on another person‘s land without the landowner‘s consent, and the use is apparent and continues for the length of time required by the applicable statute of limitations. In much the same way, title to property may be obtained by adverse possession. The requirements are that the possession of the property must be actual and exclusive—sole occupancy or use, for example—the possession must be open, notorious, and visible—not secret—and the possession must be continuous and peaceable for a required period of time. In this problem, Drake‘s use of the driveway meets all of the requirements for either easement by prescription or adverse possession. Drake‘s use was open and notorious, over a uniform route, and continuous and uninterrupted for a ten-year period. And the permission of the owners was not sought when the driveway was extended, nor did they object to the extension.

The second group will determine how the court should rule in this case and why. Does it matter that Drake knew the driveway was located largely on Wright‘s (and then Smersh‘s) property? Should it matter? Solution The court should rule in favor of Drake, whose use of the driveway satisfied all of the requirements for either easement by prescription or adverse possession, as explained in the answer to the previous question.

The third group will evaluate the underlying policy and fairness of adverse possession laws. Should the law reward persons who take possession of someone else‘s land for their own use? Does it make sense to punish owners who allow someone else to use their land without complaint? Solution As stated in the text, there are a number of public-policy reasons for the adverse possession doctrine. These include society's interest in resolving boundary disputes, determining title when title to property is in question, and ensuring that real property remains in the stream of commerce. More fundamentally, policies behind the doctrine include rewarding possessors for putting land to productive use and punishing owners who sit on their rights too long and

540

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

do not take action when they see adverse possession.

4. The fourth team will consider how the laws governing adverse possession (easement by prescription) vary from state to state. To acquire title through adverse possession, a person might be required to possess the property for five years in one state, for instance, and for twenty years in another. Are there any legitimate reasons for such regional differences? Would it be better if all states had the same requirements? Explain your answers. Solution The laws governing adverse possession vary from state to state—mostly by the period of time the possession must be adverse to vest title to the property in the adverse possessor. There are legitimate reasons for such differences, not the least of which is the authority of each state to determine the requirements of adverse possession for itself. The public policy reasons for the doctrine of adverse possession (listed in the text) can also provide grounds for differences among the states. The necessity of resolving boundary disputes, determining title to property when title is in question, and ensuring that real property remains in the stream of commerce can vary in urban, suburban, and rural environments, between sparsely and heavily populated areas, over remote and developed tracts, and so on. Rewarding adverse possessors for putting land to productive use may also have a higher priority in some locations, particularly those with distant, absentee owners. If all of the states had the same requirements, there would be a consistency and predictability to the law of adverse possession. And such circumstances could lend themselves to crossjurisdictional judicial precedents. But there does not seem to be a good policy reason for complete uniformity in the requirements of adverse possession. Nor would there be a significant advantage to it—real property cannot generally be physically transferred between jurisdictions, unlike goods and negotiable instruments, the exchange of which benefits from the Uniform Commercial Code adopted in all, or most, of the states. And the policy reasons, stated in the previous paragraph, also provide support for different requirements.

Solution and Answer Guide Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

541

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

Practice and Review .............................................................................................................................. 544 Practice and Review: Debate This ......................................................................................................... 545 Issue Spotters ........................................................................................................................................ 546 Business Scenarios and Case Problems ................................................................................................. 547 Critical Thinking and Writing Assignments ............................................................................................ 553

Critical Thinking Questions in Features Adapting the Law to the Online Environment 93. In an earlier version of the RUFADAA, an online executor had the same rights to the deceased person‘s Internet accounts as did the deceased person when alive. Why do you think these guidelines met strong opposition? Solution Opposition to the original Uniform Access to Digital Assets Act (UFADAA) was mostly based on privacy concerns. It is one thing, critics said, for an executor to have access to photos or letters in a deceased person‘s desk drawer. It is quite another to give the online executor unfettered access to every online photo and every e-mail connected with a person‘s life. Also, privacy advocates complained that that the UFADAA did not give enough protection to third parties whose online communications with the deceased person would be exposed to the executor. Furthermore, federal and state laws place strong restrictions on who can access online accounts other than the account holder. By not requiring explicit permission from the deceased person, the UFADAA was in direct conflict with this type of legislation and put companies in the difficult position of having to violate one law when complying with another.

542

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

Critical Thinking Questions in Cases Case 43.1 94. Why is an insurable interest required for the enforcement of an insurance contract? Solution The existence of an insurable interest is a primary concern in determining liability under an insurance policy. Without an insurable interest, there is no enforceable contract. An insurable interest is required for the enforcement of the contract because the contract would otherwise be little more than a wager on the risk that a loss might occur. A person can insure anything in which that person has an insurable interest. With respect to property, an insurable interest exists when the insured derives a pecuniary benefit from the property—that is, when the insured would suffer a financial loss from its destruction. Thus, for property insurance, as in the Breeden case, the insurable interest must exist at the time the loss occurs whether or not it existed when the policy was procured.

Case 43.2 95. Besides an in terrorem clause, what is an effective method to disinherit a person who would otherwise have a right to a decedent‘s estate? Discuss. Solution For most heirs, or other putative beneficiaries, simply not being mentioned in a will is sufficient to ensure that they get nothing. In other words, the key to disinheriting a person is to execute a will that leaves that individual nothing. And, in fact, in most states, under most circumstances, no one has an absolute right to anyone‘s estate. Testators can decide to will their property to whomever they choose. Because there are exceptions to protect some spouses from being completely disinherited, however, the exclusion of a spouse from participation in an estate should be explicit. Of course, the estate of a person who dies intestate will pass according to a state‘s laws of descent. Thus, the drafting and execution of a legal will is the most effective method for individuals to direct the distribution of their estates. 96. Was Thorn‘s addition of an in terrorem clause to his will ethical? Explain. Solution Yes, Thorn‘s addition of an in terrorem clause to his will was ethical. There is no requirement that testators give their estates to specific beneficiaries. A testator may choose to leave nothing to any person, for any reason. Of course, the intent should be clear. The use of an in terrorem clause to disinherit a contestant to a will can effectively demonstrate this intent. In some situations, the legal standard is the minimal ethical standard. State law does not allow a spouse to be completely disinherited, for example, and may protect minors from the loss of shelter or support. The inadvertent or accidental disinheritance of a testator‘s other natural beneficiaries may be prevented. Testators are otherwise free to leave their property to whomever. One argument in support of this

543

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

principle is the recognition of property ownership, and the owner‘s right to transfer that privilege at the owner‘s discretion. Priority is thereby given to an individual‘s allocation of capital over the state‘s distribution of wealth.

Case 43.3 97. Suppose that the Dowdy Family Trust had provided for a specific child to become co-trustee on the death of a parent—Deborah to succeed Betty, for example. How would the result have been different? Solution If the Dowdy Family Trust had provided for a specific child to become co-trustee on the death of a parent, Michael, or another specific named individual, would have succeeded Dennis on Dennis‘s death and become co-trustee with Betty. This may have still been inconsistent with other provisions of the trust, but it could have prevented the sale of the remaining trust property and thereby have avoided the dispute that gave rise to this case. If the specified successor were one of the couple‘s stepchildren, however, other disagreements might have arisen, due to the inherent conflict between the surviving parent, as current beneficiary, and the stepchild, as future beneficiary, who would have been serving as co-trustees.

Chapter Review Practice and Review In June 2018, Bernard Ramish set up a $48,000 trust fund through West Plains Credit Union to provide tuition for his nephew, Nathan Covacek, to attend Tri-State Polytechnic Institute. The trust was established under Ramish‘s control and went into effect that August. In December, Ramish suffered a brain aneurysm that caused frequent, severe headaches but no other symptoms. In August 2019, Ramish developed heat stroke and collapsed on the golf course at La Prima Country Club. After recuperating at the clubhouse, Ramish quickly wrote his will on the back of a wine list. It stated, ―My last will and testament: Upon my death, I give all of my personal property to my friend Bernard Eshom and my home to Lizzie Johansen.‖ He signed the will at the bottom in the presence of five men in the La Prima clubhouse, and all five men signed as witnesses. A week later, Ramish suffered a second aneurysm and died in his sleep. He was survived by his mother (Dorris Ramish), his nephew (Nathan Covacek), his son-in-law (Bruce Lupin), and his granddaughter (Tori Lupin). Using the information presented in the chapter, answer the following questions. 98. Does Ramish‘s testament on the back of the wine list meet the requirements for a valid will? Solution Possibly not—the doubt is created by those whom Ramish ignored. Will requirements concern (1) the testator‘s capacity, (2) the will‘s form, (3) the testator‘s signature, (4) the will‘s witnesses, and (5) the will‘s publication. As is generally required, Ramish‘s will was in writing, albeit his own handwriting (which makes it holographic). Ramish signed the will before five witnesses, who also signed it. Requirements vary from state to state, but five is a universally sufficient number. Some states require publication, which means that the testator must tell the witnesses that a document is a valid ―last will and testament.‖ The facts do not state whether Ramish did this.

544

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

As for capacity, a testator must be of legal age and sound mind when a will is made. An aneurysm and heat stroke could affect an individual‘s mental function. The problem states that Ramish had ―headaches but no other symptoms,‖ however, indicating that he was of sound mind. One aspect of this requirement is that the testator remembers in the will the ―natural objects of his bounty‖— i.e., family members or others for whom the testator has affection. Ramish‘s gifts to ―my friend‖ Eshom and Johansen may not alone call the will into question—the facts do not establish the relationship among these parties—but Ramish‘s failure to acknowledge his mother, nephew, sonin-law, and granddaughter probably would. 99. Suppose that after Ramish‘s first aneurysm in 2018, Covacek contacted an insurance company to obtain a life insurance policy on Ramish‘s life. Would Covacek have had an insurable interest in his uncle‘s life? Why or why not? Solution Yes. Covacek would have had an insurable interest in Ramish‘s life in 2018 after the first aneurysm. An insurable interest exists when an individual would benefit from the preservation of the life of the insured. For life insurance, this interest must exist at the time the policy is issued. 100.

What would the order of inheritance have been if Ramish had died intestate?

Solution Intestacy laws vary widely from state to state. Generally, if an individual dies without a will and has no spouse or surviving child, then, in order, lineal descendants (grandchildren, brothers, and sisters, and—in some states—parents of the decedent) inherit. If there are no lineal descendants, then collateral heirs (nieces, nephews, aunts, and uncles of the decedent) inherit. Here, that order might dictate that Ramish‘s granddaughter would inherit his estate. 101. What will most likely happen to the trust fund established for Covacek on Ramish‘s death? Solution A trust is an arrangement through which property is transferred from one person to a trustee to be administered for another party‘s benefit. The essential elements are (1) a designated beneficiary, (2) a designated trustee, (3) a fund sufficiently identified to enable title to pass to the trustee, and (4) actual delivery to the trustee with the intention of passing title. In this problem, Covacek is the beneficiary, Ramish appears to be the trustee, and a certain fund ($48,000) seems to have been identified as the corpus of the trust. If West Plains Credit Union were the trustee, this trust would likely continue after Ramish‘s death. If the trust were a testamentary trust (as indicated by the phrasing of the question), it would have come into existence on Ramish‘s death, again because it would likely have met the requirements for a valid trust. In the facts as stated, however, the arrangement appears to be a revocable living trust, in which case, on the grantor‘s death, the principal is transferred to the beneficiary. Thus, because Ramish has dies, Covacek would succeed to the money in the fund.

Practice and Review: Debate This 102.

Any changes to existing, fully witnessed wills should also have to be witnessed.

Solution

545

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

If a will requires witnesses to be valid, so, too, should any changes to that will. Otherwise, there are too many chances for fraud by those close to the testator. Testators should have power to make changes to their wills without the benefit of witnesses. Such un-witnessed changes should not invalidate the will.

Issue Spotters 103. Sheila makes out a will, leaving her property in equal thirds to Toby and Umeko, her children, and Velda, her niece. Two years later, Sheila is adjudged mentally incompetent, and that same year, she dies. Can Toby and Uma have Sheila‘s will revoked on the ground that she did not have the capacity to make a will? Why or why not? Solution No. To have testamentary capacity, a testator must be of legal age and sound mind at the time the will is made. Generally, the testator must (1) know the nature of the act, (2) comprehend and remember the ―natural objects of [the testator‘s] bounty,‖ (3) know the nature and extent of all personal property, and (4) understand the distribution of assets called for by the will. In this situation, Sheila had testamentary capacity at the time she made the will. The fact that she was ruled mentally incompetent two years after making the will does not provide sufficient grounds to revoke it. 104. When Ralph dies, he has not made a will and is survived by many relatives—a spouse, children, adopted children, sisters, brothers, uncles, aunts, cousins, nephews, and nieces. What determines who inherits what? Solution The estate will pass according to the state‘s intestacy laws. Intestacy laws set out how property is distributed when a person dies without a will. Their purpose is to carry out the likely intent of the decedent. The laws determine which of the deceased‘s natural heirs (including first the surviving spouse, second lineal descendants, third parents, and finally collateral heirs) inherit the deceased‘s property.

546

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

Business Scenarios and Case Problems 105. Timing of Insurance Coverage. On October 10, Joleen Vora applied for a $50,000 life insurance policy with Magnum Life Insurance Co. She named her husband, Jay, as the beneficiary. Joleen paid the insurance company the first year‘s premium on making the application. Two days later, before she had a chance to take the physical examination required by the insurance company and before the policy was issued, Joleen was killed in an automobile accident. Jay submitted a claim to the insurance company for $50,000. Can Jay collect? Explain. (See Insurance.) Solution Probably not. A life insurance policy is effective only when it is issued by the insurance company. Before the issuance of Joleen‘s policy, the insurance firm would need to evaluate her application and the results of her physical examination. Because Joleen had been unable to complete the requirements of the application (which included the physical examination) before her death, the policy could not have been issued, nor was it issued. Therefore, Jay could not collect on the policy. If, on receiving Joleen‘s premium payment, the insurance company had issued a binder stating that Joleen would be temporarily covered until the application and the results of the physical examination were evaluated, then the situation would be different. If no such binder had been issued, then Jay is entitled to a refund of the premium Joleen paid for the policy but not to the amount of the policy—$50,000. 106. Wills and Intestacy Laws. Benjamin is a widower who has two married children, Edward and Patricia. Patricia has two children, Perry and Paul. Edward has no children. Benjamin makes a will leaving his property equally to Edward and Patricia. The will provides that should a child predecease him, the grandchildren are to take per stirpes. The will is witnessed by Patricia and by Benjamin‘s lawyer and is signed by Benjamin in their presence. Benjamin dies, and Patricia has predeceased him. Edward claims the will is invalid. (See Wills.) 1.

Discuss whether the will is valid. Solution In most states, for a will to be valid, it must be in writing, signed by the testator, and witnessed (attested to) according to the statutes of the state. In this instance, Benjamin‘s will was unquestionably written (typewritten) and signed by the testator. The only problem is with the witnesses. Some states require three witnesses, and some states invalidate a will if a named beneficiary is also a witness. The Uniform Probate Code provides that a will is valid even if attested to by an interested witness. Therefore, whether the will is valid depends on the state laws dealing with witness qualifications.

Discuss the distribution of Benjamin‘s estate if the will is invalid.

Solution If the will is declared invalid, Benjamin‘s estate will pass in accordance with the state‘s intestacy laws. These statutes provide for distribution of an estate when there is no valid will. The intent of the statutes is to distribute the estate in the way that the deceased person would have wished. Generally, the estate is divided between a surviving spouse and all surviving children. Because Benjamin is a widower, if his only surviving child is Edward, the entire estate will go to Edward, and Benjamin‘s grandchildren, Perry and Paul, will receive nothing from the estate. Discuss the distribution of Benjamin‘s estate if the will is valid.

547

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

Solution If the will is valid, the estate will be divided between Benjamin‘s two children, Patricia and Edward. Should either or both predecease Benjamin, leaving children (Benjamin‘s grandchildren), the grandchildren take per stirpes the share that would have gone to their parent. In this situation Edward, as a surviving child of Benjamin, would receive one-half of the estate, and Perry and Paul, as grandchildren, would each receive per stirpes one-fourth of the estate (one-half of the share that would have gone to their deceased mother, Patricia). 107. Undue Influence. Louise Kane executed a will that left her entire estate to her grandson. When her grandson died, Louise executed a new will that named her great-grandson as her sole beneficiary and specifically disinherited her son, Tommy. At the time, Tommy‘s ex-wife was living with Louise. After Louise died, Tommy filed a suit, claiming that her will was the product of undue influence on the part of his ex-wife. Several witnesses testified that Louise had been mentally competent when she executed her will. Does undue influence appear likely based on these facts? Why or why not? (See Wills.) Solution No. Undue influence does not appear to have occurred in this problem. To invalidate a will on the basis of undue influence, a plaintiff must show that the decedent‘s plan of distribution was the result of improper pressure brought by another person. Undue influence may be inferred if the testator ignores blood relatives and names as a beneficiary a nonrelative who is in constant close contact and in a position to influence the making of the will. In this problem, although Tommy‘s ex-wife lived with Susie and was thus in a position to influence Susie‘s will, she was not a beneficiary under it, so there is no inference of undue influence. Moreover, neither of the wills that Walker executed left any property to her son, so there was no indication that she had been influenced to change her mind regarding the distribution of her estate. Additionally, she expressly disinherited her son, and several witnesses testified that she was mentally competent at the time she made the will. In the actual case on which this problem is based, the court presumed that the will was valid. 108. Insurance Provisions and Clauses. Darling‘s Renta- Car carried property insurance on its cars under a policy issued by Philadelphia Indemnity Insurance Co. The policy listed Darling‘s as the ―insured.‖ Darling‘s rented a car to Joshuah Farrington. In the rental contract, Farrington agreed to be responsible for any damage to the car and declined the optional insurance. Later, Farrington collided with a moose. Philadelphia paid Darling‘s for the damage to the car and sought to collect this amount from Farrington. Farrington argued that he was an ―insured‖ under Darling‘s policy. How should ―insured‖ be interpreted in this case? Why? [Philadelphia Indemnity Insurance Co. v. Farrington, 37 A.3d 305 (Me. 2012)] (See Insurance.)

548

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

Solution Farrington should not be included as an insured within the meaning of the property insurance policy between Darling's and Philadelphia. The existence of an insurable interest is a primary concern when determining liability under an insurance policy. In the case of personal property, an insurable interest exists when the insured derives a pecuniary benefit from the preservation and continued existence of the property. One has an insurable interest in property when one would sustain a financial loss from its destruction. As for an insurance policy‘s language, courts interpret the words according to their ordinary meanings and in light of the nature of the coverage involved. Darling's is entitled to recover the value of the loss to covered vehicles by virtue of its ownership of those vehicles and the fact that it is the owner that suffers the loss when one of its vehicles is damaged. In other words, under the Philadelphia policy, Darling‘s had an insurable interest in the car when Farrington smashed into the moose. Farrington might have had an insurable interest as well when he agreed to be responsible for any damage to the car, but he declined the insurance coverage offered in the rental contract. In the actual case on which this problem is based, in Philadelphia‘s suit against Farrington, the court entered a judgment in the insurer‘s favor. 109. Requirements of a Will. Sherman Hemsley was a wellknown actor from the 1970s. Most notably, he played George Jefferson on the television shows All in the Family and The Jeffersons. He was born to Arsena Chisolm and William Thornton. Thornton was married to another woman, and Hemsley never had a relationship with his father or that side of the family. Hemsley never married and had no children. He lived with Flora Bernal, his business manager. Diagnosed with cancer, Hemsley executed a will naming Bernal the sole beneficiary of his estate. At the signing, Hemsley indicated that he knew he was executing his will and that he had deliberately chosen Bernal, but he did not discuss his relatives or the nature of his property with his attorney or the witnesses. After his death, the Thorntons challenged the will. Was Hemsley of sound mind? Discuss. [In re Estate of Hemsley, 460 S.W.3d 629 (Tex.App.—El Paso 2014)] (See Wills.) Solution Yes, Hemsley was of sound mind—when he executed his will and otherwise. One of the requirements of a valid will is that the testator must have capacity. The testator must be of sound mind at the time the will is made. This refers to the testator‘s ability to formulate and understand a personal plan for the disposition of any property. The testator must intend the document to be a will, comprehend the kind and character of the property, and remember the names of family and friends. Here, Hemsley executed a will naming Bernal—Hemsley‘s business manager and the person with whom he lived—to be the sole beneficiary of his estate. At the signing, Hemsley indicated that he knew he was executing his will and that he had deliberately chosen Bernal. He did not discuss his relatives, but he had never had a relationship with his father or his father‘s family, he had never married, and he had no children. He also did not discuss the nature of his property, but the other factors indicate strongly that Hemsley was of sound mind when he executed his will. 110. Business Case Problem with Sample Answer— Wills. Andrew Walker executed a will giving a certain parcel of real estate in fee simple to his three children from a previous marriage— Mark Walker, Michelle Peters, and Andrea Knox—with a ―life use‖ in the property granted to his current spouse, Nora Walker. A year later, Andrew, who suffered from asbestosis, was discharged

549

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

from a hospital to spend his last days at home. He told Nora that he wished to execute a new will to change the disposition of the property to devise half of it to her. Nora recorded his wish and took her notes to the office of attorney Frederick Meagher to have the document drafted. Meagher did not see Nora‘s notes, he did not talk to Walker, no one from his office was present at the signing of the document, and, when Walker signed it, he did not declare that it was his will, as required by state law. Is the document a valid will? Explain. [In re Estate of Walker, 124 A.D.3d 970, 2 N.Y.S.3d 628 (3 Dept. 2015)] (See Wills.) —For a sample answer to Problem 43–6, go to Appendix E. Solution No. The document that Walker signed—which had been drafted in Meagher‘s office at Nora‘s direction—did not constitute a valid will. A will is the final declaration of how a person wishes to have property disposed of after death. It is a formal instrument that must follow exactly the requirements of state law to be valid. These formalities are intended to help prevent fraud. Unless they are followed, the will is declared void. A will usually must be attested to by two or three witnesses. The manner in which the witnessing must be done is generally set out in a statute, which typically requires that the testator either sign the will in the presence of the witnesses or acknowledge that the signature on the document is valid. In some states, at the signing, testators must declare that the document is their will. Here, Andrew told Nora that he wished to change the disposition of his property provided for in a prior will by devising half of it to her in a new will. She noted his wish and took her notes to the office of attorney Meagher to have the document drafted. Meagher did not see Nora‘s notes, he did not talk to Walker, no one from his office was present at the signing of the document, and, when Walker signed it, he did not declare that it was his will, as required by state law. These facts indicate that formalities required by state law for the execution of a will were not followed strictly, undercutting the validity of the document as a will. In the actual case on which this problem is based, Nora submitted this document to a New York state court for probate As Walker‘s will. His children objected. The court denied the admission of the will to probate. ―In light of the uncertainty surrounding the drafting and execution,‖ a state intermediate appellate court affirmed. 111. Defenses against Insurance Payment. American National Property and Casualty Co. issued an insurance policy to Robert Houston, insuring certain residential property and its contents against fire and other hazards. Twenty months later, Houston issued a quitclaim deed to the property to John and Judy Sykes, reserving a life estate for himself. Houston died two years after that, but John continued to renew the American policy in Houston‘s name. When a fire substantially damaged the property, John filed a claim with the insurer on behalf of Houston, whom John said was out of town and unavailable. On learning that Houston had died seven years earlier, American refused to pay, claiming that it had no liability. Who will suffer the loss under these circumstances? Why? How might this loss have been avoided? Explain. [American National Property and Casualty Co. v. Sykes, 2016 WL 390069 (S.D.Miss. E.Div. 2016)] (See Insurance.) Solution Under the circumstances described in the problem, John and Judy Sykes will suffer the loss. This loss could have been avoided if the Sykeses had obtained the consent of American National Property and Casualty Co. to assume Robert Houston‘s insurance policy, or if the Sykeses had obtained a new policy.

550

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

To be entitled to the proceeds from a property insurance policy, an insured must have an insurable interest in the property. The existence of an insurable interest is of primary concern in determining liability under the policy. One type of property insurance is fire insurance, which allocates the risk of loss or damage from a fire to certain property between the insured and the insurer. The policy in this problem was issued by American to Houston, who was the only named insured. Under a quitclaim deed, Houston transferred all of his interest in the property to the Sykeses, but reserved for himself a life estate interest. Later, Houston died—his interest in the property terminated on his death, and thus his entitlement to any proceeds payable under the policy likewise expired. John‘s attempt to continue the coverage of the American policy under Houston‘s name was unavailing. When a fire damaged the property, John filed a claim with American purportedly on Houston‘s behalf. But because the fire occurred after Houston‘s interest terminated, American is not liable on the policy for the damage. The Sykeses will suffer the loss. In the actual case on which this problem is based, American filed a suit in a Mississippi state court against the Sykeses, seeking a declaratory judgment that relieved the insurer of liability under the policy. The court issued the judgment, on the reasoning stated above. 112. Testamentary Intent. When Larry Neal died, Gary, his brother and his estate‘s executor, applied to a Texas state court to probate Larry‘s will. The will provided, ―I do give and bequeath to my niece, Valorie Jean (Neal) White, all my personal effects and all my tangible personal property, including automobiles, hangars, aircraft, fly-drive vehicles, patents, companies, and all other things owned by me at the time of my death,‖ including bank accounts, securities, and other ―intangibles.‖ Gary interpreted this provision to entitle Valorie to all of Larry‘s personal and real property. Larry‘s daughter, Lori, objected, arguing that under the terms of the will, Larry‘s personal property passed to Valorie and his real property passed by intestacy to her and Larry‘s sons. Did Larry‘s will devise his real property to Valorie? Discuss. [Estate of Neal, 2018 WL 283780 (Tex.App.—Fort Worth 2018)] (See Wills.) Solution Under the terms of Larry‘s will, he did not devise his real property to Valorie. It should instead pass by intestacy, as Lori contended. Testators can, with expressed intent, pass less than all of their property through a will. The testator‘s intent is discerned by looking at the language and provisions of the will, and giving the words their plain, ordinary, and generally accepted meanings. In this problem, Larry‘s will bequeathed to Valorie ―all my personal effects and all my tangible personal property, including automobiles, hangars, aircraft, fly-drive vehicles, patents, companies, and all other things owned by me at the time of my death,‖ including bank accounts, securities, and other ―intangibles.‖ Larry‘s daughter Lori argued that under the will, Larry‘s personal property passed to Valorie but his real property passed by intestacy. Construing Larry‘s intent from the plain meaning of the words used in his will compels a conclusion that the will did not devise his real property to Valorie. The will gave his niece ―all my personal effects,‖ which of course consist of personal property. The will also gave Valorie ―all my tangible personal property,‖ including the specific items on a list. None of the listed items is real

551

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

property, and nothing in the accompanying phrase or on the list indicates an intent to devise real property. Finally, the will gave Valorie ―all other things owned by me at the time of my death,‖ including bank accounts, securities, and other ―intangibles.‖ Plainly, this phrase refers to personal, not real, property. In the actual case on which this problem is based, the court issued a judgment in Gary‘s favor. A state intermediate appellate court reversed in part. ―Under the terms of Larry‘s will, his personal property passed to Valorie, and his real property passed by intestacy to his heirs.‖ 113. A Question of Ethics—The IDDR Approach and Bad Faith. Bernd Moving Systems owned a warehouse in Yakima, Washington. American Guarantee & Liability Insurance Co. insured Bernd under a policy that included coverage of ―Personal property of others in your care, custody and control.‖ Before storing property in the warehouse, William and Colleen Merriman were told that their goods would be fully insured. Later, a fire destroyed the warehouse and the Merrimans‘ property. American Guarantee did not inform them of Bernd‘s coverage, however. Instead, they were advised to file a claim under their homeowner‘s insurance because there would most likely be no coverage under Bernd‘s policy. [Merriman v. American Guarantee & Liability Insurance Co., 198 Wash. App. 594, 396 P.3d 351 (Div. 3 2017)] (See Insurance.) 1.

On what grounds might the Merrimans base a legal action against American Guarantee? Solution The Merrimans could base a legal action against American Guarantee on fraud and bad faith. An insurance company may not avoid payment by misleading potential beneficiaries about the existence or extent of coverage. And a company may not act in bad faith. For instance, if an insurer denied coverage without a reasonable basis, the insured could file a bad faith tort action to recover. In this problem, Bernd owned and operated a warehouse. American Guarantee insured Bernd under a policy that included coverage of ―Personal property of others in your care, custody and control.‖ As customers of Bernd, the Merrimans were told that their goods would be fully insured. When a fire destroyed the warehouse and their property, however, American Guarantee did not tell them of Bernd‘s coverage.

552

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

A duty to disclose in a business transaction arises if, among other circumstances, disclosure is necessary to prevent a statement of facts from being misleading. Here, the Merrimans were clearly misled when they were told to file a claim under their own homeowner‘s insurance because there would most likely be no coverage under Bernd‘s policy. 2.

Are there sufficient grounds to argue that the insurer acted unethically? Discuss. Solution Yes, there are sufficient grounds to argue that the insurer acted unethically. The business of insurance is affected by the public interest, which requires that all participants avoid deception and practice honesty. Thus, the duty of good faith is imposed on the entire insurance industry, including insurers. This is a legal standard, serving as the basis for a bad faith tort claim. This is also an ethical standard, providing a basis for a conclusion about the ethics of a deceitful party. An insurance company may have an ethical duty to its owners and other stakeholders, including those insured under its policies, to avoid the payment of wrongful claims. But a company may not ethically avoid payment by deceiving claimants about the available coverage. And, as noted above, an insurance company may not act in bad faith. For example, thee must be a reasonable basis on which to deny recovery on a claim. In this case, the Merrimans were misled about the lack of coverage under their warehouser‘s American Guarantee policy for the loss of their property in a fire. Their loss was in fact covered. Why would the insurer deceive the claimants? Most likely, it was an attempt to avoid payment on a claim, which would, at least in the short term, work to the economic benefit of its stakeholders. The weakness of this choice is clear—the truth was likely to come out, and the result could work to the detriment of the stakeholders in the long term through an erosion of trust in the insurer. One attribute of an ethical character is admitting when you are wrong. In the actual case on which this problem is based, the Merrimans learned of Bernd‘s insurance policy through discovery as part of a suit against the warehouse operator. They entered into a settlement agreement with American Guarantee after the insurer conceded that the policy covered the property of Bernd‘s customers.

Critical Thinking and Writing Assignments 114. Time-Limited Group Assignment—Intestacy Laws. Three and a half years after Lauren and Warren Woodward were married, they were informed that Warren had leukemia. At the time, the couple had no children, and physicians told the Woodwards that the leukemia treatment might leave Warren sterile. The couple arranged for Warren‘s sperm to be collected and placed in a sperm bank for later use. Two years after Warren died, Lauren gave birth to twin girls who had been conceived through artificial insemination using his sperm. The following year, Lauren applied for Social Security survivor benefits for the two children. Her application was rejected on the ground that she had not established that the twins were the husband‘s children within the meaning of the Social Security Act. Woodward then filed a paternity action in Massachusetts, and the probate court determined that Warren Woodward was the twins‘ father. She then filed an action in court to determine the inheritance rights of the twins. (See Wills.)

553

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

The first group will outline how a court should decide the inheritance rights of children conceived from the sperm of a deceased individual and his surviving spouse. Solution The court should decide the inheritance rights of children conceived from the sperm of a deceased individual and his surviving spouse based on the children‘s genetic relationship with the decedent, and whether the decedent consented both to reproduce posthumously and to support any resulting child. Of course, if the state inheritance statutes limit the class of posthumous children to those in utero at the time of the decedent‘s death or have certain other requirements, those standards must be met and applied. The purpose of the state intestacy laws and other state and individual interests might be considered as well.

The second group will decide if children conceived after a parent‘s death (by means of artificial insemination or in vitro fertilization) still inherit under intestate succession laws and will explain why or why not. Solution It is in the best interest of the children conceived after a parent‘s death (by means of artificial insemination or in vitro fertilization) that those children have a right to inherit from their parents. There are three important factors to take into consideration in deciding this question—the best interest of the children, the state‘s interest in the orderly administration of estates, and the reproductive rights of the genetic parents. The most important factor is the best interest of the children. Generally, all children should be entitled to the same rights under the law regardless of the circumstances of their conception. Among these rights is the right to inherit from their parents.

3. The third group will consider the inheritance rights of a child who was conceived by means of artificial insemination, in vitro fertilization, or a surrogate. Should they be different from the rights of a child conceived in the traditional manner? Assuming the biological parent is not part of the child‘s life, should the child still be able to inherit from the biological parent? Why or why not? Solution A child who is conceived after the parent‘s death by means of artificial insemination or in vitro fertilization should be allowed to inherit from the deceased parent if the other parent establishes the genetic relationship with the decedent and shows that the decedent consented to reproduce posthumously and to support any resulting child. On the same basis, a child who is conceived after the father‘s death by means of a surrogate should also be allowed to inherit from the deceased father. It is in the best interest of these children that inheritance rights be granted.

554

Solution and Answer Guide: Miller, Business Law Today - Comprehensive Edition: Text & Cases 13e, 9780357634783; Chapter 43: Insurance, Wills, and Trusts

555