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Learning Objectives
By the end of this section, you will be able to:
• Explain how the landlord’s reversionary interest works and how it may be assigned.
• Describe the two ways in which a tenant’s leasehold interest may be transferred to another party.
General Rule
At common law, the interests of the landlord and tenant may be transferred freely unless (1) the tenancy is at will; (2) the lease requires either party to perform significant personal services, which would be substantially less likely to be performed if the interest was transferred; or (3) the parties agree that the interest may not be transferred.
Landlord’s Interest
When the landlord sells his interest, the purchaser takes subject to the lease. If there are tenants with leases in an apartment building, the new landlord may not evict them simply because he has taken title. The landlord may divide his interest as he sees fit, transferring all or only part of his entire interest in the property. He may assign his right to the rent or sell his reversionary interest in the premises. For instance, Simone takes a three-year lease on an apartment near the university. Simone’s landlord gives his aged uncle his reversionary interest for life. This means that Simone’s landlord is now the uncle, and she must pay him rent and look to him for repairs and other performances owed under the lease. When Simone’s lease terminates, the uncle will be entitled to rent the premises. He does so, leasing to another student for three years. One year later, the uncle dies. His nephew (Simone’s original landlord) has the reversionary interest and so once again becomes the landlord. He must perform the lease that the uncle agreed to with the new student, but when that lease expires, he will be free to rent the premises as he sees fit.
Tenant’s Interest
Why would a tenant be interested in transferring her leasehold interest? For at least two reasons: she might need to move before her lease expired, or she might be able to make money on the leasehold itself. In recent years, many companies in New York have discovered that their present leases were worth far more to them by moving out than staying in. They had signed long-term leases years ago when the real estate market was glutted and were paying far less than current market prices. By subletting the premises and moving to cheaper quarters, they could pocket the difference between their lease rate and the market rate they charged their subtenants.
The tenant can transfer her interest in the lease by assigning or by subletting. In an assignment, the tenant transfers all interest in the premises and all obligations. Thus the assignee-tenant is duty bound to pay the landlord the periodic rental and to perform all other provisions in the lease. If the assignee defaulted, however, the original tenant would remain liable to the landlord. In short, with an assignment, both assignor and assignee are liable under the lease unless the landlord releases the assignor. By contrast, a sublease is a transfer of something less than the entire leasehold interest (see Figure 32.1). For instance, the tenant might have five years remaining on her lease and sublet the premises for two years, or she might sublet the ground floor of a four-story building. Unlike an assignee, the subtenant does not step into the shoes of the tenant and is not liable to the landlord for performance of the tenant’s duties. The subtenant’s only obligations are to the tenant. What distinguishes the assignment from the sublease is not the name but whether or not the entire leasehold interest has been transferred. If not, the transfer is a sublease.
Many landlords include clauses in their leases prohibiting assignments or subleases, and these clauses are generally upheld. But the courts construe them strictly, so that a provision barring subleases will not be interpreted to bar assignments.
Key Takeaway
The interests of landlords and tenants can be freely transferred unless the parties agree otherwise or unless there is a tenancy at will. If the tenant assigns her leasehold interest, she remains liable under the lease unless the landlord releases her. If less than the entire leasehold interest is transferred, it is a sublease rather than an assignment. But the original lease may prohibit either or both.
Exercises
1. What is the difference between an assignment and a sublease?
2. Are the duties of the tenant any different if the reversionary interest is assigned? Suppose that Simone is in year one of a three-year lease and that Harry is the landlord. If Harry assigns his reversionary interest to Louise, can Louise raise the rent for the next two years beyond what is stated in the original lease? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/32%3A_Landlord_and_Tenant_Laws/32.03%3A_Transfer_of_Landlords_or_Tenants_Interest.txt |
Learning Objectives
By the end of this section, you will be able to:
• State the general common-law rule as to the liability of the landlord for injuries occurring on the leased premises.
• State the exceptions to the general rule, and explain the modern trend toward increased liability of the landlord.
In Chapter 28, we discussed the tort liability of the owner or occupier of real estate to persons injured on the property. As a general rule, when injury occurs on premises rented to a tenant, it is the tenant—an occupier—who is liable. The reason for this rule seems clear: The landlord has given up all but a reversionary interest in the property; he has no further control over the premises. Indeed, he is not even permitted on the property without the tenant’s permission. But over the years, certain exceptions have developed to the rule that the landlord is not liable. The primary reason for this change is the recognition that the landlord is better able to pay for repairs to his property than his relatively poorer tenants and that he has ultimate control over the general conditions surrounding the apartment or apartment complex.
Exceptions to the General Rule
Hidden Dangers Known to Landlord
The landlord is liable to the tenant, her family, or guests who are injured by hidden and dangerous conditions that the landlord knew about or should have known about but failed to disclose to the tenant.
Dangers to People off the Premises
The landlord is liable to people injured outside the property by defects that existed when the lease was signed. Simone rents a dilapidated house and agrees with the landlord to keep the building repaired. She neglects to hire contractors to repair the cracked and sagging wall on the street. The building soon collapses, crushing several automobiles parked alongside. Simone can be held responsible and so can the landlord; the tenant’s contractual agreement to maintain the property is not sufficient to shift the liability away from the landlord. In a few cases, the landlord has even been held liable for activities carried on by the tenant, but only because he knew about them when the lease was signed and should have known that the injuries were probable results.
Premises Leased for Admitting the Public
A landlord is responsible for injuries caused by dangerous conditions on property to be used by the public if the danger existed when the lease was made. Thus an uneven floor that might cause people to trip or a defective elevator that stops a few inches below the level of each floor would be sufficiently dangerous to pin liability on the landlord.
Landlord Retaining Control of Premises
Frequently, a landlord will retain control over certain areas of the property—for example, the common hallways and stairs in an apartment building. When injuries occur as a result of faulty and careless maintenance of these areas, the landlord will be responsible. In more than half the states, the landlord is liable for failure to remove ice and snow from a common walkway and stairs at the entrance. In one case, the tenant even recovered damages for a broken hip caused when she fell in fright from seeing a mouse that jumped out of her stove; she successfully charged the landlord with negligence in failing to prevent mice from entering the dwelling in areas under his control.
Faulty Repair of Premises
Landlords often have a duty to repair the premises. The duty may be statutory or may rest on an agreement in the lease. In either case, the landlord will be liable to a tenant or others for injury resulting from defects that should have been repaired. No less important, a landlord will be liable even if he has no duty to repair but negligently makes repairs that themselves turn out to be dangerous.
Key Takeaway
At common law, injuries taking place on leased premises were the responsibility of the tenant. There were notable exceptions, including situations where hidden dangers were known to the landlord but not the tenant, where the premises’ condition caused injury to people off the premises, or where faulty repairs caused the injuries. The modern trend is to adopt general negligence principles to determine landlord liability. Thus where the landlord does not use reasonable care and subjects others to an unreasonable risk of harm, there may be liability for the landlord. This varies from state to state.
Exercises
1. What was the basic logic of the common law in having tenants be responsible for all injuries that took place on leased premises?
2. Does the modern trend of applying general negligence principles to landlords make more sense? Explain your answer. | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/32%3A_Landlord_and_Tenant_Laws/32.04%3A_Landlords_Tort_Liability.txt |
Constructive Eviction
Fidelity Mutual Life Insurance Co. v. Kaminsky
768 S.W.2d 818 (Tx. Ct. App. 1989)
MURPHY, JUSTICE
The issue in this landlord-tenant case is whether sufficient evidence supports the jury’s findings that the landlord and appellant, Fidelity Mutual Life Insurance Company [“Fidelity”], constructively evicted the tenant, Robert P. Kaminsky, M.D., P.A. [“Dr. Kaminsky”] by breaching the express covenant of quiet enjoyment contained in the parties’ lease. We affirm.
Dr. Kaminsky is a gynecologist whose practice includes performing elective abortions. In May 1983, he executed a lease contract for the rental of approximately 2,861 square feet in the Red Oak Atrium Building for a two-year term which began on June 1, 1983. The terms of the lease required Dr. Kaminsky to use the rented space solely as “an office for the practice of medicine.” Fidelity owns the building and hires local companies to manage it. At some time during the lease term, Shelter Commercial Properties [“Shelter”] replaced the Horne Company as managing agents. Fidelity has not disputed either management company’s capacity to act as its agent.
The parties agree that: (1) they executed a valid lease agreement; (2) Paragraph 35 of the lease contains an express covenant of quiet enjoyment conditioned on Dr. Kaminsky’s paying rent when due, as he did through November 1984; Dr. Kaminsky abandoned the leased premises on or about December 3, 1984 and refused to pay additional rent; anti-abortion protestors began picketing at the building in June of 1984 and repeated and increased their demonstrations outside and inside the building until Dr. Kaminsky abandoned the premises.
When Fidelity sued for the balance due under the lease contract following Dr. Kaminsky’s abandonment of the premises, he claimed that Fidelity constructively evicted him by breaching Paragraph 35 of the lease. Fidelity apparently conceded during trial that sufficient proof of the constructive eviction of Dr. Kaminsky would relieve him of his contractual liability for any remaining rent payments. Accordingly, he assumed the burden of proof and the sole issue submitted to the jury was whether Fidelity breached Paragraph 35 of the lease, which reads as follows:
Quiet Enjoyment
Lessee, on paying the said Rent, and any Additional Rental, shall and may peaceably and quietly have, hold and enjoy the Leased Premises for the said term.
A constructive eviction occurs when the tenant leaves the leased premises due to conduct by the landlord which materially interferes with the tenant’s beneficial use of the premises. Texas law relieves the tenant of contractual liability for any remaining rentals due under the lease if he can establish a constructive eviction by the landlord.
The protests took place chiefly on Saturdays, the day Dr. Kaminsky generally scheduled abortions. During the protests, the singing and chanting demonstrators picketed in the building’s parking lot and inner lobby and atrium area. They approached patients to speak to them, distributed literature, discouraged patients from entering the building and often accused Dr. Kaminsky of “killing babies.” As the protests increased, the demonstrators often occupied the stairs leading to Dr. Kaminsky’s office and prevented patients from entering the office by blocking the doorway. Occasionally they succeeded in gaining access to the office waiting room area.
Dr. Kaminsky complained to Fidelity through its managing agents and asked for help in keeping the protestors away, but became increasingly frustrated by a lack of response to his requests. The record shows that no security personnel were present on Saturdays to exclude protestors from the building, although the lease required Fidelity to provide security service on Saturdays. The record also shows that Fidelity’s attorneys prepared a written statement to be handed to the protestors soon after Fidelity hired Shelter as its managing agent. The statement tracked TEX. PENAL CODE ANN. §30.05 (Vernon Supp. 1989) and generally served to inform trespassers that they risked criminal prosecution by failing to leave if asked to do so. Fidelity’s attorneys instructed Shelter’s representative to “have several of these letters printed up and be ready to distribute them and verbally demand that these people move on and off the property.” The same representative conceded at trial that she did not distribute these notices. Yet when Dr. Kaminsky enlisted the aid of the Sheriff’s office, officers refused to ask the protestors to leave without a directive from Fidelity or its agent. Indeed, an attorney had instructed the protestors to remain unless the landlord or its representative ordered them to leave. It appears that Fidelity’s only response to the demonstrators was to state, through its agents, that it was aware of Dr. Kaminsky’s problems.
Both action and lack of action can constitute “conduct” by the landlord which amounts to a constructive eviction.…
This case shows ample instances of Fidelity’s failure to act in the fact of repeated requests for assistance despite its having expressly covenanted Dr. Kaminsky’s quiet enjoyment of the premises. These instances provided a legally sufficient basis for the jury to conclude that Dr. Kaminsky abandoned the leased premises, not because of the trespassing protestors, but because of Fidelity’s lack of response to his complaints about the protestors. Under the circumstances, while it is undisputed that Fidelity did not “encourage” the demonstrators, its conduct essentially allowed them to continue to trespass.
[The trial court judgment is affirmed.]
Case Questions
A constructive eviction occurs when the tenant leaves the leased premises because of conduct by the landlord that materially interferes with the tenant’s beneficial use of the premises.
1. At the trial, who concluded that Fidelity’s “conduct” constituted constructive eviction? Is this a question of fact, an interpretation of the contract, or both?
2. How can failure to act constitute “conduct”? What could explain Fidelity’s apparent reluctance to give notice to protestors that they might be arrested for trespass?
Landlord’s Tort Liability
Stephens v. Stearns
106 Idaho 249; 678 P.2d 41 (Idaho Sup. Ct. 1984)
Donaldson, Chief Justice
Plaintiff-appellant Stephens filed this suit on October 2, 1978, for personal injuries she sustained on July 15, 1977, from a fall on an interior stairway of her apartment. Plaintiff’s apartment, located in a Boise apartment complex, was a “townhouse” consisting of two separate floors connected by an internal stairway.
The apartments were built by defendant Koch and sold to defendant Stearns soon after completion in 1973. Defendant Stearns was plaintiff’s landlord from the time she moved into the apartment in 1973 through the time of plaintiff’s fall on July 15, 1977. Defendant Albanese was the architect who designed and later inspected the apartment complex.
* * *
When viewed in the light most favorable to appellant, the facts are as follows: On the evening of July 15, 1977, Mrs. Stephens went to visit friends. While there she had two drinks. She returned to her apartment a little past 10:00 p.m. Mrs. Stephens turned on the television in the living room and went upstairs to change clothes. After changing her clothes, she attempted to go downstairs to watch television. As Mrs. Stephens reached the top of the stairway, she either slipped or fell forward. She testified that she “grabbed” in order to catch herself. However, Mrs. Stephens was unable to catch herself and she fell to the bottom of the stairs. As a result of the fall, she suffered serious injury. The evidence further showed that the stairway was approximately thirty-six inches wide and did not have a handrail although required by a Boise ordinance.
* * *
In granting defendant Stearns’ motion for directed verdict, the trial judge concluded that there was “an absolute lack of evidence” and that “to find a proximate cause between the absence of the handrail and the fall suffered by the plaintiff would be absolutely conjecture and speculation.” (Although the trial judge’s conclusion referred to “proximate cause,” it is apparent that he was referring to factual or actual cause. See Munson v. State, Department of Highways, 96 Idaho 529, 531 P.2d 1174 (1975).) We disagree with the conclusion of the trial judge.
We have considered the facts set out above in conjunction with the testimony of Chester Shawver, a Boise architect called as an expert in the field of architecture, that the primary purpose of a handrail is for user safety. We are left with the firm conviction that there is sufficient evidence from which reasonable jurors could have concluded that the absence of a handrail was the actual cause of plaintiff’s injuries; i.e., that plaintiff would not have fallen, or at least would have been able to catch herself, had there been a handrail available for her to grab.
In addition, we do not believe that the jury would have had to rely on conjecture and speculation to find that the absence of the handrail was the actual cause. To the contrary, we believe that reasonable jurors could have drawn legitimate inferences from the evidence presented to determine the issue. This comports with the general rule that the factual issue of causation is for the jury to decide. McKinley v. Fanning, 100 Idaho 189, 595 P.2d 1084 (1979); Munson v. State, Department of Highways, supra. In addition, courts in several other jurisdictions, when faced with similar factual settings, have held that this issue is a question for the jury.
* * *
Rather than attempt to squeeze the facts of this case into one of the common-law exceptions, plaintiff instead has brought to our attention the modern trend of the law in this area. Under the modern trend, landlords are simply under a duty to exercise reasonable care under the circumstances. The Tennessee Supreme Court had the foresight to grasp this concept many years ago when it stated: “The ground of liability upon the part of a landlord when he demises dangerous property has nothing special to do with the relation of landlord and tenant. It is the ordinary case of liability for personal misfeasance, which runs through all the relations of individuals to each other.” Wilcox v. Hines, 100 Tenn. 538, 46 S.W. 297, 299 (1898). Seventy-five years later, the Supreme Court of New Hampshire followed the lead of Wilcox. Sargent v. Ross, 113 N.H. 388, 308 A.2d 528 (1973). The Sargent court abrogated the common-law rule and its exceptions, and adopted the reasonable care standard by stating:
We thus bring up to date the other half of landlord-tenant law. Henceforth, landlords as other persons must exercise reasonable care not to subject others to an unreasonable risk of harm.…A landlord must act as a reasonable person under all of the circumstances including the likelihood of injury to others, the probable seriousness of such injuries, and the burden of reducing or avoiding the risk.
Id. at 534 [Citations]
Tennessee and New Hampshire are not alone in adopting this rule. As of this date, several other states have also judicially adopted a reasonable care standard for landlords.
* * *
In commenting on the common-law rule, A. James Casner, Reporter of Restatement (Second) of Property—Landlord and Tenant, has stated: “While continuing to pay lip service to the general rule, the courts have expended considerable energy and exercised great ingenuity in attempting to fit various factual settings into the recognized exceptions.” Restatement (Second) of Property—Landlord and Tenant ch. 17 Reporter’s Note to Introductory Note (1977). We believe that the energies of the courts of Idaho should be used in a more productive manner. Therefore, after examining both the common-law rule and the modern trend, we today decide to leave the common-law rule and its exceptions behind, and we adopt the rule that a landlord is under a duty to exercise reasonable care in light of all the circumstances.
We stress that adoption of this rule is not tantamount to making the landlord an insurer for all injury occurring on the premises, but merely constitutes our removal of the landlord’s common-law cloak of immunity. Those questions of hidden danger, public use, control, and duty to repair, which under the common-law were prerequisites to the consideration of the landlord’s negligence, will now be relevant only inasmuch as they pertain to the elements of negligence, such as foreseeability and unreasonableness of the risk. We hold that defendant Stearns did owe a duty to plaintiff Stephens to exercise reasonable care in light of all the circumstances, and that it is for a jury to decide whether that duty was breached. Therefore, we reverse the directed verdict in favor of defendant Stearns and remand for a new trial of plaintiff’s negligence action against defendant Stearns.
Case Questions
1. Why should actual cause be a jury question rather than a question that the trial judge decides on her own?
2. Could this case have fit one of the standard exceptions to the common-law rule that injuries on the premises are the responsibility of the tenant?
3. Does it mean anything at all to say, as the court does, that persons (including landlords) must “exercise reasonable care not to subject others to an unreasonable risk of harm?” Is this a rule that gives very much direction to landlords who may wonder what the limit of their liabilities might be? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/32%3A_Landlord_and_Tenant_Laws/32.05%3A_Cases.txt |
Summary
A leasehold is an interest in real property that terminates on a certain date. The leasehold itself is personal property and has three major forms: (1) the estate for years, (2) the periodic tenancy, and (3) the tenancy at will. The estate for years has a definite beginning and end; it need not be measured in years. A periodic tenancy—sometimes known as an estate from year to year or month to month—is renewed automatically until either landlord or tenant notifies the other that it will end. A tenancy at will lasts only as long as both landlord and tenant desire. Oral leases are subject to the Statute of Frauds. In most states, leases to last longer than a year must be in writing, and the lease must identify the parties and the premises, specify the duration, state the rent, and be signed by the party to be charged.
The law imposes on the landlord certain duties toward the tenant and gives the tenant corresponding rights, including the right of possession, habitable condition, and noninterference with use. The right of possession is breached if a third party has paramount title at the time the tenant is due to take possession. In most states, a landlord is obligated to provide the tenant with habitable premises not only when the tenant moves in but also during the entire period of the lease. The landlord must also refrain from interfering with a tenant’s permissible use of the premises.
If the landlord breaches an obligation, the tenant has several remedies. He may terminate the lease, recover damages, or (in several states) use a rent-related remedy (by withholding rent, by applying it to remedy the defect, or by abatement).
The tenant has duties also. The tenant must pay the rent. If she abandons the property and fails to pay, most states do not require the landlord to mitigate damages, but several states are moving away from this general rule. The tenant may physically change the property to use it to her best advantage, but she may not make structural alterations or commit waste. The tenant must restore the property to its original condition when the lease ends. This rule does not include normal wear and tear.
Should the tenant breach any of her duties, the landlord may terminate the lease and seek damages. In the case of a holdover tenant, the landlord may elect to hold the tenant to another rental term.
The interest of either landlord or tenant may be transferred freely unless the tenancy is at will, the lease requires either party to perform significant personal services that would be substantially less likely to be performed, or the parties agree that the interest may not be transferred.
Despite the general rule that the tenant is responsible for injuries caused on the premises to outsiders, the landlord may have significant tort liability if (1) there are hidden dangers he knows about, (2) defects that existed at the time the lease was signed injure people off the premises, (3) the premises are rented for public purposes, (4) the landlord retains control of the premises, or (5) the landlord repairs the premises in a faulty manner.
Exercises
1. Lanny orally agrees to rent his house to Tenny for fifteen months, at a monthly rent of \$1,000. Tenny moves in and pays the first month’s rent. Lanny now wants to cancel the lease. May he? Why?
2. Suppose in Exercise 1 that Tenny had an option to cancel after one year. Could Lanny cancel before the end of the year? Why?
3. Suppose in Exercise 1 that Lanny himself is a tenant and has leased the house for six months. He subleases the house to Tenny for one year. The day before Tenny is to move into the house, he learns of Lanny’s six-month lease and attempts to terminate his one-year lease. May he? Why?
4. Suppose in Exercise 3 that Tenny learned of Lanny’s lease the day after he moved into the house. May he terminate? Why?
5. Simon owns a four-story building and rents the top floor to a college student. Simon is in the habit of burning refuse in the backyard, and the smoke from the refuse is so noxious that it causes the student’s eyes to water and his throat to become raw. Has Simon breached a duty to the student? Explain.
6. In Exercise 5, if other tenants (but not Simon) were burning refuse in the backyard, would Simon be in breach? Why?
7. Assume in Exercise 5 that Simon was in breach. Could the student move out of the apartment and terminate the lease? What effect would this have on the student’s duty to pay rent? Explain.
SELF CHECK QUESTIONS
1. International law derives from
1. An estate for years
1. has a definite beginning and end
2. is a leasehold estate
3. usually terminates automatically at midnight of the last day specified in the lease
4. includes all of the above
2. Not included among the rights given to a tenant is
1. paramount title
2. possession
3. habitable condition
4. noninterference with use
3. The interest of either landlord or tenant may be transferred freely
1. unless the tenancy is at will
2. unless the lease requires significant personal services unlikely to be performed by someone else
3. unless either of the above apply
4. under no circumstances
4. When injuries are caused on the premises to outsiders,
1. the tenant is always liable
2. the landlord is always liable
3. the landlord may be liable if there are hidden dangers the landlord knows about
4. they have no cause of action against the landlord or tenant since they have no direct contractual relationship with either party
5. Legally a tenant may
1. commit waste
2. make some structural alterations to the property
3. abandon the property at any time
4. physically change the property to suit it to her best advantage, as long as no structural alterations are made
1. d
2. a
3. c
4. c
5. d | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/32%3A_Landlord_and_Tenant_Laws/32.06%3A_Summary_and_Exercises.txt |
Learning Objectives
After reading this chapter, you should understand the following:
• The concepts of sovereignty, self-determination, failed states, and failing states
• The sources of international law, and examples of treaties, conventions, and customary international law
• How civil-law disputes between the parties from different nation-states can be resolved through national court systems or arbitration
• The well-recognized bases for national jurisdiction over various parties from different nation-states
• The doctrines of forum non conveniens, sovereign immunity, and act of state
The force and authority of a government in any given territory is fundamental to sovereignty. Historically, that was understood to mean a nation’s “right” to issue its own currency, make and enforce laws within its borders without interference from other nations (the “right of self-determination” that is noted in the Charter of the United Nations), and to defend its territory with military force, if necessary. In a nation at relative peace, sovereignty can be exercised without great difficulty. But many countries are in civil war, and others experience “breakaway” areas where force must be used to assert continued sovereignty. In some countries, civil war may lead to the formation of new nation-states, such as in Sudan in 2011.
Thumbnail: The Peace Palace in The Hague, Netherlands, which is the seat of the International Court of Justice. (Public Domain; Yeu Ninje via Wikipedia)
33: International Law
J. L. Austin, the legal realist, famously defined law as “the command of a sovereign.” He had in mind the fact that legal enforcement goes beyond negotiation and goodwill, and may ultimately have to be enforced by some agent of the government. For example, if you fail to answer a summons and complaint, a default judgment will be entered against you; if you fail to pay the judgment, the sheriff (or US marshal) will actually seize assets to pay the judgment, and will come armed with force, if necessary.
In the United States, there was a Civil War from 1860 to 1864, and even now, there are separatist movements, groups who refuse to recognize the authority of the local, state, or national governments. From time to time, these groups will declare their independence of the sovereign, raise their own flag, refuse to pay taxes, and resist government authority with arms. In the United States, the federal government typically responds to these “mini-secessionist” movements with force.
In Canada, the province of Quebec has considered separating from Canada, and this came close to reality in 1995 on a referendum vote for secession that gained 49.4 percent of the votes. Away from North America, claims to exclusive political and legal authority within some geographic area are often the stuff of civil and regional wars. Consider Kosovo’s violent secession from Yugoslavia, or Chechnya’s attempted secession from Russia. At stake in all these struggles is the uncontested right to make and enforce laws within a certain territory. In some nation-states, government control has failed to achieve effective control over substantial areas, leaving factions, tribal groups, or armed groups in control. For such nations, the phrase “failed states” or “failing states” has sometimes been used. A failing state usually has some combination of lack of control over much of its territory, failure to provide public services, widespread corruption and criminality, and sharp economic decline. Somalia, Chad, and Afghanistan, among others, head the list as of 2011.
In a functioning state, the right to make and enforce law is not contested or in doubt. But in the international arena, there is no sovereign lawgiver and law enforcer. If a criminal burglarizes your house and is caught, the legal authorities in your state have little difficulty bringing him to justice. But suppose a dictator or military-run government oppresses some of the citizenry, depriving these citizens of the chance to speak freely, to carry on a trade or profession, to own property, to be educated, or to have access to water and a livable environment, or routinely commits various atrocities against ethnic groups (forced labor, rape, pillage, murder, torture). Who will bring the dictator or government to justice, and before what tribunal?
There is still no forum (court or tribunal) that is universally accepted as a place to try to punish such people. The International Criminal Court has wide support and has prosecuted several individuals for crimes, but the United States has still not agreed to its jurisdiction.
During the 1990s, the United States selectively “policed” certain conflicts (Kosovo, Haiti, Somalia), but it cannot consistently serve over a long period of time as the world’s policeman. The United States has often allowed human rights to be violated in many nations without much protest, particularly during the Cold War with the Union of Soviet Socialist Republics (USSR), where alliances with dictatorships and nondemocratic regimes were routinely made for strategic reasons.
Still, international law is no myth. As we shall see, there are enforceable treaties and laws that most nations abide by, even as they are free to defect from these treaties. Yet the recent retreat by the United States from pending international agreements (the Kyoto Protocol, the International Criminal Court, and others) may be a sign that multilateralism is on the wane or that other nations and regional groupings (the European Union, China) will take a more prominent role in developing binding multilateral agreements among nations.
Key Takeaway
International law is based on the idea of the nation-state that has sovereignty over a population of citizens within a given geographical territory. In theory, at least, this sovereignty means that nation-states should not interfere with legal and political matters within the borders of other nation-states.
Exercises
1. Using news sources, find at least one nation in the world where other nations are officially commenting on or objecting to what goes on within that nation’s borders. Are such objections or comments amounting to an infringement of the other nation’s sovereignty?
2. Using news sources, find at least one nation in the world that is engaged in trying to change the political and legal landscape of another nation. What is it doing, and why? Is this an infringement of the other nation’s sovereignty?
3. What is a failed state? What is a failing state? What is the difference? Is either one a candidate for diplomatic recognition of its sovereignty? Discuss. | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.01%3A_Introduction_to_International_Law.txt |
Learning Objectives
By the end of this section, you will be able to:
• Explain what a treaty is and how it differs from a convention.
• Understand that a treaty can be a voluntary relinquishment of some aspects of sovereignty.
• Describe customary international law, and explain how it is different from treaties as a source of international law.
• Describe some of the difficulties in enforcing one nation’s judicial judgments in another nation.
In this section, we shall be looking at a number of different sources of international law. These sources include treaties and conventions, decisions of courts in various countries (including decisions in your own state and nation), decisions of regional courts (such as the European Court of Justice), the World Trade Organization (WTO), resolutions of the United Nations (UN), and decisions by regional trade organizations such as the North American Free Trade Agreement (NAFTA). These sources are different from most of the cases in your textbook, either because they involve parties from different nations or because the rule makers or decision makers affect entities beyond their own borders.
In brief, the sources of international law include everything that an international tribunal might rely on to decide international disputes. International disputes include arguments between nations, arguments between individuals or companies from different nations, and disputes between individuals or companies and a foreign nation-state. Article 38(1) of the Statute of the International Court of Justice (ICJ) lists four sources of international law: treaties and conventions, custom, general principles of law, and judicial decisions and teachings.
The ICJ only hears lawsuits between nation-states. Its jurisdiction is not compulsory, meaning that both nations in a dispute must agree to have the ICJ hear the dispute.
Treaties and Conventions
Even after signing a treaty or convention, a nation is always free to go it alone and repudiate all regional or international bodies, or refuse to obey the dictates of the United Nations or, more broadly and ambiguously, “the community of nations.” The United States could repudiate NAFTA, could withdraw from the UN, and could let the WTO know that it would no longer abide by the post–World War II rules of free trade embodied in the General Agreement on Tariffs and Trade (GATT). The United States would be within its rights as a sovereign to do so, since it owes allegiance to no global or international sovereign. Why, however, does it not do so? Why is the United States so involved with the “entangling alliances” that George Washington warned about? Simply put, nations will give away part of their sovereignty if they think it’s in their self-interest to do so. For example, if Latvia joins the European Union (EU), it gives up its right to have its own currency but believes it has more to gain.
A treaty is nothing more than an agreement between two sovereign nations. In international law, a nation is usually called a state or nation-state. This can be confusing, since there are fifty US states, none of which has power to make treaties with other countries. It may be helpful to recall that the thirteen original states under the Articles of Confederation were in fact able to have direct relations with foreign states. Thus New Jersey (for a few brief years) could have had an ambassador to France or made treaties with Spain. Such a decentralized confederation did not last long. Under the present Constitution, states gave up their right to deal directly with other countries and vested that power in the federal government.
There are many treaties to which the United States is a party. Some of these are conventions, which are treaties on matters of common concern, usually negotiated on a regional or global basis, sponsored by an international organization, and open to adoption by many nations. For example, as of 2011, there were 192 parties (nation-states) that had signed on to the Charter of the UN, including the United States, Uzbekistan, Ukraine, Uganda, United Arab Emirates, United Kingdom of Great Britain and Northern Ireland, and Uruguay (just to name a few of the nations starting with U).
The most basic kind of treaty is an agreement between two nation-states on matters of trade and friendly relations. Treaties of friendship, commerce, and navigation (FCN treaties) are fairly common and provide for mutual respect for each nation-state’s citizens in (1) rights of entry, (2) practice of professions, (3) right of navigation, (4) acquisition of property, (5) matters of expropriation or nationalization, (6) access to courts, and (7) protection of patent rights. Bilateral investment treaties (BITs) are similar but are more focused on commerce and investment. The commercial treaties may deal with a specific product or product group, investment, tariffs, or taxation.
Nation-states customarily enter not only into FCN treaties and BITs but also into peace treaties or weapons limitations treaties, such as the US-Russia Strategic Arms Reduction Talks (START) treaty. Again, treaties are only binding as long as each party continues to recognize their binding effect. In the United States, the procedure for ratifying a treaty is that the Senate must approve it by a two-thirds vote (politically, an especially difficult number to achieve). Once ratified, a treaty has the same force of law within the United States as any statute that Congress might pass.
Custom
Custom between nations is another source of international law. Custom is practice followed by two or more nations in the course of dealing with each other. These practices can be found in diplomatic correspondence, policy statements, or official government statements. To become custom, a consistent and recurring practice must go on over a significant period of time, and nations must recognize that the practice or custom is binding and must follow it because of legal obligation and not mere courtesy. Customs may become codified in treaties.
General Principles of Law, or Customary International Law
Even without treaties, there would be some international law, since not all disputes are confined to the territory of one nation-state. For example, in In re the Bremen, a US company’s disagreement with a German company was heard in US courts. The US courts had to decide where the dispute would properly be heard. In giving full effect to a forum-selection clause, the US Supreme Court set out a principle that it hoped would be honored by courts of other nations—namely, that companies from different states should honor any forum-selection clause in their contract to settle disputes at a specific place or court. (See the Bremen case, Section 33.5.1 “Forum-selection clauses”). If that principle is followed by enough national court systems, it could become a principle of customary international law. As an example, consider that for many years, courts in many nations believed that sovereign immunity was an established principle of international law.
Judicial Decisions in International Tribunals; Scholarly Teachings
The Statute of the International Court of Justice recognizes that international tribunals may also refer to the teachings of preeminent scholars on international law. The ICJ, for example, often referred to the scholarly writings of Sir Hersh Lauterpacht in its early decisions. Generally, international tribunals are not bound by stare decisis (i.e., they may decide each case on its merits). However, courts such as the ICJ do refer to their own past decisions for guidance.
There are many international tribunals, including the European Court of Justice, the ICJ, and the International Criminal Court. Typically, however, disputes between corporations or between individuals that cross national boundaries must be resolved in national court systems or in arbitration. In other words, there is no international civil court, and much complexity in international law derives from the fact that national court systems must often choose from different sources of law, using different legal traditions in order to resolve international disputes. For example, a court in one nation may have some difficulty accepting the judgment of a foreign nation’s court system, as we see in Koster v. Automark (see Section 33.5.2 “Due process in the enforcement of judgments”).
Due Process and Recognition of Foreign Judgments
Issues surrounding recognition of foreign judgments arise when one nation’s courts have questions about the fairness of procedures used in foreign courts to acquire the judgment. Perhaps the defendant was not notified or did not have ample time in which to prepare a defense, or perhaps some measure of damages was assessed that seemed distinctly unfair. If a foreign state makes a judgment against a US company, the judgment will not be recognized and enforced in the United States unless the US court believes that the foreign judgment provided the US company with due process. But skepticism about a foreign judgment works the other way, as well. For example, if a US court were to assess punitive damages against a Belgian company, and the successful plaintiff were to ask for enforcement of the US judgment in Belgium, the Belgian court would reject that portion of the award based on punitive damages. Compensatory damages would be allowed, but as Belgian law does not recognize punitive damages, it might not recognize that portion of the US court’s award.
Concerns about notice, service of process, and the ability to present certain defenses are evident in Koster v. Automark. Many such concerns are eliminated with the use of forum-selection clauses. The classic case in US jurisprudence is the Bremen case, which resolves difficult questions of where the case should be tried between a US and German company by approving the use of a forum-selection clause indicating that a court in the United Kingdom would be the only forum that could hear the dispute.
Part of what is going on in Bremen is the Supreme Court’s concern that due process should be provided to the US company. What is fair (procedurally) is the dominant question in this case. One clear lesson is that issues of fairness regarding personal jurisdiction can be resolved with a forum-selection clause—if both parties agree to a forum that would have subject matter jurisdiction, at least minimal fairness is evident, because both parties have “consented” to have the forum decide the case.
Arbitration
The idea that a forum-selection clause could, by agreement of the parties, take a dispute out of one national court system and into another court system is just one step removed from the idea that the parties can select a fair resolution process that does not directly involve national court systems. In international arbitration, parties can select, either before or after a dispute arises, an arbitrator or arbitral panel that will hear the dispute. As in all arbitration, the parties agree that the arbitrator’s decision will be final and binding. Arbitration is generally faster, can be less expensive, and is always private, being a proceeding not open to media scrutiny.
Typically, an arbitration clause in the contract will specify the arbitrator or the means of selecting the arbitrator. For that purpose, there are many organizations that conduct international arbitrations, including the American Arbitration Association, the International Chamber of Commerce, the International Centre for Settlement of Investment Disputes, and the United Nations Commission on International Trade Law. Arbitrators need not be judges or lawyers; they are usually business people, lawyers, or judges who are experienced in global commercial transactions. The arbitration clause is thus in essence a forum-selection clause and usually includes a choice of law for the arbitrator or arbitral panel to follow.
An arbitral award is not a judgment. If the losing party refuses to pay the award, the winning party must petition a court somewhere to enforce it. Fortunately, almost every country that is engaged in international commerce has ratified the United Nations Convention on the Recognition and Enforcement of Arbitral Awards, sometimes known as the New York Convention. The United States adopted this convention in 1970 and has amended the Federal Arbitration Act accordingly. Anyone who has an arbitral award subject to the convention can attach property of the loser located in any country that has signed the convention.
Key Takeaway
Treaties and conventions, along with customary international law, are the primary sources of what we call international law. Disputes involving parties from different nation-states are resolved in national (federal) court systems, and one nation’s recognition and enforcement of another nation’s judicial orders or judgments will require reciprocal treaties or some review that the order or judgment was fairly obtained (that there was due process in the determination of the order or judgment).
Exercises
1. At the US Senate website, read about the history of treaties in the United States. What is an “executive agreement,” and why has the use of executive agreements grown so fast since World War II?
2. Is NAFTA a treaty or an executive agreement? What practical difference does it make if it is one rather than the other? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.02%3A_Sources_and_Practice_of_International_Law.txt |
Learning Objectives
By the end of this section, you will be able to:
• Define and describe the three traditional bases for a nation’s jurisdiction over those individuals and entities from other nation-states.
• Explain forum non conveniens and be able to apply that in a case involving citizens from two different nation-states.
• Describe and explain the origins of both sovereign immunity and the act-of-state doctrine, and be able to distinguish between the two.
Bases for National Jurisdiction under International Law
A nation-state has jurisdiction to make and enforce laws (1) within its own borders, (2) with respect to its citizens (nationals”) wherever they might be, and (3) with respect to actions taking place outside the territory but having an objective or direct impact within the territory. In the Restatement (Third) of Foreign Relations Law, these three jurisdictional bases are known as (1) the territorial principle, (2) the nationality principle, and (3) the objective territoriality principle.
As we have already seen, many difficult legal issues involve jurisdictional problems. When can a court assert authority over a person? (That’s the personal jurisdiction question.) When can a court apply its own law rather than the law of another state? When is it obligated to respect the legal decisions of other states? All these problems have been noted in the context of US domestic law, with its state-federal system; the resolution of similar problems on a global scale are only slightly more complicated.
The territorial principle is fairly simple. Anything that happens within a nation’s borders is subject to its laws. A German company that makes direct investment in a plant in Spartanburg, South Carolina, is subject to South Carolina law and US law as well.
Nationality jurisdiction often raises problems. The citizens of a nation-state are subject to its laws while within the nation and beyond. The United States has passed several laws that govern the conduct of US nationals abroad. United States companies may not, for example, bribe public officials of foreign countries in order to get contracts (Foreign Corrupt Practices Act of 1976). Title VII of the Civil Rights Act also applies extraterritorially—where a US citizen is employed abroad by a US company.
For example, suppose Jennifer Stanley (a US citizen) is discriminated against on the basis of gender by Aramco (a US-based company) in Saudi Arabia, and she seeks to sue under Title VII of the Civil rights Act of 1964. The extraterritorial reach of US law seems odd, especially if Saudi Arabian law or custom conflicts with US law. Indeed, in EEOC v. Arabian American Oil Co., the Supreme Court was hesitant to say that US law would “reach” across the globe to dictate proper corporate conduct.EEOC v. Arabian American Oil Co. 499 U.S. 244 (1991). Later that year, Congress made it clear by amending Title VII so that its rules would in fact reach that far, at least where US citizens were the parties to a dispute. But if Saudi Arabian law directly conflicted with US law, principles of customary international law would require that territorial jurisdiction would trump nationality jurisdiction.
Note that where the US laws conflict with local or host country laws, we have potential conflict in the extraterritorial application of US law to activities in a foreign land. See, for example, Kern v. Dynalectron.Kern v. Dynalectron, 746 F.2d 810 (1984). In Kern, a Baptist pilot (US citizen) wanted to work for a company that provided emergency services to those Muslims who were on a pilgrimage to Mecca. The job required helicopter pilots to occasionally land to provide emergency services. However, Saudi law required that all who set foot in Mecca must be Muslim. Saudi law provided for death to violators. Kern (wanting the job) tried to convert but couldn’t give up his Baptist roots. He sued Dynalectron (a US company) for discrimination under Title VII, claiming that he was denied the job because of his religion. Dynalectron did not deny that they had discriminated on the basis of his religion but argued that because of the Saudi law, they had no viable choice. Kern lost on the Title VII claim (his religion was a bona fide occupational qualification). The court understood that US law would apply extraterritorially because of his nationality and the US nationality of his employer.
The principle of objective territoriality is fairly simple: acts taking place within the borders of one nation can have a direct and foreseeable impact in another nation. International law recognizes that nation-states act appropriately when they make and enforce law against actors whose conduct has such direct effects. A lawsuit in the United States against Osama bin Laden and his relatives in the Middle East was based on objective territoriality. (Based in Afghanistan, the Al Qaeda leader who claimed credit for attacks on the United States on September 11, 2001.)
Where a defendant is not a US national or is not located in the United States when prosecution or a civil complaint is filed, there may be conflicts between the United States and the country of the defendant’s nationality. One of the functions of treaties is to map out areas of agreement between nation-states so that when these kinds of conflicts arise, there is a clear choice of which law will govern. For example, in an extradition treaty, two nation-states will set forth rules to apply when one country wants to prosecute someone who is present in the other country. In general, these treaties will try to give priority to whichever country has the greater interest in taking jurisdiction over the person to be prosecuted.
Once jurisdiction is established in US courts in cases involving parties from two different nations, there are some important limiting doctrines that business leaders should be aware of. These are forum non conveniens, sovereign immunity, and the act-of-state doctrine. Just as conflicts arise over the proper venue in US court cases where two states’ courts may claim jurisdiction, so do conflicts occur over the proper forum when the court systems of two nation-states have the right to hear the case.
Forum Non Conveniens; Forum-Selection Clauses
Forum non conveniens is a judicial doctrine that tries to determine the proper forum when the courts of two different nation-states can claim jurisdiction. For example, when Union Carbide’s plant in Bhopal, India, exploded and killed or injured thousands of workers and local citizens, the injured Indian plaintiffs could sue Union Carbide in India (since Indian negligence law had territorial effect in Bhopal and Union Carbide was doing business in India) or Union Carbide in the United States (since Union Carbide was organized and incorporated in the United States, which would thus have both territorial and nationality bases for jurisdiction over Union Carbide). Which nation’s courts should take a primary role? Note that forum non conveniens comes into play when courts in two different nation-states both have subject matter and personal jurisdiction over the matter. Which nation’s court system should take the case? That, in essence, is the question that the forum non conveniens doctrine tries to answer.
In the Bremen case (Section 33.5.1 “Forum-selection clauses”), the German contractor (Unterweser) had agreed to tow a drilling rig owned by Zapata from Galveston, Texas, to the Adriatic Sea. The drilling rig was towed by Unterweser’s vessel, The Bremen. An accident in the Gulf damaged the drilling rig, and Zapata sued in US district court in Florida. Unterweser argued that London was a “better,” or more convenient, forum for the resolution of Zapata’s claim against Unterweser, but the district court rejected that claim. Had it not been for the forum-selection clause, the claim would have been resolved in Tampa, Florida. The Bremen case, although it does have a forum non conveniens analysis, is better known for its holding that in cases where sophisticated parties engage in arms-length bargaining and select a forum in which to settle their disputes, the courts will not second-guess that selection unless there is fraud or unless one party has overwhelming bargaining power over the other.
In short, parties to an international contract can select a forum (a national court system and even a specific court within that system, or an arbitral forum) to resolve any disputes that might arise. In the Bremen case, Zapata was held to its choice; this tells you that international contracting requires careful attention to the forum-selection clause. Since the Bremen case, the use of arbitration clauses in international contracting has grown exponentially. The arbitration clause is just like a forum-selection clause; instead of the party’s selecting a judicial forum, the arbitration clause points to resolution of the dispute by an arbitrator or an arbitral panel.
Where there is no forum-selection clause, as in most tort cases, corporate defendants often find it useful to invoke forum non conveniens to avoid a lawsuit in the United States, knowing that the lawsuit elsewhere cannot as easily result in a dollar-value judgment. Consider the case of Gonzalez v. Chrysler Corporation (see Section 33.5.3 “Forum non conveniens”).
Sovereign Immunity
For many years, sovereigns enjoyed complete immunity for their own acts. A king who established courts for citizens (subjects) to resolve their disputes would generally not approve of judges who allowed subjects to sue the king (the sovereign) and collect money from the treasury of the realm. If a subject sued a foreign sovereign, any judgment would have to be collectible in the foreign realm, and no king would allow another king’s subjects to collect on his treasury, either. In effect, claims against sovereigns, domestic or foreign (at home or abroad), just didn’t get very far. Judges, seeing a case against a sovereign, would generally dismiss it on the basis of “sovereign immunity.” This became customary international law.
In the twentieth century, the rise of communism led to state-owned companies that began trading across national borders. But when a state-owned company failed to deliver the quantity or quality of goods agreed upon, could the disappointed buyer sue? Many tried, but sovereign immunity was often invoked as a reason why the court should dismiss the lawsuit. Indeed, most lawsuits were dismissed on this basis. Gradually, however, a few courts began distinguishing between governmental acts and commercial acts: where a state-owned company was acting like a private, commercial entity, the court would not grant immunity. This became known as the “restrictive” version of sovereign immunity, in contrast to “absolute” sovereign immunity. In US courts, decisions as to sovereign immunity after World War II were often political in nature, with the US State Department giving advisory letters on a case-by-case basis, recommending (or not recommending) that the court grant immunity to the foreign state. Congress moved to clarify matters in 1976 by passing the Foreign Sovereign Immunities Act, which legislatively recognized the restrictive theory. Note, especially, Section 1605(a)(2).
Jurisdictional Immunities of Foreign States
28 USCS § 1602 (1998)
§ 1602. Findings and declaration of purpose
The Congress finds that the determination by United States courts of the claims of foreign states to immunity from the jurisdiction of such courts would serve the interests of justice and would protect the rights of both foreign states and litigants in United States courts. Under international law, states are not immune from the jurisdiction of foreign 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. Claims of foreign states to immunity should henceforth be decided by courts of the United States and of the States in conformity with the principles set forth in this chapter [28 USCS §§ 1602 et seq.].
§ 1603. Definitions
For purposes of this chapter [28 USCS §§ 1602 et seq.]—
(a) A “foreign state”, except as used in section 1608 of this title, includes a political subdivision of a foreign state or an agency or instrumentality of a foreign state as defined in subsection (b).
(b) An “agency or instrumentality of a foreign state” means any entity—
(1) which is a separate legal person, corporate or otherwise, and
(2) which is an organ of a foreign state or political subdivision thereof, or a majority of whose shares or other ownership interest is owned by a foreign state or political subdivision thereof, and
(3) which is neither a citizen of a State of the United States as defined in section 1332(c) and (d) of this title nor created under the laws of any third country.
(c) The “United States” includes all territory and waters, continental or insular, subject to the jurisdiction of the United States.
(d) A “commercial activity” means either a regular course of commercial conduct or a particular commercial transaction or act. The commercial character of an activity shall be determined by reference to the nature of the course of conduct or particular transaction or act, rather than by reference to its purpose.
(e) A “commercial activity carried on in the United States by a foreign state” means commercial activity carried on by such state and having substantial contact with the United States.
§ 1604. Immunity of a foreign state from jurisdiction
Subject to existing international agreements to which the United States is a party at the time of enactment of this Act [enacted Oct. 21, 1976] a foreign state shall be immune from the jurisdiction of the courts of the United States and of the States except as provided in sections 1605 to 1607 of this chapter.
§ 1605. General exceptions to the jurisdictional immunity of a foreign state
(a) A foreign state shall not be immune from the jurisdiction of courts of the United States or of the States in any case—
(1) in which the foreign state has waived its immunity either explicitly or by implication, notwithstanding any withdrawal of the waiver which the foreign state may purport to effect except in accordance with the terms of the waiver;
(2) in which the action is based upon a commercial activity carried on in the United States by the foreign state; or upon an act performed in the United States in connection with a commercial activity of the foreign state elsewhere; or upon an act outside the territory of the United States in connection with a commercial activity of the foreign state elsewhere and that act causes a direct effect in the United States;
(3) in which rights in property taken in violation of international law are in issue and that property or any property exchanged for such property is present in the United States in connection with a commercial activity carried on in the United States by the foreign state; or that property or any property exchanged for such property is owned or operated by an agency or instrumentality of the foreign state and that agency or instrumentality is engaged in a commercial activity in the United States;
(4) in which rights in property in the United States acquired by succession or gift or rights in immovable property situated in the United States are in issue;
(5) not otherwise encompassed in paragraph (2) above, in which money damages are sought against a foreign state for personal injury or death, or damage to or loss of property, occurring in the United States and caused by the tortious act or omission of that foreign state or of any official or employee of that foreign state while acting within the scope of his office or employment; except this paragraph shall not apply to—
(A) any claim based upon the exercise or performance or the failure to exercise or perform a discretionary function regardless of whether the discretion be abused, or
(B) any claim arising out of malicious prosecution, abuse of process, libel, slander, misrepresentation, deceit, or interference with contract rights;
Act of State
A foreign country may expropriate private property and be immune from suit in the United States by the former owners, who might wish to sue the country directly or seek an order of attachment against property in the United States owned by the foreign country. In the United States, the government may constitutionally seize private property under certain circumstances, but under the Fifth Amendment, it must pay “just compensation” for any property so taken. Frequently, however, foreign governments have seized the assets of US corporations without recompensing them for the loss. Sometimes the foreign government seizes all private property in a certain industry, sometimes only the property of US citizens. If the seizure violates the standards of international law—as, for example, by failing to pay just compensation—the question arises whether the former owners may sue in US courts. One problem with permitting the courts to hear such claims is that by time of suit, the property may have passed into the hands of bona fide purchasers, perhaps even in other countries.
The Supreme Court has enunciated a doctrine governing claims to recover for acts of expropriation. This is known as the act-of-state doctrine. As the Supreme Court put it in 1897, “Every sovereign State is bound to respect the independence of every other sovereign State, and the courts of one country will not sit in judgment on…[and thereby adjudicate the legal validity of] the acts of the government of another done within its own territory.”Underhill v. Hernandez, 168 U.S. 250, 252 (1897). This means that US courts will “reject private claims based on the contention that the damaging act of another nation violates either US or international law.”Mannington Mills, Inc. v. Congoleum Corp., 595 F.2d 1287 (3d Cir. 1979). Sovereign immunity and the act-of-state doctrine rest on different legal principles and have different legal consequences. The doctrine of sovereign immunity bars a suit altogether: once a foreign-government defendant shows that sovereign immunity applies to the claims the plaintiff has raised, the court has no jurisdiction even to consider them and must dismiss the case. By contrast, the act-of-state doctrine does not require dismissal in a case properly before a court; indeed, the doctrine may be invoked by plaintiffs as well as defendants. Instead, it precludes anyone from arguing against the legal validity of an act of a foreign government. In a simple example, suppose a widow living in the United States is sued by her late husband’s family to prevent her from inheriting his estate. They claim she was never married to the deceased. She shows that while citizens of another country, they were married by proclamation of that country’s legislature. Although legislatures do not marry people in the United States, the act-of-state doctrine would bar a court from denying the legal validity of the marriage entered into in their home country.
The Supreme Court’s clearest statement came in a case growing out of the 1960 expropriation of US sugar companies operating in Cuba. A sugar broker had entered into contracts with a wholly owned subsidiary of Compania Azucarera Vertientes-Camaguey de Cuba (C.A.V.), whose stock was principally owned by US residents. When the company was nationalized, sugar sold pursuant to these contracts had been loaded onto a German vessel still in Cuban waters. To sail, the skipper needed the consent of the Cuban government. That was forthcoming when the broker agreed to sign contracts with the government that provided for payment to a Cuban bank rather than to C.A.V. The Cuban bank assigned the contracts to Banco Nacional de Cuba, an arm of the Cuban government. However, when C.A.V. notified the broker that in its opinion, C.A.V. still owned the sugar, the broker agreed to turn the process of the sale over to Sabbatino, appointed under New York law as receiver of C.A.V.’s assets in the state. Banco Nacional de Cuba then sued Sabbatino, alleging that the broker’s refusal to pay Banco the proceeds amounted to common-law conversion.
The federal district court held for Sabbatino, ruling that if Cuba had simply failed to abide by its own law, C.A.V.’s stockholders would have been entitled to no relief. But because Cuba had violated international law, the federal courts did not need to respect its act of appropriation. The violation of international law, the court said, lay in Cuba’s motive for the expropriation, which was retaliation for President Eisenhower’s decision to lower the quota of sugar that could be imported into the United States, and not for any public purpose that would benefit the Cuban people; moreover, the expropriation did not provide for adequate compensation and was aimed at US interests only, not those of other foreign nationals operating in Cuba. The US court of appeals affirmed the lower court’s decision, holding that federal courts may always examine the validity of a foreign country’s acts.
But in Banco Nacional de Cuba v. Sabbatino, the Supreme Court reversed, relying on the act-of-state doctrine.Banco Nacional de Cuba v. Sabbatino, 376 U.S. 398 (1964). This doctrine refers, in the words of the Court, to the “validity of the public acts a recognized foreign sovereign power commit[s] within its own territory.” If the foreign state exercises its own jurisdiction to give effect to its public interests, however the government defines them, the expropriated property will be held to belong to that country or to bona fide purchasers. For the act-of-state doctrine to be invoked, the act of the foreign government must have been completely executed within the country—for example, by having enacted legislation expropriating the property. The Supreme Court said that the act-of-state doctrine applies even though the United States had severed diplomatic relations with Cuba and even though Cuba would not reciprocally apply the act-of-state doctrine in its own courts.
Despite its consequences in cases of expropriations, the act-of-state doctrine is relatively narrow. As W. S. Kirkpatrick Co., Inc. v. Environmental Tectonics Co. (Section 33.5.4 “Act of State”) shows, it does not apply merely because a judicial inquiry in the United States might embarrass a foreign country or even interfere politically in the conduct of US foreign policy.
Key Takeaway
Each nation-state has several bases of jurisdiction to make and enforce laws, including the territorial principle, nationality jurisdiction, and objective territoriality. However, nation-states will not always choose to exercise their jurisdiction: the doctrines of forum non conveniens, sovereign immunity, and act of state limit the amount and nature of judicial activity in one nation that would affect nonresident parties and foreign sovereigns.
Exercises
1. Argentina sells bonds on the open market, and buyers all around the world buy them. Five years later, Argentina declares that it will default on paying interest or principal on these bonds. Assume that Argentina has assets in the United States. Is it likely that a bondholder in the United States can bring an action in US courts that will not be dismissed for lack of subject matter jurisdiction?
2. During the Falkland Island war between Argentina and Great Britain, neutral tanker traffic was at risk of being involved in hostilities. Despite diplomatic cables from the United States assuring Argentina of the vessels’ neutrality, an oil tanker leased by Amerada Hess, traveling from Puerto Rico to Valdez, Alaska, was repeatedly bombed by the Argentine air force. The ship had to be scuttled, along with its contents. Will a claim by Amerada Hess be recognized in US courts? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.03%3A_Important_Doctrines_of_Nation-State_Judicial_Decisions.txt |
Learning Objectives
By the end of this section, you will be able to:
• Understand why nation-states have sometimes limited imports but not exports.
• Explain why nation-states have given up some of their sovereignty by lowering tariffs in agreement with other nation-states.
Before globalization, nation-states traded with one another, but they did so with a significant degree of protectiveness. For example, one nation might have imposed very high tariffs (taxes on imports from other countries) while not taxing exports in order to encourage a favorable “balance of trade.” The balance of trade is an important statistic for many countries; for many years, the US balance of trade has been negative because it imports far more than it exports (even though the United States, with its very large farms, is the world’s largest exporter of agricultural products). This section will explore import and export controls in the context of the global agreement to reduce import controls in the name of free trade.
Export Controls
The United States maintains restrictions on certain kinds of products being sold to other nations and to individuals and firms within those nations. For example, the Export Administration Act of 1985 has controlled certain exports that would endanger national security, drain scarce materials from the US economy, or harm foreign policy goals. The US secretary of commerce has a list of controlled commodities that meet any of these criteria.
More specifically, the Arms Export Control Act permits the president to create a list of controlled goods related to military weaponry, and no person or firm subject to US law can export any listed item without a license. When the United States has imposed sanctions, the International Emergency Economic Powers Act (IEEPA) has often been the legislative basis; and the act gives the president considerable power to impose limitations on trade. For example, in 1979, President Carter, using IEEPA, was able to impose sanctions on Iran after the diplomatic hostage crisis. The United States still imposes travel restrictions and other sanctions on Cuba, North Korea, and many other countries.
Import Controls and Free Trade
Nation-states naturally wish to protect their domestic industries. Historically, protectionism has come in the form of import taxes, or tariffs, also called duties. The tariff is simply a tax imposed on goods when they enter a country. Tariffs change often and vary from one nation-state to another. Efforts to implement free trade began with the General Agreement on Tariffs and Trade (GATT) and are now enforced through the World Trade Organization (WTO); the GATT and the WTO have sought, through successive rounds of trade talks, to decrease the number and extent of tariffs that would hinder the free flow of commerce from one nation-state to another. The theory of comparative advantage espoused by David Ricardo is the basis for the gradual but steady of tariffs, from early rounds of talks under the GATT to the Uruguay Round, which established the WTO.
The GATT was a huge multilateral treaty negotiated after World War II and signed in 1947. After various “rounds” of re-negotiation, the Uruguay Round ended in 1994 with the United States and 125 other nation-states signing the treaty that established the WTO. In 1948, the worldwide average tariff on industrial goods was around 40 percent. That number is now more like 4 percent as globalization has taken root. Free-trade proponents claim that globalization has increased general well-being, while opponents claim that free trade has brought outsourcing, industrial decline, and the hollowing-out of the US manufacturing base. The same kinds of criticisms have been directed at the North American Free Trade Agreement (NAFTA).
The Uruguay Round was to be succeeded by the Doha Round. But that round has not concluded because developing countries have not been satisfied with the proposed reductions in agricultural tariffs imposed by the more developed economies; developing countries have been resistant to further agreements unless and until the United States and the European Union lower their agricultural tariffs.
There are a number of regional trade agreements other than NAFTA. The European Union, formerly the Common Market, provides for the free movement of member nations’ citizens throughout the European Union (EU) and sets union-wide standards for tariffs, subsidies, transportation, human rights, and many other issues. Another regional trade agreement is Mercosur—an organization formed by Brazil, Argentina, Uruguay, and Paraguay to improve trade and commerce among those South American nations. Almost all trade barriers between the four nations have been eliminated, and the organization has also established a broad social agenda focusing on education, culture, the environment, and consumer protection.
Key Takeaway
Historically, import controls were more common than export controls; nation-states would typically impose tariffs (taxes) on goods imported from other nation-states. Some nation-states, such as the United States, nevertheless maintain certain export controls for national security and military purposes. Most nation-states have voluntarily given up some of their sovereignty in order to gain the advantages of bilateral and multilateral trade and investment treaties. The most prominent example of a multilateral trade treaty is the GATT, now administered by the WTO. There are also regional free-trade agreements, such as NAFTA and Mercosur, that provide additional relaxation of tariffs beyond those agreed to under the WTO.
Exercises
1. Look at various sources and describe, in one hundred or fewer words, why the Doha Round of WTO negotiations has not been concluded.
2. What is the most recent bilateral investment treaty (BIT) that has been concluded between the United States and another nation-state? What are its key provisions? Which US businesses are most helped by this treaty? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.04%3A_Regulating_Trade.txt |
Forum-selection clauses
In re the Bremen
407 U.S. 1 (1972)
MR. CHIEF JUSTICE BURGER delivered the opinion of the Court.
We granted certiorari to review a judgment of the United States Court of Appeals for the Fifth Circuit declining to enforce a forum-selection clause governing disputes arising under an international towage contract between petitioners and respondent. The circuits have differed in their approach to such clauses. For the reasons stated hereafter, we vacate the judgment of the Court of Appeals.
In November 1967, respondent Zapata, a Houston-based American corporation, contracted with petitioner Unterweser, a German corporation, to tow Zapata’s ocean-going, self-elevating drilling rig Chaparral from Louisiana to a point off Ravenna, Italy, in the Adriatic Sea, where Zapata had agreed to drill certain wells.
Zapata had solicited bids for the towage, and several companies including Unterweser had responded. Unterweser was the low bidder and Zapata requested it to submit a contract, which it did. The contract submitted by Unterweser contained the following provision, which is at issue in this case:
Any dispute arising must be treated before the London Court of Justice.
In addition the contract contained two clauses purporting to exculpate Unterweser from liability for damages to the towed barge. After reviewing the contract and making several changes, but without any alteration in the forum-selection or exculpatory clauses, a Zapata vice president executed the contract and forwarded it to Unterweser in Germany, where Unterweser accepted the changes, and the contract became effective.
On January 5, 1968, Unterweser’s deep sea tug Bremen departed Venice, Louisiana, with the Chaparral in tow bound for Italy. On January 9, while the flotilla was in international waters in the middle of the Gulf of Mexico, a severe storm arose. The sharp roll of the Chaparral in Gulf waters caused its elevator legs, which had been raised for the voyage, to break off and fall into the sea, seriously damaging the Chaparral. In this emergency situation Zapata instructed the Bremen to tow its damaged rig to Tampa, Florida, the nearest port of refuge.
On January 12, Zapata, ignoring its contract promise to litigate “any dispute arising” in the English courts, commenced a suit in admiralty in the United States District Court at Tampa, seeking \$3,500,000 damages against Unterweser in personam and the Bremen in rem, alleging negligent towage and breach of contract. Unterweser responded by invoking the forum clause of the towage contract, and moved to dismiss for lack of jurisdiction or on forum non conveniens grounds, or in the alternative to stay the action pending submission of the dispute to the “London Court of Justice.” Shortly thereafter, in February, before the District Court had ruled on its motion to stay or dismiss the United States action, Unterweser commenced an action against Zapata seeking damages for breach of the towage contract in the High Court of Justice in London, as the contract provided. Zapata appeared in that court to contest jurisdiction, but its challenge was rejected, the English courts holding that the contractual forum provision conferred jurisdiction.
In the meantime, Unterweser was faced with a dilemma in the pending action in the United States court at Tampa. The six-month period for filing action to limit its liability to Zapata and other potential claimants was about to expire, but the United States District Court in Tampa had not yet ruled on Unterweser’s motion to dismiss or stay Zapata’s action. On July 2, 1968, confronted with difficult alternatives, Unterweser filed an action to limit its liability in the District Court in Tampa. That court entered the customary injunction against proceedings outside the limitation court, and Zapata refiled its initial claim in the limitation action.
It was only at this juncture, on July 29, after the six-month period for filing the limitation action had run, that the District Court denied Unterweser’s January motion to dismiss or stay Zapata’s initial action. In denying the motion, that court relied on the prior decision of the Court of Appeals in Carbon Black Export, Inc. In that case the Court of Appeals had held a forum-selection clause unenforceable, reiterating the traditional view of many American courts that “agreements in advance of controversy whose object is to oust the jurisdiction of the courts are contrary to public policy and will not be enforced.”
* * *
Thereafter, on January 21, 1969, the District Court denied another motion by Unterweser to stay the limitation action pending determination of the controversy in the High Court of Justice in London and granted Zapata’s motion to restrain Unterweser from litigating further in the London court. The District Judge ruled that, having taken jurisdiction in the limitation proceeding, he had jurisdiction to determine all matters relating to the controversy. He ruled that Unterweser should be required to “do equity” by refraining from also litigating the controversy in the London court, not only for the reasons he had previously stated for denying Unterweser’s first motion to stay Zapata’s action, but also because Unterweser had invoked the United States court’s jurisdiction to obtain the benefit of the Limitation Act.
On appeal, a divided panel of the Court of Appeals affirmed, and on rehearing en banc the panel opinion was adopted, with six of the 14 en banc judges dissenting.The term en banc means that all the judges of a circuit court of appeals heard oral arguments and voted to decide the outcome of the case. As had the District Court, the majority rested on the Carbon Black decision, concluding that “at the very least” that case stood for the proposition that a forum-selection clause “will not be enforced unless the selected state would provide a more convenient forum than the state in which suit is brought.” From that premise the Court of Appeals proceeded to conclude that, apart from the forum-selection clause, the District Court did not abuse its discretion in refusing to decline jurisdiction on the basis of forum non conveniens. It noted that (1) the flotilla never “escaped the Fifth Circuit’s mare nostrum, and the casualty occurred in close proximity to the district court”; (2) a considerable number of potential witnesses, including Zapata crewmen, resided in the Gulf Coast area; (3) preparation for the voyage and inspection and repair work had been performed in the Gulf area; (4) the testimony of the Bremen crew was available by way of deposition; (5) England had no interest in or contact with the controversy other than the forum-selection clause. The Court of Appeals majority further noted that Zapata was a United States citizen and “[t]he discretion of the district court to remand the case to a foreign forum was consequently limited”—especially since it appeared likely that the English courts would enforce the exculpatory clauses. In the Court of Appeals’ view, enforcement of such clauses would be contrary to public policy in American courts under Bisso v. Inland Waterways Corp., 349 U.S. 85 (1955), and Dixilyn Drilling Corp. v. Crescent Towing & Salvage Co., 372 U.S. 697 (1963). Therefore, “[t]he district court was entitled to consider that remanding Zapata to a foreign forum, with no practical contact with the controversy, could raise a bar to recovery by a United States citizen which its own convenient courts would not countenance.”
We hold, with the six dissenting members of the Court of Appeals, that far too little weight and effect were given to the forum clause in resolving this controversy. For at least two decades we have witnessed an expansion of overseas commercial activities by business enterprises based in the United States. The barrier of distance that once tended to confine a business concern to a modest territory no longer does so. Here we see an American company with special expertise contracting with a foreign company to tow a complex machine thousands of miles across seas and oceans. The expansion of American business and industry will hardly be encouraged if, not-withstanding solemn contracts, we insist on a parochial concept that all disputes must be resolved under our laws and in our courts. Absent a contract forum, the considerations relied on by the Court of Appeals would be persuasive reasons for holding an American forum convenient in the traditional sense, but in an era of expanding world trade and commerce, the absolute aspects of the doctrine of the Carbon Black case have little place and would be a heavy hand indeed on the future development of international commercial dealings by Americans. We cannot have trade and commerce in world markets and international waters exclusively on our terms, governed by our laws, and resolved in our courts.
Forum-selection clauses have historically not been favored by American courts. Many courts, federal and state, have declined to enforce such clauses on the ground that they were “contrary to public policy,” or that their effect was to “oust the jurisdiction” of the court. Although this view apparently still has considerable acceptance, other courts are tending to adopt a more hospitable attitude toward forum-selection clauses. This view…is that such clauses are prima facie valid and should be enforced unless enforcement is shown by the resisting party to be “unreasonable” under the circumstances.
We believe this is the correct doctrine to be followed by federal district courts sitting in admiralty. It is merely the other side of the proposition recognized by this Court in National Equipment Rental, Ltd. v. Szukhent, 375 U.S. 311 (1964), holding that in federal courts a party may validly consent to be sued in a jurisdiction where he cannot be found for service of process through contractual designation of an “agent” for receipt of process in that jurisdiction. In so holding, the Court stated: “[I]t is settled…that parties to a contract may agree in advance to submit to the jurisdiction of a given court, to permit notice to be served by the opposing party, or even to waive notice altogether.”
This approach is substantially that followed in other common-law countries including England. It is the view advanced by noted scholars and that adopted by the Restatement of the Conflict of Laws. It accords with ancient concepts of freedom of contract and reflects an appreciation of the expanding horizons of American contractors who seek business in all parts of the world. Not surprisingly, foreign businessmen prefer, as do we, to have disputes resolved in their own courts, but if that choice is not available, then in a neutral forum with expertise in the subject matter. Plainly, the courts of England meet the standards of neutrality and long experience in admiralty litigation. The choice of that forum was made in an arm’s-length negotiation by experienced and sophisticated businessmen, and absent some compelling and countervailing reason it should be honored by the parties and enforced by the courts.
* * *
The judgment of the Court of Appeals is vacated and the case is remanded for further proceedings consistent with this opinion.
Vacated and remanded.
MR. JUSTICE DOUGLAS, dissenting.
* * *
The Limitation Court is a court of equity and traditionally an equity court may enjoin litigation in another court where equitable considerations indicate that the other litigation might prejudice the proceedings in the Limitation Court. Petitioners’ petition for limitation [407 U.S. 1, 23] subjects them to the full equitable powers of the Limitation Court.
Respondent is a citizen of this country. Moreover, if it were remitted to the English court, its substantive rights would be adversely affected. Exculpatory provisions in the towage control provide (1) that petitioners, the masters and the crews “are not responsible for defaults and/or errors in the navigation of the tow” and (2) that “[d]amages suffered by the towed object are in any case for account of its Owners.” Under our decision in Dixilyn Drilling Corp v. Crescent Towing & Salvage Co., 372 U.S. 697, 698, “a contract which exempts the tower from liability for its own negligence” is not enforceable, though there is evidence in the present record that it is enforceable in England. That policy was first announced in Bisso v. Inland Waterways Corp., 349 U.S. 85; and followed in Boston Metals Co. v. The Winding Gulf, 349 U.S. 122.
* * *
Moreover, the casualty occurred close to the District Court, a number of potential witnesses, including respondent’s crewmen, reside in that area, and the inspection and repair work were done there. The testimony of the tower’s crewmen, residing in Germany, is already available by way of depositions taken in the proceedings. [407 U.S. 1, 24]
All in all, the District Court judge exercised his discretion wisely in enjoining petitioners from pursuing the litigation in England.
I would affirm the judgment below.
Case Questions
1. Without a forum-selection clause, would the court in England have personal jurisdiction over either party?
2. Under forum non conveniens, there will be two courts, both of which have subject matter and personal jurisdiction—and the court will defer jurisdiction to the more “convenient” forum. If there were no forum-selection clause here, could the US court defer jurisdiction to the court in London?
3. Will Zapata recover anything if the case is heard in London?
4. Is it “fair” to let Unterweser excuse itself from liability? If not, under what ethical perspective does it “make sense” or “seem reasonable” for the court to allow Zapata to go to London and recover very little or nothing?
Due process in the enforcement of judgments
Koster v. Automark
640 F.2d 77 (N.D. Ill. 1980)
MARVIN E. ASPEN, District Judge:
On November 23, 1970, plaintiff Koster and defendant Automark Industries Incorporated (“Automark”) consummated a five-month course of negotiation by entering into an agreement whereby Automark promised to purchase 600,000 valve cap gauges during 1971. As a result of Automark’s alleged breach of this agreement, plaintiff brought an action for damages in the District Court in Amsterdam, 3rd Lower Chamber A. On October 16, 1974, plaintiff obtained a default judgment in the amount of Dutch Florins 214,747,50—\$66,000 in American currency at the rate of exchange prevailing on December 31, 1971—plus costs and interest. Plaintiff filed this diversity action on January 27, 1978, to enforce that foreign judgment.
The case now is before the Court on plaintiff’s motion for summary judgment pursuant to Federal Rules of Civil Procedure (Fed.R.Civ.P) 56(a). Defendant contests this motion on three grounds: (1) that service was inadequate, (2) that defendant lacked the minimum contacts necessary to render it subject to in personam jurisdiction in Amsterdam, and (3) that defendant has meritorious defenses to the action which it could not present in the foreign proceeding. For the reasons that follow, however, the Court finds defendant’s contentions unavailing.
[Note: The discussion on inadequate service has been omitted from what follows.]
As the court noted in Walters…service of process cannot confer personal jurisdiction upon a court in the absence of minimum contacts. The requirement of minimum contacts is designed to ensure that it is reasonable to compel a party to appear in a particular forum to defend against an action. Shaffer v. Heitner, 433 U.S. 186 (1977); International Shoe Co. v. Washington, 326 U.S. 317 (1945). Here, it is undisputed that Automark initiated the negotiations by a letter to plaintiff dated June 25, 1970. The five-month period of negotiations, during which time defendant sent several letters and telegrams to plaintiff in Amsterdam, led to the agreement of November 23, 1970. Moreover, although there is no evidence as to the contemplated place of performance, plaintiff attests—without contradiction—that the payment was to be made in Amsterdam.
On facts not dissimilar from these, the Illinois courts have found the existence of minimum contacts sufficient to justify long-arm personal jurisdiction under the Illinois statute. Ill.Rev.Stat. Ch. 110, § 17(a)(1). In Colony Press, Inc. v. Fleeman, 17 Ill.App.3d 14, 308 N.E.2d 78 (1st Dist. 1974), the court found that minimum contacts existed where the defendant had initiated the negotiations by submitting a purchase order to an Illinois company and the contract was to be performed in Illinois. And in Cook Associates, Inc. v. Colonial Broach & Machine Co., 14 Ill.App.3d 965, 304 N.E.2d 27 (1st Dist. 1973), the court found that a single telephone call into Illinois initiating a business transaction that was to be performed in Illinois by an Illinois agency was enough to establish personal jurisdiction in Illinois. Thus, the Court finds that the Amsterdam court had personal jurisdiction over Automark.
Finally, defendant suggests that it has meritorious defenses which it could not present because of its absence at the judicial proceeding in Amsterdam; specifically, that there was no binding agreement and, alternatively, that its breach was justified by plaintiff’s failure to perform his end of the bargain. It is established beyond question, however, that a default judgment is a conclusive and final determination that is accorded the same res judicata effect as a judgment after a trial on the merits. Such a judgment may be attacked collaterally only on jurisdictional grounds, or upon a showing that the judgment was obtained by fraud or collusion. Thus, defendant is foreclosed from challenging the underlying merits of the judgment obtained in Amsterdam.
[In a footnote, the court says:] “Again, even assuming that defendant could attack the judgment on the merits, it has failed to raise any genuine issue of material fact.…An affidavit by defendant’s secretary states only that “to the best of [his] knowledge” there was no contract with anyone in Amsterdam. Yet, there is no affidavit from the party who negotiated and allegedly contracted with plaintiff; nor is there any explanation why such an affidavit was not filed. In the face of the copy of a letter of agreement provided by plaintiff, this allegation is insufficient to create a factual question. Moreover, defendant offers no extrinsic material in support of its allegation of non-performance by plaintiff. Thus, even were the Court to consider defendant’s alleged defenses to the contract action, it would grant summary judgment for plaintiff on the merits.”
Accordingly, the Court finds that plaintiff is entitled to enforcement of the foreign judgment. Thus, plaintiff’s motion for summary judgment is granted. It is so ordered.
Case Questions
1. Why do you think Automark did not go to Amsterdam to contest this claim by Koster?
2. Why does the Illinois court engage in a due process analysis of personal jurisdiction?
3. What if the letter of agreement had an arbitration clause? Would the court in Amsterdam have personal jurisdiction over Automark?
Forum non conveniens
Gonzalez v. Chrysler Corporation
301 F.3d 377 (5th Cir. 2002)
[Note: Although the court’s opinion was appealed to the Supreme Court, no writ of certiorari was issued, so the following decision stands as good precedent in forum non conveniens cases.]
Opinion by E. GRADY JOLLY, Circuit Judge.
In this forum non conveniens case, we first consider whether the cap imposed by Mexican law on the recovery of tort damages renders Mexico an inadequate forum for resolving a tort suit by a Mexican citizen against an American manufacturer and an American designer of an air bag. Holding that Mexico—despite its cap on damages—represents an adequate alternative forum, we next consider whether the district court committed reversible error when it concluded that the private and public interest factors so strongly pointed to Mexico that Mexico, instead of Texas, was the appropriate forum in which to try this case. Finding no reversible error, we affirm the district court’s judgment dismissing this case on the ground of forum non conveniens.
In 1995, while in Houston, the plaintiff, Jorge Luis Machuca Gonzalez (“Gonzalez”) saw several magazine and television advertisements for the Chrysler LHS. The advertisements sparked his interest. So, Gonzalez decided to visit a couple of Houston car dealerships. Convinced by these visits that the Chrysler LHS was a high quality and safe car, Gonzalez purchased a Chrysler LHS upon returning to Mexico.
On May 21, 1996, the wife of the plaintiff was involved in a collision with another moving vehicle while driving the Chrysler LHS in Atizapan de Zaragoza, Mexico. The accident triggered the passenger-side air bag. The force of the air bag’s deployment instantaneously killed Gonzalez’s three-year-old son, Pablo.
Seeking redress, Gonzalez brought suit in Texas district court against (1) Chrysler, as the manufacturer of the automobile; (2) TRW,, Inc. and TRW Vehicle Safety Systems, Inc., as the designers of the front sensor for the air bag; and (3) Morton International, Inc., as designer of the air bag module. Gonzalez asserted claims based on products liability, negligence, gross negligence, and breach of warranty. As noted, Gonzalez chose to file his suit in Texas. Texas, however, has a tenuous connection to the underlying dispute. Neither the car nor the air bag module was designed or manufactured in Texas. The accident took place in Mexico, involved Mexican citizens, and only Mexican citizens witnessed the accident. Moreover, Gonzalez purchased the Chrysler LHS in Mexico (although he shopped for the car in Houston, Texas). Because of these factors, the district court granted the defendants’ identical motions for dismissal on the ground of forum non conveniens. Gonzalez now appeals.
II. A
The primary question we address today involves the threshold inquiry in the forum non conveniens analysis: Whether the limitation imposed by Mexican law on the award of damages renders Mexico an inadequate alternative forum for resolving a tort suit brought by a Mexican citizen against a United States manufacturer.
We should note at the outset that we may reverse the grant or denial of a motion to dismiss on the ground of forum non conveniens only “where there has been a clear abuse of discretion.” Baumgart v. Fairchild Aircraft Corp., 981 F.2d 824, 835 (5th Cir. 1993).
The forum non conveniens inquiry consists of four considerations. First, the district court must assess whether an alternative forum is available. See Alpine View Co. Ltd. v. Atlas Copco AB, 205 F.3d 208, 221 (5th Cir. 2000). An alternative forum is available if “the entire case and all parties can come within the jurisdiction of that forum.” In re Air Crash Disaster Near New Orleans, La. on July 9, 1982, 821 F.2d 1147, 1165 (5th Cir. 1987) (en banc), vacated on other grounds sub nom., Pan Am. World Airways, Inc. v. Lopez, 490 U.S. 1032, 104 L. Ed. 2d 400, 109 S. Ct. 1928 (1989). Second, the district court must decide if the alternative forum is adequate. See Alpine View, 205 F.3d at 221. An alternative forum is adequate if “the parties will not be deprived of all remedies or treated unfairly, even though they may not enjoy the same benefits as they might receive in an American court.” In re Air Crash, 821 F.2d at 1165 (internal citation omitted).
If the district court decides that an alternative forum is both available and adequate, it next must weigh various private interest factors. See Baumgart, 981 F.2d at 835-36. If consideration of these private interest factors counsels against dismissal, the district court moves to the fourth consideration in the analysis. At this stage, the district court must weigh numerous public interest factors. If these factors weigh in the moving party’s favor, the district court may dismiss the case. Id. at 837.
B. 1
The heart of this appeal is whether the alternative forum, Mexico, is adequate. (The court here explains that Mexico is an amenable forum because the defendants have agreed to submit to the jurisdiction of the Mexican courts.) The jurisprudential root of the adequacy requirement is the Supreme Court’s decision in Piper Aircraft Co. v. Reyno, 454 U.S. 235, 70 L. Ed. 2d 419, 102 S. Ct. 252 (1981). The dispute in Piper Aircraft arose after several Scottish citizens were killed in a plane crash in Scotland. A representative for the decedents filed a wrongful death suit against two American aircraft manufacturers. The Court noted that the plaintiff filed suit in the United States because “[US] laws regarding liability, capacity to sue, and damages are more favorable to her position than are those of Scotland.” Id. The Court further noted that “Scottish law does not recognize strict liability in tort.” Id. This fact, however, did not deter the Court from reversing the Third Circuit. In so doing, the Court held that “although the relatives of the decedent may not be able to rely on a strict liability theory, and although their potential damage award may be smaller, there is no danger that they will be deprived of any remedy or treated unfairly [in Scotland].” Thus, the Court held that Scotland provided an adequate alternative forum for resolving the dispute, even though its forum provided a significantly lesser remedy. In a footnote, however, Justice Marshall observed that on rare occasions this may not be true:
At the outset of any forum non conveniens inquiry, the court must determine whether there exists an alternative forum. Ordinarily, this requirement will be satisfied when the defendant is “amenable to process” in the other jurisdiction. In rare circumstances, however, where the remedy offered by the other forum is clearly unsatisfactory, the other forum may not be an adequate alternative, and the initial requirement may not be satisfied. Thus, for example, dismissal would not be appropriate where the alternative forum does not permit litigation of the subject matter of the dispute.
.…
Citing the language from this footnote, Gonzalez contends that a Mexican forum would provide a clearly unsatisfactory remedy because (1) Mexican tort law does not provide for a strict liability theory of recovery for the manufacture or design of an unreasonably dangerous product and (2) Mexican law caps the maximum award for the loss of a child’s life at approximately \$ 2,500 (730 days’ worth of wages at the Mexican minimum wage rate). Thus, according to Gonzalez, Mexico provides an inadequate alternative forum for this dispute.
B.2
(a) Gonzalez’s first contention may be quickly dismissed based on the explicit principle stated in Piper Aircraft. As noted, there the Supreme Court held that Scotland’s failure to recognize strict liability did not render Scotland an inadequate alternative forum. Id. at 255. There is no basis to distinguish the absence of a strict products liability cause of action under Mexican law from that of Scotland. Piper Aircraft therefore controls. Accordingly, we hold that the failure of Mexican law to allow for strict liability on the facts of this case does not render Mexico an inadequate forum.
(b) Gonzalez’s second contention—that the damage cap renders the remedy available in a Mexican forum “clearly unsatisfactory”—is slightly more problematic. Underlying this contention are two distinct arguments: First, Gonzalez argues that if he brings suit in Mexico, the cap on damages will entitle him to a de minimis recovery only—a clearly unsatisfactory award for the loss of a child. Second, Gonzalez argues that because of the damage cap, the cost of litigating this case in Mexico will exceed the potential recovery. As a consequence, the lawsuit will never be brought in Mexico. Stated differently, the lawsuit is not economically viable in Mexico. It follows, therefore, that Mexico offers no forum (much less an adequate forum) through which Gonzalez can (or will) seek redress. We address each argument in turn.
(b)(i)
In addressing Gonzalez’s first argument, we start from basic principles of comity. Mexico, as a sovereign nation, has made a deliberate choice in providing a specific remedy for this tort cause of action. In making this policy choice, the Mexican government has resolved a trade-off among the competing objectives and costs of tort law, involving interests of victims, of consumers, of manufacturers, and of various other economic and cultural values. In resolving this trade-off, the Mexican people, through their duly-elected lawmakers, have decided to limit tort damages with respect to a child’s death. It would be inappropriate—even patronizing—for us to denounce this legitimate policy choice by holding that Mexico provides an inadequate forum for Mexican tort victims. In another forum non conveniens case, the District Court for the Southern District of New York made this same point observing (perhaps in a hyperbolic choice of words) that “to retain the litigation in this forum, as plaintiffs request, would be yet another example of imperialism, another situation in which an established sovereign inflicted its rules, its standards and values on a developing nation.” In re Union Carbide Corp. Gas Plant Disaster at Bhopal, India in December, 1984, 634 F. Supp. 842, 867 (S.D.N.Y. 1986), aff’d as modified, 809 F.2d 195 (2d Cir. 1987). In short, we see no warrant for us, a United States court, to replace the policy preference of the Mexican government with our own view of what is a good policy for the citizens of Mexico.
Based on the considerations mentioned above, we hold that the district court did not err when it found that the cap on damages did not render the remedy available in the Mexican forum clearly unsatisfactory.
(b) (ii) We now turn our attention to Gonzalez’s “economic viability” argument—that is, because there is no economic incentive to file suit in the alternative forum, there is effectively no alternative forum.
The practical and economic realities lying at the base of this dispute are clear. At oral argument, the parties agreed that this case would never be filed in Mexico. In short, a dismissal on the ground of forum non conveniens will determine the outcome of this litigation in Chrysler’s favor. We nevertheless are unwilling to hold as a legal principle that Mexico offers an inadequate forum simply because it does not make economic sense for Gonzalez to file this lawsuit in Mexico. Our reluctance arises out of two practical considerations.
First, the plaintiff’s willingness to maintain suit in the alternative (foreign) forum will usually depend on, inter alia, (1) whether the plaintiff’s particular injuries are compensable (and to what extent) in that forum; (2) not whether the forum recognizes some cause of action among those applicable to the plaintiff’s case, but whether it recognizes his most provable and compensable action; (3) similarly, whether the alternative forum recognizes defenses that might bar or diminish recovery; and (4) the litigation costs (i.e., the number of experts, the amount of discovery, geographic distances, attorney’s fees, etc.) associated with bringing that particular case to trial. These factors will vary from plaintiff to plaintiff, from case to case. Thus, the forum of a foreign country might be deemed inadequate in one case but not another, even though the only difference between the two cases might be the cost of litigation or the recovery for the plaintiff’s particular type of injuries. In sum, we find troublesome and lacking in guiding principle the fact that the adequacy determination could hinge on constantly varying and arbitrary differences underlying the “economic viability” of a lawsuit.
Second, if we allow the economic viability of a lawsuit to decide the adequacy of an alternative forum, we are further forced to engage in a rudderless exercise of line drawing with respect to a cap on damages: At what point does a cap on damages transform a forum from adequate to inadequate? Is it, as here, \$2,500? Is it \$50,000? Or is it \$100,000? Any recovery cap may, in a given case, make the lawsuit economically unviable. We therefore hold that the adequacy inquiry under Piper Aircraft does not include an evaluation of whether it makes economic sense for Gonzalez to file this lawsuit in Mexico.
C.
Having concluded that Mexico provides an adequate forum, we now consider whether the private and public interest factors nonetheless weigh in favor of maintaining this suit in Texas. As noted, the district court concluded that the public and the private interest factors weighed in favor of Mexico and dismissed the case on the ground of forum non conveniens. Our review of this conclusion is restricted to abuse of discretion. See Alpine View, 205 F.3d at 220.
The district court found that almost all of the private and public interest factors pointed away from Texas and toward Mexico as the appropriate forum. It is clear to us that this finding does not represent an abuse of discretion. After all, the tort victim was a Mexican citizen, the driver of the Chrysler LHS (Gonzalez’s wife) is a Mexican citizen, and the plaintiff is a Mexican citizen. The accident took place in Mexico. Gonzalez purchased the car in Mexico. Neither the car nor the air bag was designed or manufactured in Texas. In short, there are no public or private interest factors that would suggest that Texas is the appropriate forum for the trial of this case.
III.
For the foregoing reasons, the district court’s dismissal of this case on the ground of forum non conveniens is
AFFIRMED.
Case Questions
1. How can an alternative forum be “adequate” if no rational lawyer would take Gonzalez’s case to file in a Mexican state court?
2. To what extent does it strike you as “imperialism” for a US court to make a judgment that a Mexican court is not “adequate”?
Act of State
W. S. Kirkpatrick Co., Inc. v. Environmental Tectonics Co.
493 U.S. 400 (1990)
Justice Scalia delivered the Court’s opinion.
In 1981, Harry Carpenter, who was then Chairman of the Board and Chief Executive Officer of petitioner W. S. Kirkpatrick & Co., Inc. (Kirkpatrick) learned that the Republic of Nigeria was interested in contracting for the construction and equipment of an aeromedical center at Kaduna Air Force Base in Nigeria. He made arrangements with Benson “Tunde” Akindele, a Nigerian Citizen, whereby Akindele would endeavor to secure the contract for Kirkpatrick. It was agreed that in the event the contract was awarded to Kirkpatrick, Kirkpatrick would pay to two Panamanian entities controlled by Akindele an amount equal to 20% of the contract price, which would in turn be given as a bribe to officials of the Nigerian government. In accordance with this plan, the contract was awarded to petitioner W. S. Kirkpatrick & Co., International (Kirkpatrick International), a wholly owned subsidiary of Kirkpatrick; Kirkpatrick paid the promised “commission” to the appointed Panamanian entities; and those funds were disbursed as bribes. All parties agree that Nigerian law prohibits both the payment and the receipt of bribes in connection with the award of a government contract.
Respondent Environmental Tectonics Corporation, International, an unsuccessful bidder for the Kaduna contract, learned of the 20% “commission” and brought the matter to the attention of the Nigerian Air Force and the United States Embassy in Lagos. Following an investigation by the Federal Bureau of Investigation, the United States Attorney for the District of New Jersey brought charges against both Kirkpatrick and Carpenter for violations of the Foreign Corrupt Practices Act of 1977 and both pleaded guilty.
Respondent then brought this civil action in the United States District Court of the District of New Jersey against Carpenter, Akindele, petitioners, and others, seeking damages under the Racketeer Influenced and Corrupt Organizations Act, the Robinson-Patman Act, and the New Jersey Anti-Racketeering Act. The defendants moved to dismiss the complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure on the ground that the action was barred by the act of state doctrine.
The District Court concluded that the act of state doctrine applies “if the inquiry presented for judicial determination includes the motivation of a sovereign act which would result in embarrassment to the sovereign or constitute interference in the conduct of foreign policy of the United States.” Applying that principle to the facts at hand, the court held that respondents suit had to be dismissed because in order to prevail respondents would have to show that “the defendants or certain other than intended to wrongfully influenced the decision to award the Nigerian contract by payment of a bribe, that the government of Nigeria, its officials or other representatives knew of the offered consideration forewarning the Nigerian contract to Kirkpatrick, that the bribe was actually received or anticipated and that but for the payment or anticipation of the payment of the bribed, ETC would have been awarded the Nigerian contract.”
The Court of Appeals for the Third Circuit reversed.
This Courts’ description of the jurisprudential foundation for the act of state doctrine has undergone some evolution over the years. We once viewed the doctrine as an expression of international law, resting upon “the highest considerations of international comity and expediency,” Oetjen v. Central Leather Co., 246 U.S. 297, 303-304 (1918). We have more recently described it, however, as a consequence of domestic separation of powers, reflecting “the strong sense of the Judicial Branch that its engagement in the task of passing on the validity of foreign acts of state may hinder” the conduct of foreign affairs, Banco Nacional de Cuba v. Sabbatino, 376 U.S. 398, 423 (1964). Some Justices have suggested possible exceptions to application of the doctrine, where one or both of the foregoing policies would seemingly not be served: an exception, for example, for acts of state that consist of commercial transactions, since neither modern international comity nor the current position of our Executive Branch accorded sovereign immunity to such acts…or an exception for cases in which the executive branch has represented that it has no objection to denying validity to the foreign sovereign act, since then the court should be impeding no foreign-policy goals.
We find it unnecessary, however, to pursue those inquiries, since the factual predicate for application of the act of state doctrine does not exist. Nothing in the present suit requires the court to declare invalid, and thus ineffective as “a rule of decision for the courts of this country,” the official act of a foreign sovereign.
In every case in which we have held the act of state doctrine applicable, the relief sought or the defense interposed would have required a court in the United States to declare invalid the official acts of a foreign sovereign performed within its own territory.…In Sabbatino, upholding the defendant’s claim to the funds would have required a holding that Cuba’s expropriation of goods located in Havana was null and void. In the present case, by contrast, neither the claim nor any asserted defense requires a determination that Nigeria’s contract with Kirkpatrick International was, or, was not effective.
Petitioners point out, however, that the facts necessary to establish respondent’s claim will also establish that the contract was unlawful. Specifically, they note that in order to prevail respondent must prove that petitioner Kirkpatrick made, and Nigerian officials received, payments that violate Nigerian law, which would, they assert, support a finding that the contract is invalid under Nigerian law. Assuming that to be true, it still does not suffice. The act of state doctrine is not some vague doctrine of abstention but a “principle of decision binding on federal and state courts alike.” As we said in Ricaud, “the act within its own boundaries of one sovereign State…becomes a rule of decision for the courts of this country.” Act of state issues only arise when a court must decide—that is, when the outcome of the case turns upon—the effect of official action by a foreign sovereign. When that question is not in the case, neither is the act of state doctrine. This is the situation here. Regardless of what the court’s factual findings may suggest as to the legality of the Nigerian contract, its legality is simply not a question to be decided in the present suit, and there is thus no occasion to apply the rule of decision that the act of state doctrine requires.
* * *
The short of the matter is this: Courts in the United States have the Power, and ordinarily the obligation, to decide cases and controversies properly presented to them. The act of state doctrine does not establish an exception for cases and controversies that may embarrass foreign governments, but merely requires that; in the process of deciding, the acts of foreign sovereigns taken within their own jurisdictions shall be deemed valid: That doctrine has no application to the present case because the validity of no foreign sovereign act is at issue.
The judgment of the Court for the Third Circuit is affirmed.
Case Questions
1. Why is this case not about sovereign immunity?
2. On what basis does the US court take jurisdiction over an event or series of events that takes place in Nigeria?
3. If the court goes on to the merits of the case and determines that an unlawful bribe took place in Nigeria, is it likely that diplomatic relations between the United States and Nigeria will be adversely affected? | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.05%3A_Cases.txt |
Summary
International law is not like the domestic law of any one country. The sovereign, or lawgiver, in any particular nation-state has the power to make and enforce laws within its territory. But globally, there is no single source of law or law enforcement. Thus international law is a collection of agreements between nation-states (treaties and conventions), customary international law (primarily based on decisions of national court systems), and customary practice between nation-states. There is an international court of justice, but it only hears cases between nation-states. There is no international court for the resolution of civil disputes, and no regional courts for that purpose, either.
The lack of unified law and prevalence of global commerce means that local and national court systems have had to devise ways of forcing judgments from one national court system or another to deal with claims against sovereigns and to factor in diplomatic considerations as national judicial systems encounter disputes that involve (directly or indirectly) the political and diplomatic prerogatives of sovereigns. Three doctrines that have been devised are sovereign immunity, act of state, and forum non conveniens. The recognition of forum-selection clauses in national contracting has also aided the use of arbitration clauses, making international commercial-dispute resolution more efficient. Arbitral awards against any individual or company in most nations engaged in global commerce are more easily enforceable than judgments from national court systems.
In terms of regulating trade, the traditional practice of imposing taxes (tariffs) on imports from other countries (and not taxing exports to other countries) has been substantially modified by the emergence of the General Agreement on Tariffs and Trade (GATT) rules as now enforced by the World Trade Organization (WTO). The United States has a practice of regulating exports, however, to take into account national security and other foreign policy considerations. For example, the Export Administration Act of 1985 has controlled certain exports that would endanger national security, drain scarce materials from the US economy, or harm foreign policy goals. The US secretary of commerce has a list of controlled commodities that meet any of these criteria.
Exercises
1. Assume that the United States enters into a multilateral treaty with several third-world countries under which then-existing private claims to molybdenum and certain other minerals in the United States are assigned to an international agency for exploitation. When the owner of a US mine continues to dig for ore covered by the treaty, the Justice Department sues to enjoin further mining. What is the result? Why?
2. A foreign government enters into a contract with a US company to provide computer equipment and services for the intelligence arm of its military forces. After the equipment has been supplied, the foreign government refuses to pay. The US company files suit in federal court in the United States, seeking to attach a US bank account owned by the foreign government. The foreign government claims that the US court has no jurisdiction and that even if it does, the government is immune from suit. What is the result?
3. Would the result in Exercise 2 be any different if the US company had maintained its own equipment on a lease basis abroad and the foreign government had then expropriated the equipment and refused to pay the US company its just value?
4. The Concentrated Phosphate Export Association consists of the five largest phosphate producers. The Agency for International Development (AID) undertook to sell fertilizer to Korea and solicited bids. The association set prices and submitted a single bid on 300,000 tons. A paid the contract price, determined the amounts to be purchased, coordinated the procedure for buying, and undertook to resell to Korea. The Justice Department sued the association and its members, claiming that their actions violated Section 1 of the Sherman Act. What defense might the defendants have? What is the result?
5. Canada and Russia have competing claims over fishing and mining rights in parts of the Arctic Ocean. Assuming they cannot settle their competing claims through diplomatic negotiation, where might they have their dispute settled?
SELF CHECK QUESTIONS
1. International law derives from
1. the US Constitution
2. the common law
3. treaties
4. customary international law
5. c and d
2. Foreign nations are immune from suit in US courts for governmental acts because of
1. the international sovereign immunity treaty
2. a United Nations law forbidding suits against foreign sovereigns
3. the Foreign Sovereign Immunities Act
4. precedent created by the US Supreme Court
3. A foreign government’s expropriation of private assets belonging to a nonresident is
1. a violation of international law
2. a violation of the US Constitution
3. permitted by the domestic law of most nation-states
4. in violation of the act-of-state doctrine
4. Arbitration of business disputes is
1. frowned upon by courts for replacing public dispute resolution with private dispute resolution
2. permissible when a country’s laws permit it
3. permissible if the parties agree to it
4. a and b
5. b and c
1. d
2. a
3. c
4. e | textbooks/biz/Civil_Law/Foundations_of_Business_Law_and_the_Legal_Environment/33%3A_International_Law/33.06%3A_Summary_and_Exercises.txt |
Learning Objectives
• Understand the nature and sources of law.
• Know the types of modern legal systems in the world.
• Understand the various functions of a legal system.
• Learn the primary sources of law in the United States.
01: Introduction to Law and Types of Legal Systems
It is important for business people to understand the legal environment in which they are operating. To be successful, businesses must understand how law and economic principles influence each other. Businesses want to be successful, which usually means they want to be profitable. While a basic economic principle is that businesses act in their own self-interest, they must do so within the parameters of the law. Sometimes businesses weigh the penalties of violating the law against the chances of getting caught to determine how they should behave. In both instances, the law is a restraint on behavior.
Most people want to conduct their business legally. Following the rules saves money, time, and frustration, and it preserves individual and professional reputations. So, if businesses have an incentive to operate legally, why are do so many legal disputes occur? There are many reasons for this, including that many of our laws are poorly written, and reasonable people may disagree about what is “right.” Legal injuries happen even under the best of circumstances, and parties need a method to be compensated for their damages.
A common theme in the study of law is responsibility. Law seeks to answer the questions:
1. Who is responsible, and what is their liability? and
2. How does a business limit exposure to liability in the first place?
A solid understanding of business law minimizes the risk of liability and avoids legal disputes. The law provides a reasonable expectation of how things will be in the future based on how they have been in the past. It provides predictability and stability.
This book does not teach how to practice law or conduct legal research. The goals of this book are practical. Think about studying business law as a map by which to navigate business dealings. We want to help you minimize the risk of legal liability and avoid serious legal disputes. This book serves as an introduction to legal topics that affect businesses. By understanding the legal landscape, you will have a better opportunity for business success.
Counselor’s Corner Even if a business is not officially “international,” it is important to understand the legal systems of the world because consumers come from all over. Consumers, business partners, and competitors are products of their environments, including their societies and legal systems. Therefore, their expectations and how they interact with each other are influenced directly by their legal systems of origin. The most successful businesses take this into account. Not only for avoiding legal liability, but also for enhanced consumer satisfaction. ~Arham M., attorney
1.02: What Is Law and What Functions Does It Serve
Law is the system of rules which a particular nation or community recognizes as regulating the actions of its members and which it may enforce by the imposition of penalties. In a nation, the law can serve to (1) keep the peace, (2) maintain the status quo, (3) preserve individual rights, (4) protect minorities, (5) promote social justice, and (6) provide for orderly social change. Some legal systems serve these purposes better than others.
Although a nation ruled by an authoritarian government may keep the peace and maintain the status quo, it may also oppress minorities or political opponents (e.g., China, Zimbabwe, or Syria). Under colonialism, European nations often imposed peace in nations whose borders were created by those same European nations. With regard to the functions of the law, the empires may have kept the peace—largely with force—but they changed the status quo and seldom promoted the native peoples’ rights or social justice.
In nations with various ethnic and tribal groups, it is often difficult for a single, united government to rule effectively. In Rwanda, for example, power struggles between Hutus and Tutsis resulted in the genocide of the Tutsi minority. In nations of the former Soviet Union, the withdrawal of a central power created power vacuums that were exploited by local leaders. When Yugoslavia broke up, the different ethnic groups—Croats, Bosniaks, and Serbs—fought bitterly rather than share power. In Iraq and Afghanistan, the blending of different groups of families, tribes, sects, and ethnic groups into an effective national governing body continues to be a challenge.
These situations highlight the struggle of a nation to implement and maintain the Rule of Law. The Rule of Law is a system in which laws are public knowledge, are clear in meaning, and apply equally to everyone. These systems uphold national political and civil liberties. Rule of law systems establish authority, create expectations for behavior, and establish redress for grievances and penalties for deviance. Governance of conflict and the attainment of peace among the governed are its primary goals. One of the greatest benefits of the Rule of Law is that it allows people to understand what is expected of them.
The United States is a Rule of Law System. The US Constitution is based on the principle that people have rights that cannot be taken away by the government. Instead, the role of the government is to protect the individual rights of its citizens. The US Constitution’s preamble states, “We the People…in Order to…insure domestic Tranquility.” This is just one example of how the US legal system was established to address the functions of a legal system. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/01%3A_Introduction_to_Law_and_Types_of_Legal_Systems/1.01%3A_Introduction_to_Law_and_Types_of_Legal_Systems.txt |
There are four main legal systems in the modern world:
1. Common law;
2. Civil law;
3. Religious law; and
4. Customary law/monarchy.
As the world becomes more interdependent, a fifth category of legal systems has developed — the hybrid legal system, which is a legal system that is a combination of two or more legal systems.
Type of Legal System Characteristics
Common Law
• Written judicial decisions of appellate courts are binding legal authority on lower courts when interpreting and applying the same or similar questions of law
• The legal system is adversarial
• The outcome of a case is often decided by a jury of the parties’ peers
Civil Law
• All legal rules are in comprehensive legislative enactments often called Codes
• Written judicial decisions of appellate courts are not binding legal authority
• The legal system is inquisatorial
Religious Law
• Religious documents are used as legal sources
• All major world religions have a religious legal system
• Most nations that have religious legal systems use them to supplement a secular national system
Customary Law
• Legal system used by a monarchy or tribe
• Grants specific legal powers to kings, queens, sultans or tribal leaders as heads of state
• Monarchs and leaders often seen to be “above the law”
Hybrid Law
• Combination of 2 or more legal systems within a nation
Common Law Systems
The legal system in the United States comes from the English common law tradition and the US Constitution. English common law is a system that gives written judicial decisions the force of law. As a result, the US legal system recognizes an appellate court’s ability to interpret and apply the law to future litigants through precedent. Precedent is a judicial opinion that is considered legal authority for future cases involving the same or similar questions of law. The benefit of this system is consistency and resolution of disputes without requiring the parties to take legal matters to court.
A famous example of how precedent works is the US Supreme Court case Brown v. Board of Education of Topeka. In this landmark 1954 case, the Justices unanimously ruled that racial segregation of children in public schools is unconstitutional. Brown v. Board of Education is one of the cornerstones of the Civil Rights Movement and helped establish the precedent that “separate-but-equal” education and other services were not, in fact, equal at all. The case required all racially segregated public schools to integrate, not just in Topeka, Kansas. In addition, Brown has been cited as legal precedent in thousands of cases nationwide involving racial equality.
The common law legal system is adversarial. This means that the parties bring their cases to the court for resolution. The judge or jury hears the parties’ evidence and arguments before making a final decision. It is the parties’ burden to investigate the facts, argue the law, and present their best case. Judges and juries do not do independent investigations nor are they responsible for helping parties argue their cases. It is a party’s responsibility to raise all legal issues.
Another characteristic of common law systems is that cases are often decided by juries of the parties’ peers. In both civil and criminal matters, the parties usually have a right to have a jury pulled from local citizens to resolve the dispute. When a jury determines the outcome of a case, the judge acts as a “gatekeeper,” who decides what evidence and legal arguments the jury can properly consider. The judge ensures the parties receive a fair trial while the jury decides the outcome of the trial.
The common law tradition is unique to England, the United States, and former British colonies. Although there are differences among common law systems (e.g., whether judiciaries may declare legislative acts unconstitutional and how frequently juries may be used), all of them recognize the use of precedent, and none of them relies solely on the comprehensive, legislative codes that are prevalent in civil law systems.
Civil Law Systems
Civil law systems were developed in Europe and are based on Roman and Napoleonic law. Civil law systems are also called code systems because all the legal rules are in one or more comprehensive legislative enactments. During Napoleon’s reign, a comprehensive book of laws—a code—was developed for all of France. The code covered criminal law and procedure, non-criminal law and procedure, and commercial law. The code is used to resolve only cases brought to the courts, which are usually decided by judges without a jury.
Civil law systems are inquisitorial systems in which judges actively investigate cases. Judges have the authority to request documents and testimony, as well as to shape the parties’ legal claims. In addition, judges are not required to follow the decisions of other courts in similar cases. The law is in the code, not in the cases. The legislature, not the courts, is the primary place to enact and modify laws.
Civil law systems are used throughout Europe, Central and South America, Asia and Africa. France, Germany, Holland, Spain, and Portugal had colonies outside of Europe, and many of these colonies adopted the legal practices that were imposed on them by colonial rule.
There are also communist and socialist legal systems that differ significantly from traditional civil law systems. Legal scholars debate whether this is a separate type of legal system or a subset of modern civil law systems. In a communist or socialist legal system, the nation has a code but most property is owned by the government or agricultural cooperatives. In addition, the judiciary is subservient to the Communist party and is not an independent branch of government.
Religious Law Systems
Religious law systems arise from the sacred texts of religious traditions and usually apply to all aspects of life, including social and business relations. In religious legal systems, a religious document is used as a primary legal source. All major world religions–Judaism, Christianity, Islam, Buddhism and Hinduism–have a religious legal system. The Islamic legal system (Sharia) with Islamic jurisprudence (Fiqh) is the most widely used religious legal system in the world. Most nations that have religious legal systems use them to supplement their secular national system. Only Saudi Arabia (Islamic) and the Vatican (Christian) are pure theocracies that have only a religious legal system in their nations.
Customary Law Systems
Customary legal systems are becoming increasingly less common. A customary system is used by a monarchy and grants specific legal powers to the kings, queens, sultans or tribal leaders as heads of state. A challenge of a customary system is that the ruler is seen to be “above the law” because the laws do not apply equally to the ruler and subjects. There are only a handful of monarchies remaining in the world, and most of them have evolved into hybrid legal systems or have adopted a different type of legal system.
Hybrid Law Systems
Hybrid legal systems are a combination of two or more legal systems within a nation. India is a classic example of a nation with a hybrid legal system. As a former British colony, India has a common law legal system, which recognizes the power of the Supreme Court and High Courts to make binding judicial decisions as a form of precedent. However, most of its laws are integrated codes found in a Napoleonic code system. In addition, India has separate personal codes that apply to Muslims, Christians, and Hindus. As a result, India has a hybrid system made up of common law, civil law and religious law systems.
Figure 1.1 Legal Systems of the World Map | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/01%3A_Introduction_to_Law_and_Types_of_Legal_Systems/1.03%3A_Modern_Legal_Systems_of_the_World.txt |
Where does law come from? How do individuals and businesses know right from wrong? Not all actions that are considered “wrong” or inappropriate are violations of the law. They simply may represent social norms. So what is the difference? There are two types of rules in our society—social norms and laws.
Social norms are the informal rules that govern behavior in groups and societies. Social norms and cultural expectations may be violated with negative social or professional consequences for doing so. However, no legal repercussions follow violating social norms alone.
Violations of law are different. Violating the law carries penalties, such as civil liability, fines, or loss of liberty. While it is optional to conform to social customs, people are compelled to obey the law under threat of penalty.
Laws are generally classified as public law or private law. Public law applies to everyone. It is law that has been created by a legitimate authority with the power to create law, and it applies to the people within its jurisdiction. In the United States, the lawmaking authority itself is also subject to those laws, because no one is “above” the law. If the law is violated, penalties may be levied against violators. Examples of public law include constitutions, criminal laws, and administrative laws. For example, if someone steals items from a store, the thief is violating public law. He committed the crime of theft which affects the community as a whole (not just the store owners), and the crime is defined in public legislation.
Private law is law that is binding on specific parties. For instance, parties to a contract are involved in a private law agreement. The terms of the contract apply to the parties of the contract but not anyone else. If the parties have a contract dispute, the terms of the contract and the remedy for breach will apply only to the parties of the contract. In addition to contracts, other examples of private law include tort and property laws. For example, if someone installs an industrial smoker on his property and the smoke creates a dense haze in the neighbor’s yard, there may be a violation of private law because the smoke is interfering with the neighbor’s right to peacefully enjoy one’s property.
Laws are also classified as civil or criminal. Civil law is usually brought by a private party against another private party. For example, one company decides to sue another for breach of contract. Or a customer sues a business when injured by the company’s product. Most laws affecting businesses are civil.
Criminal law involves a governmental decision to prosecute someone for violating a criminal statute. If someone breaks a criminal law, he or she could lose their freedom (i.e. be sent to prison) or lose their life (i.e. if convicted of a capital offense). In a civil action, no one is sent to prison. Usually, liability results in the loss of property such as money or assets.
Civil Criminal
Source of Law statute or common law statutes defining crimes
Who files case? business or individual suffering harm the government (e.g. District Attorney)
Burden of Proof preponderance of evidence beyond a reasonable doubt
Remedy damages, injunction, specific performance punishment (e.g. fine or imprisonment)
Purpose provide compensation or private relief protect society
Additionally, some law is procedural and some law is substantive. Procedural law describes the legal process and rules that are required and must be followed. For instance, parties who are sued in court must receive notice of the lawsuit before the court can impose judgment against them. Substantive law refers to the actual substance of the law or the merits of the claim, case, or action. Substantive law embodies the ideas of legal rights and duties and is captured by different sources of law, including the Constitution, statutes, and common law.
For example, if someone drives fifty-five miles per hour in a forty mile-per-hour zone, she has broken the substantive rule of law of the speed limit. However, how and what gets decided in court related to the speeding ticket is a matter of procedural law. For example, whether the driver is entitled to a hearing before a judge, whether she has a right to be represented by legal counsel, whether the hearing takes place within a certain amount of time after the ticket was issued, and what type of evidence can be presented are procedural law issues.
Sources of Law
In the United States, our laws come primarily from:
• Federal and state constitutions;
• Statutory law from Congress, the state legislatures, and local legislative bodies;
• Common law from federal and state appellate courts;
• Administrative rules and regulations;
• Treaties and conventions; and
• Executive orders.
Constitutions
The most fundamental law in the United States is the US Constitution, which is the supreme law of the nation. Any law that conflicts with it is void. The Constitution serves three important functions. First, it establishes the structure of our national government and identifies the powers of the legislative, executive, and judicial branches. Second, it defines the boundaries of each branch’s authority and creates “checks” on each branch by the other branches. For example, the president is the commander-in-chief of the armed forces, but does not have the power to declare war. That duty falls to Congress. And, third, the Constitution guarantees civil liberties and individual rights.
The power granted to the federal government by the Constitution is limited. Any powers not expressly granted to the federal government by the Constitution are reserved to the states. This means that if the Constitution does not give the federal government power over a particular area, then the states regulate it.
The first ten amendments to the Constitution are known as the Bill of Rights. Despite the limited power granted to the federal government by the Constitution, the Bill of Rights protects certain individual civil rights and liberties from governmental interference. These rights include the freedom of speech and religion, the right to bear arms, and the rights of individuals who are suspected and accused of crimes.
Figure 1.2 Separation of Powers of the Federal Government
Each state also has its own constitution, which serves essentially the same function for the state government as the US Constitution serves for the federal government. Specifically, they establish limits of state government power, establish the organization and duties of the different branches of government at the state level, and protect fundamental rights of state citizens. This dual system of government in the United States is called federalism, which is a governance structure whereby the federal government and the state governments coexist through a shared power scheme.
Figure 1.3 Separation of Powers of the State Governments
Statutes
Statutes are laws created by a legislative body. Congress is the federal legislative body, and each state also has its own legislative body. Almost all statutes are created by the same method. An idea for a new law is proposed in the legislature. This proposal is called a bill. The House of Representatives and Senate independently vote on a bill. If the majority of both chambers approves it, the bill is sent to the president or governor for approval. If the president or governor signs the bill, then it becomes a statute.
Local governments, such as counties, cities, and townships, may be authorized under a state constitution to create or adopt ordinances. An ordinance is a legislative act of a local government entity. Examples of ordinances include building codes, zoning laws, and misdemeanors such as jaywalking.
Common Law
Binding legal principles also come from the courts. When appellate courts decide a case, they may interpret and apply legal principles in a way that are binding on lower courts in the future. The process of applying a prior appellate decision to a case is called precedent. Simply put, precedent is when judges use past decisions to guide them. The benefit of precedent is that it makes the law predictable and furthers the rule of law by applying legal principles to the greater community, not just the parties to a lawsuit. Businesses value common law systems because they reduce the cost of business. For example, if a business is unsure of how its contract rights will be applied by the court, it can understand its rights by learning how courts interpreted similar contract provisions in past lawsuits. This allows businesses to assess their risks, determine their liability, and make rational business decisions without the expense of litigation.
Administrative Rules and Regulations
Administrative law is the collection of rules and decisions made by agencies to fill in particular details missing from constitutions and statutes. For example, the Internal Revenue Service (IRS) is the federal agency responsible for collecting national taxes and administering the Internal Revenue Code enacted by Congress. All businesses and individuals must follow the IRS rules and regulations about how to report, file, and pay applicable taxes that Congress levies. Congress passes statute defining “what” taxes need to be paid. The IRS adopts the rules about “how” those taxes are paid.
In the United States, many of the day-to-day regulation of businesses is done by administrative agencies. These agencies are created by the legislature to implement and enforce a particular statute. Agencies often report to the executive branch, but some are run by independent commissions. Legislative bodies give agencies the power to create rules and regulations that individuals and businesses must follow to comply with the statute. For example, the Environmental Protection Agency (EPA) was created to implement and enforce the Clean Air Act and the Clean Water Act.
Treaties and Conventions
A treaty is a binding agreement between two nations. A convention is a binding agreement among a group of nations. In the US, a treaty or convention is generally negotiated by the executive branch. To be binding, the US Constitution requires the Senate to ratify treaties by a two-thirds vote. Once ratified, a treaty becomes part of federal law with the same weight and effect as a statute passed by the entire Congress. Therefore, treaties and conventions have equal standing as statutes in US law.
Executive Orders
Article II, Section 1 of the US Constitution gives the president the power to “take care that the laws be faithfully executed.” Under this power, the president may issue executive orders requiring officials in the executive branch to perform their duties in a particular manner. State governors have the same authority under state constitutions. Although they are not laws that apply directly to individuals and businesses, executive orders are important legal documents because they direct the government’s enforcement efforts.
Hierarchy of Sources of Law
Priority Source Comment
1 Constitutions Exist at both federal and state levels
2 (tie) Statutes Laws passed by the federal or state legislatures
2 (tie) Treaties and Conventions International agreements that have the same standing as statutes
4 Judicial Opinions Court interpretation and application of constitutions, statutes, treaties, agency regulations, and executive orders
5 Agency Regulations Rules and regulations adopted by administrative agencies at the federal, state, or local level
6 Executive Orders Guidance from the president or governor to executive branch officials about how to perform their duty
1.05: Concluding Thoughts
Understanding business law is essential to successfully running any type of business because a solid understanding of laws and regulations helps avoid liability and minimizes risk. In business, it is not enough to conduct business ethically. Knowledge of business law is essential to successful business practices. Ultimately, business people should be able to recognize legal issues, minimize liability exposure, and know when to consult an attorney.
Legal systems vary widely in their aims and in the way they resolve disputes. Common law systems are adversarial, use juries and adhere to precedent. Civil law systems are inquisatorial, do not use juries and do not recognize precedent. All major world religions have a legal system, although only two nations have a purely national religious system. Many nations have hybrid legal systems that combine two or more legal systems.
The legal system in the United States is composed of multiple jurisdictions at the local, state and federal levels. Local and state laws may not conflict with federal laws. Primary sources of law in the United States include constitutional law, statutory law, common law, administrative law, treaties, and executive orders. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/01%3A_Introduction_to_Law_and_Types_of_Legal_Systems/1.04%3A_Sources_of_Law.txt |
Learning Objectives
• Understand the US court system and how it affects the conduct of businesses.
• Understand the three branches of government and how they check and balance each other’s powers.
• Explore the state and federal court systems.
02: The United States Court System
In the United States, law and government are interdependent. The US Constitution establishes the basic framework of the federal government and imposes certain limitations on the powers of government. In turn, the various branches of government are intimately involved in making, enforcing, and interpreting the law. Most law comes from Congress and the state legislatures. Courts interpret the laws and apply them to cases.
Laws are meaningless if they are not enforced. Companies have to make many decisions daily, from product development to marketing to maintaining growth. These decisions are based on financial considerations and legal requirements. If a company violates a law, it is often held accountable through litigation in courts.
Counselor’s Corner Under the Supreme Court’s Citizens United decision, business entities enjoy the same right as natural persons to influence the political process through contributions. Because federal judges are appointed for life, businesses cannot directly influence actions of the judicial branch. However, they can do so indirectly by lobbying Congress on laws that it considers and lobbying the president concerning enforcement priorities. While all states have a comparable three-branch system, in some states (not in Colorado), judges obtain office through partisan elections. In such states, businesses can seek to influence the judicial branch through supporting judges whose philosophy favors business generally or a particular industry. For these reasons, in choosing whether to litigate in state or federal court, businesses should consider that federal judges may be more likely to take politically unpopular actions. ~John W., judge
2.02: Separation of Powers
Under the US Constitution, power is separated among three branches of government. Article I of the Constitution allocates the legislative power to Congress, which is composed of the House of Representatives and the Senate. Congress makes laws and represents the will of the people. Article II of the Constitution creates the executive power in the president and makes the president responsible for enforcing the laws passed by Congress. Article III of the Constitution establishes a separate and independent judiciary, which is in charge of applying and interpreting the meaning of the law. The US Supreme Court is the highest court in the federal judiciary and consists of nine Justices.
Figure 2.1 Separation of Powers of the Branches of the Federal Government
The Constitution is remarkably short in describing the judicial branch. Under the Constitution, there are only two requirements to becoming a federal judge: nomination by the president and confirmation by the Senate. Article III provides: “The judicial power of the United States, shall be vested in one Supreme Court, and in such inferior courts as the Congress may from time to time ordain and establish.” The Constitution also guarantees that how judges decide cases does not affect their jobs because they have lifetime tenure and a salary that cannot be reduced.
Separation of powers is discussed in more detail in Chapter 5.
Marbury v. Madison
In 1800, the presidential election between John Adams and Thomas Jefferson nearly tore the nation apart. John Adams was the President and his Vice-President, Thomas Jefferson, ran against him. They were both Founding Fathers but were members of different political parties that had opposing visions for the future of the new nation. The election was bitter, partisan, and divisive. Jefferson won but wasn’t declared the winner until early in 1801. In the meantime, Adams and other Federalists in Congress attempted to leave their mark on government by creating a slate of new life-tenured judgeships and appointing Federalists to those positions. For the judgeships to become effective, official commissions had to be delivered in person to the new judges. At the time power transitioned from Adams to Jefferson, several commissions had not been delivered, and Jefferson ordered his acting secretary of state to stop delivering them. When Jefferson came to power, there was not a single federal judge from his Democratic-Republican Party, and he refused to expand the Federalist influence any further.
One Federalist judge, William Marbury, sued Secretary of State James Madison to deliver his commission. The case was filed in the Supreme Court, led by Chief Justice John Marshall, who was also a Federalist. In a shrewd move, Marshall ruled against Marbury while declaring that it was the Supreme Court’s role to decide the meaning of the Constitution. This is called judicial review, and it makes the US Supreme Court an equal branch of government to the Executive and Legislative branches. Because President Jefferson won the case, he was willing to accept the Supreme Court’s assertion of power as an equal branch of government.
Checks and Balances
The US Constitution establishes the three branches of the federal government as independent branches with their own authority. The Founding Fathers were fearful of setting up an authoritarian regime, where the rulers of the government are above the law and often rule arbitrarily. Therefore, the Founding Fathers ensured that each branch of government had a “check” on the other two branches in order to “balance” the power of the government among the branches. Therefore, if a president decided to become a dictator, the other two branches could prevent him.
Figure 2.2 Checks and Balances of the Federal Government
Judicial review means that any federal court can hold any act of the president or Congress to be unconstitutional. This is the power of the Judicial Branch to ensure that the Executive and Legislative branches do not overstep their powers and violate the Constitution.
The other branches each have a “check” on the judiciary. For example, the president (Executive branch) can control the judiciary by nominating judges. The president can also pardon those convicted by a federal court. A pardon is an executive order vacating a criminal sentence for a crime.
Congress also plays an important role in “checking” the judiciary. The most obvious role is in confirming judicial selections. In addition to confirmation, Congress also controls the judiciary through its annual budgetary process. Although the Constitution protects judicial salaries from any reductions, Congress is not obligated to grant any raises. Finally, Congress can control the judiciary by determining how the courts are organized and what kind of cases the courts can hear, except for the types of cases the Constitution lists as the original jurisdiction of the Supreme Court. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/02%3A_The_United_States_Court_System/2.01%3A_Introduction.txt |
There are fifty-six separate legal systems in the United States: those of the fifty states, the federal government, the District of Columbia, the military, and three territorial systems. Within each legal system is a complex interplay among executive, legislative, and judicial branches of government. This division of authority between a central, federal government and state governments is known as federalism.
In the United States, the federal government only has the authority given to it by the states via the US Constitution. If a power is not granted to the federal government, the states retain the power. For example, the federal government cannot tax the exchange of goods between states as “exports.” The Constitution limits the power of the federal government, and the state constitutions limit the power of the state governments.
Figure 2.3 Federalism Between Federal and State Governments
Federalism is discussed in more detail in Chapter 5.
Jurisdiction
The authority of a court to hear a particular type of case is called jurisdiction. State and federal courts hear different types of cases, involving different laws, different law enforcement agencies, and different judicial systems. The rules governing the procedures used in these courts are known as civil procedure or criminal procedure.
The rules of subject matter jurisdiction dictate whether a case is heard in federal or state court. The vast majority of civil lawsuits are filed in state courts, including lawsuits involving state laws such as property, contracts, probate law, and torts. State laws also involve most criminal cases, and domestic issues such as divorce and child custody. Torts are any civil wrong other than a breach of contract and include a variety of situations in which people and businesses suffer legal injury. Some states are friendlier toward torts than others, and the resulting patchwork of tort laws means that companies that do business across the nation need to know the different standards they are held to based on the state their customers live in.
Given the wide array of subject areas regulated by state law, most businesses deal with state courts. Federal court subject matter jurisdiction is generally limited to federal question jurisdiction. In other words, federal courts hear cases involving the Constitution or a federal law. Cases involving the interpretation of treaties to which the United States is a party are also subject to federal court jurisdiction. Finally, lawsuits between states can be filed directly in the US Supreme Court.
Sometimes a federal court may hear a case involving state law. These cases are called diversity jurisdiction cases, and they arise when all plaintiffs in a civil case are from different states than all defendants, and the amount claimed by the plaintiffs exceeds seventy-five thousand dollars. For example, a citizen of New Jersey may sue a citizen of New York over a contract dispute in federal court. But if both were citizens of New York, the plaintiff would be limited to the state court of New York. Diversity jurisdiction cases allow one party who feels it may not receive a fair trial where its opponent has a “home court advantage” to seek a neutral forum to try the case.
Type of Jurisdiction Description Minimum Dollar Requirement Applicable Law
Federal Question Cases involving the US Constitution, treaties, or federal laws & regulations None Federal law
Diversity of Citizenship Cases brought between citizens of different states \$75,000 State law | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/02%3A_The_United_States_Court_System/2.03%3A_Federalism.txt |
Within the federal court and the state court systems, there are a hierarchy of courts. The first level of court is a trial court or a court of limited jurisdiction such as traffic court and small claims court. Trial courts accept evidence and testimony to determine what happened in a case. Appellate courts review the decisions of the trial court, without holding a new trial, to determine whether the parties received a fair trial and whether the appropriate law was applied.
Figure 2.4 Court System Hierarchy
In the federal court system, cases are filed in the US District Court. There are ninety-four judicial districts in the nation, which are named for their geographical location. However, some states with low population have only one judicial district, while more populous states have multiple judicial districts. The US Department of Justice, which acts as the prosecutor representing the federal government in both civil and criminal cases, divides its attorneys among the ninety-four judicial districts.
As a trial court, the US District Courts hear both civil and criminal cases. At trial, witnesses are called and their testimonies are recorded into a trial record. The losing party is entitled to appeal the case to the US Circuit Court of Appeals. There are thirteen circuit courts in the United States. A party losing an appeal at the circuit court level may ask the US Supreme Court to hear its case. However, the Constitution only requires the Supreme Court to hear a few types of appeals.
Figure 2.5 Map of Federal Circuit Courts
In the state court system, a trial court of general jurisdiction accepts most types of civil and criminal cases. These courts are called various names such as superior court, circuit court, or district court. There may be other courts of limited jurisdiction at the state level, such as traffic court, family court, or small claims court. Like their federal counterparts, state trial courts hold trials, and preserve a trial record for review by an appellate court. Finally, in certain state cases that involve a federal constitutional right, a party that loses at the state supreme court level can appeal to the US Supreme Court. These cases typically involve the application of the Constitution to criminal procedure, evidence collection, or punishment.
Whenever an appeal is filed, the trial record is forwarded to the appellate court for review. Appellate courts do not conduct new trials and are unable to recall witnesses or call new witnesses. The trial court’s duty is to figure out the facts of the case—who did what, when, why, or how. This process of fact-finding is an important part of the judicial process, and a great deal of deference is placed on the judgment of the fact finder, which is usually the jury. The issues on appeal are therefore limited to questions of law or legal errors. The deference to the fact finder means that, as a practical matter, appeals are hard to win.
Figure 2.6 Roles of Trial and Appellate Courts
2.05: Concluding Thoughts
The US Constitution establishes the three branches of the federal government and gives them the ability to check each other’s authority. The Judicial branch oversees the actions of the Executive and Legislative branches through judicial review to ensure that they do not violate the Constitution. While not perfect, the US federalist system was designed to restrain governmental power and to prevent the rise of an authoritarian regime.
The Judicial Branch is the only unelected branch of government. Marbury v. Madison established the doctrine of judicial review, which allows courts to determine the final validity of laws as well as the meaning of the Constitution. The president can check the judiciary through appointments and the pardon power. Congress can check the judiciary through confirming judges, administrative control of court calendars and funds, and legislation about the types of cases a court can hear.
There are fifty-six separate legal systems in the United States. Subject matter jurisdiction is the authority of a court to hear a case based on the type of dispute. State law claims are generally heard in state courts, while federal question cases are generally heard in federal court. Federal courts may hear state law claims under diversity jurisdiction. Federal cases are filed in a US District Court and appealed to a US Circuit Court of Appeals. State cases are typically filed in a trial court and appealed to an intermediate court of appeals. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/02%3A_The_United_States_Court_System/2.04%3A_Trial_and_Appellate_Courts.txt |
3.1 Introduction
LEARNING OBJECTIVES
1. Identify the parties involved in litigation.
2. Explore the responsibilities of attorneys.
3. Understand the roles and types of juries.
4. Explore the standing requirement.
5. Follow a trial from opening statements to closing arguments.
Litigation provides an opportunity for each side in a dispute to tell their story to an impartial jury or judge to decide who wins. Business professionals have a responsibility to their company and stakeholders to avoid legal liability. Acting ethically helps achieve this goal. Agreeing to mediation or arbitration may help businesses avoid court. However, litigation may be the only dispute-resolution mechanism available or the one that is best for the situation.
Counselor’s Corner Litigation is like any other business effort: you are trying to get someone to see things your way. The best way to do that is to be likable and persuasive to the judge, other lawyers, and the jury. Construct your theory of the case early on. Meet your deadlines. Maintain a strict ethical standard in your professional life. Work hard to explore both sides of the case, and develop a short and compelling statement about why your side should prevail. If you do all that, you will make it easy for others to want to find in your favor. Why does this work? Because as humans, we want good to prevail. Be good. ~Valerie M., magistrate
3.2 The Parties, Attorneys, and Jury
The Parties
The litigation system relies on parties to bring forth and defend their respective claims. The party that begins a civil lawsuit is called the plaintiff. The plaintiff sues the defendant to recover damages for, or to stop, a legal wrong. In a criminal trial, the party that initiates litigation is the prosecution, representing the people within a state or federal government. In a criminal trial the accused wrongdoer is also called the defendant.
Cases may involve multiple plaintiffs and multiple defendants. Civil procedure encourages parties to bring their complaints against each other at once. All parties, and every possible claim (each claim is a separate violation of law) arising out of a single incident or series of related incidents, should be identified and raised in a lawsuit.
Except in some small-claims courts, parties may hire attorneys to represent them. Individuals who represent themselves are called pro se litigants. The complexities of litigation require knowledge and objectivity to succeed. Courts hold pro se litigants to the same standards as they do attorneys. Therefore, a pro se litigant is expected to understand and follow all the rules of the court and applicable laws.
Attorneys
In the United States, law school is a graduate-level program that usually takes three years to complete. Law school graduates earn a Juris Doctorate degree, or JD. Graduates then take the bar exam in the state where they wish to practice. If they pass the exam and background check, they can apply to be licensed in that state. Because the practice of law in the United States varies widely by jurisdiction, attorneys are only permitted to practice in jurisdictions where they are licensed.
Attorneys are bound by a professional code of ethics that is overseen by the supreme court of the state where they are licensed. One of the most important rules of professional responsibility is the obligation to keep a client’s secrets. The communications between a client and his or her attorney are absolutely confidential under the attorney-client privilege doctrine. The privilege belongs to the client, and the attorney is not permitted to reveal any of these communications without the client’s consent. A narrow exception exists for clients who tell their attorneys they intend to harm others or themselves. Attorneys must avoid violating the privilege because it exists for the client’s benefit. Someone who cannot communicate with his or her attorney freely is unable to help the attorney prepare the best possible case.
In spite of an attorney’s professional obligations to his or her client, it’s important to remember that ultimately an attorney’s first duty is to the administration of justice. The requirements for attorneys to be civil, honest, and fair are written to ensure that attorneys represent the very best aspects of the judicial system. For example, a client admits to his attorney that he is guilty of a crime. The client then wants to testify under oath that he is innocent. Although an attorney cannot reveal what her client has told her, the attorney is prohibited from knowingly suborning perjury. The attorney must either convince the client to not testify or withdraw from the case.
An attorney owes her client zealous advocacy, but her zeal must be constrained within the bounds placed on her as an officer of the Court and under the Court’s rules. Attorneys cannot assert legal claims or arguments that are not well-founded under existing law or through the modification or expansion of law. Attorneys are also prohibited from using the courts for a purpose unrelated to the resolution of a legitimate legal cause of action.
The Jury
In the US legal system, the jury has a very special role of citizen participation in the administration of justice. As the trier of fact, the jury has the duty of determining the truth in any given situation: who said and did what, why, and when. The litigation system is a process in which each side gets to present its case to a group of unbiased citizens, and then ask them to decide who wins the case.
There are two types of juries. A grand jury is a group of citizens convened by the prosecution in serious criminal cases to determine (1) whether probable cause exists to believe that a crime has occurred, and (2) whether it’s more likely than not that the defendant committed the crime. If the grand jury decides probable cause exists, then the government may bring criminal charges against the defendant. The grand jury prevents prosecutors from abusing their powers of arrest and indictment. The grand jury requirement exists at the federal level and in most states. A grand jury typically meets for an extended period of time and hears several different cases.
The grand jury does not determine guilt or innocence. A petit jury does that. This jury is impaneled for a specific trial. During the trial, members of the jury listen to the evidence presented and then deliberate as a group on the facts of the case. They then apply the law, as instructed by the judge, to the facts. There are typically twelve members in a petit jury in criminal trials and from six to twelve members in civil trials. In a criminal trial, a jury must arrive at a unanimous verdict to convict a defendant of the crimes charged.
The jury system is incredibly important because ordinary citizens adjudicate all sorts of disputes. There are problems with administering this system, however.
Both grand and petit juries are drawn from citizen voter and driver license rolls. In high-profile cases, it may be difficult to find citizens who have not heard about the case or who can be impartial. Another problem arises from the burdens placed on jurors’ personal lives through their service. While most states have laws that prevent an employer from firing a worker or taking any negative action against workers on jury duty, there is no legal requirement that an employer continue to pay a worker on jury duty. Some citizens, such as those who are self-employed, risk losing personal income by serving on juries.
Another potential problem arises in the composition of the jury. To provide a fair jury, courts attempt to draw from a cross-section of society to reflect the diversity of the surrounding community. Local court rules typically allow judges to excuse potential jurors for hardship or extreme inconvenience. The only professions that are automatically exempt are active-duty military members, police officers, firefighters, and public officers. In spite of these administrative problems, the jury system remains a cornerstone of the US legal system.
3.3 Standing
Standing is a constitutional requirement. Article III of the US Constitution grants the judiciary the power to hear “cases” and “controversies.” This means actual cases and controversies, not merely hypothetical ones. The standing requirement means that courts are unable to give advisory opinions. Standing is a doctrine that limits judicial overreach by limiting the types of cases that are litigated in court.
To demonstrate standing, a party has to prove that it has an actual case to proceed. This is a procedural matter, and it requires the case to be brought at the right time. If a case is brought too early, it is not yet ripe. If it’s brought too late, then the case is moot.
The case also has to be brought by the right person. To show standing, a plaintiff has to demonstrate that he or she has an actual stake in the litigation, or something of value that would be lost if he or she loses the case. It’s important to note that standing is not related to the merits of the case. It only means that a party may proceed with litigation.
3.4 Subject Matter and Personal Jurisdiction
In order to hear a case, courts must have subject matter jurisdiction over the type of dispute and personal jurisdiction over the parties. As discussed in Chapter 2, subject matter jurisdiction is the legal authority to hear and decide a case or controversy. The court must dismiss a case if it lacks either form of jurisdiction.
Personal jurisdiction is the power of the court to compel the parties to appear in court. Personal jurisdiction requires litigants to have some form of minimum contacts with the state where the case is filed. Personal jurisdiction seeks to avoid inconvenient litigation, even if the case has merit.
A court obtains personal jurisdiction over the plaintiff when the plaintiff files a lawsuit. The court obtains personal jurisdiction over a defendant when he or she is served with process or waives service.
Obtaining personal jurisdiction over the defendant requires some connection between the defendant and the state where the court is located. Businesses that incorporate, have a physical location, or do business in a state create personal jurisdiction through their actions within the state. Owning property in a state also creates personal jurisdiction.
Personal jurisdiction, like standing, is a constitutional requirement. Most states have long-arm statutes that set forth the procedure by which out-of-state defendants can be required to appear before a court. The statutes provide for how service of process occurs. Service of process is the process by which a defendant is notified that it is being sued. Service of process typically requires a copy of the notice to appear before a court to be personally delivered to the defendant or the defendant’s agent. In the case of businesses, service of process is usually delivering a copy of the notice to appear to their registered agent. Service can be more challenging with individuals.
Basis of Personal Jurisdiction Description
Consent
• A business or individual agrees to the jurisdiction of the court
Residence
• A business or individual resides in the state
Service of Process
• The defendant is served a summons and complaint within the state
Long-arm Statute
• A resident business or individual was involved in an incident in another state; or
• A non-resident business or individual was involved in an incident within the state
3.5 Venue
Venue is the proper geographic location of the court to hear a case because the place has some connection with the events that give rise to the lawsuit. While multiple courts may have subject matter and personal jurisdiction over a dispute, only a few may be the proper venue. For example, by doing business in Colorado a company is subject to the jurisdiction of Colorado courts. However, the court in the county where the plaintiff was injured or where the business maintains an office would be the proper court to hear the dispute.
3.6 Pretrial Procedures
Figure 3.1 Litigation Flowchart
Pleadings
In civil cases, litigation begins with the filing of a complaint by the plaintiff. The complaint is a legal document setting forth who the parties are, the facts of the case, and what laws the plaintiff claims defendant has violated. The complaint ends with a prayer for relief. The plaintiff may be seeking damages (money), specific performance in certain types of contract cases, or an injunction.
The complaint is filed with the clerk of the court where the lawsuit is to be heard. The clerk will issue a summons, which is an official notice that a lawsuit has been filed with the court and summons the defendant(s) to court to defend against it. To be effective, the defendant(s) must be served the summons and a copy of the complaint.
In certain types of cases, there may be a large number of plaintiffs injured by a defendant’s actions. This may happen in a product liability lawsuit where a product is purchased by many thousands of consumers, all of whom experience the same product failure. In these cases, several lead plaintiffs may attempt to form a class in a class action lawsuit against the defendant(s). Under federal civil procedure rules, class actions may be granted when:
1. There are so many plaintiffs that
2. It is impractical for them to file separate lawsuits;
3. There are questions of law or fact that are common to members of the class; and
4. The lead plaintiffs will fairly and adequately protect the interests of the class.
The defendant must file an answer to the complaint within a specified period of time, usually thirty days. The answer is a paragraph-by-paragraph response to the complaint, admitting certain allegations and denying others. The answer may admit, for example, noncontroversial claims by the plaintiff such as the defendant’s name, address, and the nature of the defendant’s relationship with the plaintiff. Each time the defendant denies a plaintiff’s claim in the complaint, that sets up a controversy or argument that must be litigated. The answer may also contain any affirmative defenses and counterclaims the defendant wishes to pursue. Taken together, the complaint and answer are known as the pleadings.
Discovery
After pleadings are filed, litigation moves into the discovery phase. Discovery is a process in which each side finds out information about the other’s case. Discovery is designed to prevent trial by surprise, where either side may suddenly produce a damning piece of evidence. Because trials are based on the discovery of truth, they should be tried on the merits of the case rather than a party’s deceit. In that spirit, the rules of discovery are broad. Relevant evidence is discoverable even if it is later ruled to be inadmissible at trial by the judge. Parties are also obligated to turn over material that supports their case, without demand from the other side unless it is protected by the attorney-client privilege.
Type of Discovery Description
Request for Admission
• There are four types of discovery. The simplest is a request for admission. Remember that a complaint contains a series of claims the plaintiff is making against the defendant. The parties may ask each other to admit that certain facts are true or that a contested claim is true. Doing so narrows the issues for trial because it is one less thing that the jury has to decide. Even if the parties dispute legal liability, if they agree upon the facts that caused the dispute, the case may take less time and money to resolve.
The second type of discovery is an interrogatory. These are written questions addressed to the other party. The questions tend to be simple and straightforward. Interrogatories seek to gather information about what happened, who was involved, a company’s structure, and the names and addresses of witnesses.
A third form of discovery is a request for production. A party can request another party produce relevant documents to the lawsuit, including internal company reports, emails, product manuals, and employee records. In some cases physical evidence may also be produced. For example, if a consumer sued a vehicle manufacturer because a wheel fell off while driving, the manufacturer may ask the consumer to produce the vehicle so that its engineers can inspect it. Failure to preserve and produce key evidence in litigation can lead to charges of spoliation, which may result in severe sanctions against the offending party.
Finally, discovery can take the form of a deposition. A deposition is a sworn oral statement, in response to questions, given by a potential witness in a trial to the attorneys in the case. A deposition is attended by the witness being deposed, attorneys from all the parties, and a court reporter who keeps a written or video transcript of the deposition. There is no judge present, so there is great latitude for parties to ask questions, even if the answers are not admissible in court. Depositions help prepare for trial by knowing everything a witness may say in court. They also serve to pin down a witness’s testimony, because a witness who changes testimony between a deposition and trial can be impeached.
Motions
At any point in litigation, either party may file motions with the court. A motion is a request to the court to rule on an issue or claim.
If a defendant is properly served and does not answer the complaint, the plaintiff can file a motion for default judgment. In essence, the plaintiff asks the court to enter judgment in his or her favor because the defendant refused to show up to court to defend against the case. The alleged facts are admitted by default and the plaintiff may receive all the relief requested.
At the beginning of a lawsuit, a party can file a motion to dismiss for failure to state a claim. In this motion, the defendant argues that even if everything in the complaint is factually true, the plaintiff is not entitled to legal relief. In other words, the defendant’s conduct has not broken any laws.
If a long period of time has passed since the incident in question and the filing of the lawsuit, a defendant may file a motion to dismiss based on the statute of limitations. Every civil and criminal action has a statute of limitations, which requires lawsuits to be brought within a specified period of time. Statutes of limitations exists to encourage parties to file their lawsuits quickly, while evidence is still fresh and relevant witnesses remember what occurred. As time passes, evidence may be destroyed, witnesses may die or move away, and those who can be located can’t remember what they saw or heard. In other words, the quicker a lawsuit is filed, the more likely that the truth will be discovered through litigation. For businesses, a statute of limitations also allows it to “close the books” on past liabilities.
Another motion that is filed before discovery and trial is a motion for judgment on the pleadings. This motion asks the court to determine whether a genuine issue of material fact exists that allows the case to proceed. These motions are not as common as motions to dismiss but they are an important tool to dismiss lawsuits that are fatally flawed before the parties spend too much money. For example, if a business is sued by several parties for injuries resulting from a common cause but the complaints allege conflicting facts, the business may file a motion for judgment on the pleadings. In other words, the defendant is asking the court to dismiss the complaints because they contradict each other in a way that it is impossible to reconcile. If dismissed, the plaintiffs may file new complaints that are not flawed.
Similar to a motion for judgment on the pleadings, a motion for summary judgment asks the court to enter judgment in a party’s favor instead of trying the case. Filed after discovery, this motion asks the court to rule that there are no genuine issues of facts for trial. For example, if a plaintiff admits during his deposition that he lied about being involved in an accident, the defendant may bring a motion for summary judgment because the plaintiff brought a fraudulent lawsuit. Although any party may file a motion for summary judgment, defendants file and win many more motions for summary judgment than plaintiffs.
Pretrial Motion Description
Motion for Default Judgment
• A party may submit an affidavit in support of any motion. An affidavit is a written statement made under oath. Affidavits play an important role in pretrial procedure because they are an effective way for parties to tell their side of the story to the judge.
3.7 The Trial and Appeal
After discovery is completed, the case is scheduled for a trial. In civil litigation, well over 90 percent of cases filed are resolved or settled before trial. If a case goes to trial, it means there are genuine issues of fact that the parties cannot resolve, and both sides are determined to win.
The first step in this process is to select a jury. The process of selecting a jury is called voir dire. Voir dire typically begins with the jurors filling out a written questionnaire. The questionnaire asks the jurors to identify their occupation, any work or occupational conflicts, and any potential conflicts of interest with the case. The process then continues with attorneys quizzing each potential juror to determine if he or she has any biases against upholding the law and whether he or she can keep an open mind during the trial.
After a jury has been selected and sworn in, the trial begins. The plaintiff or prosecution begins by giving an opening statement that is a preview of the trial. Attorneys inform the jury during opening statements what they expect to prove at trial. Attorneys do not make any arguments during the opening statement; they simply lay out what jurors can expect from the trial ahead. After plaintiff’s opening statement, the defendant may give an opening statement.
After opening statements, the trial moves into the examination phase. The plaintiff presents evidence first. Evidence may be in the form of documents and witness testimony. The other parties have the right to cross-examine witnesses who testify at trial. During the cross-examination, the attorney will try to discredit the witness to convince the jury that the witness is not credible. The attorney may probe into any potential biases the witness may have or try to prove that the witness’s recollection of events may not be as clear or certain as the witness believes.
Once the plaintiff has called all their witnesses and introduced all their evidence, the plaintiff will rest their case. The defendant then has an opportunity to present witnesses and evidence on their behalf. After the defense has rested its case, the attorneys once again address the jury in closing arguments. Here, the attorneys summarize the case for the jury. They address what witnesses were called and what the witnesses said. During closing arguments, the attorneys are permitted to be much more persuasive and argumentative than during the opening statement. They appeal to the jury’s emotions and argue how the jury should interpret the evidence before them.
After closing arguments are made, the judge instructs the jury on the relevant law. The jury then deliberates. During deliberations, the jury will decide what facts are true. Then it will apply those facts to the law as outlined in the jury instructions.
Central to the jury’s deliberations is the burden of proof applicable to the case. In civil cases the burden of proof is preponderance of the evidence. This standard requires the scales of justice to tilt ever so slightly toward one party. If the jury believes one side is 51 percent correct and the other is 49 percent correct, that is enough to declare a winner. It is an easy standard to meet because it only requires a party to prove that its side is more likely than not telling the truth.
During jury deliberations, the jurors are permitted to ask the judge for clarification about the law and to request to see the evidence again. If the jury is unable to come to a verdict, the jury is said to be deadlocked, and a mistrial results. Since trials are expensive and time consuming, the judge will usually instruct the jury to try its best before giving up. If the jury arrives at a decision, it is called a verdict.
The judge enters the jury’s verdict as a judgment of the court. After that, the losing party has the right to file an appeal. The appellate court only reviews the record for legal errors and cannot call new witnesses or substitute its judgment on the facts for the jury’s.
Once all appeals are exhausted, the winning party may collect the judgment entered in its favor. This process is called execution. If a party is unable or unwilling to pay the judgment, the court can order the party’s assets to be sold to satisfy the judgment.
A party cannot refile a lawsuit once it has been decided in the hopes of a more favorable outcome. The doctrine of res judicata holds that once a dispute is litigated and resolved, the parties are barred from relitigating the issue again. Res judicata is a Latin phrase that means “the thing has been decided” and it is a rule of finality in the legal system.
3.8 Concluding Thoughts
Litigation is a method for parties who cannot resolve their disputes to have a judge or jury determine what happened and whether legal liability exists. Although it may be challenging to keep the names of the parties, motions, and parts of the process straight, businesses need to understand the process to navigate it successfully. Litigation is a long and expensive process, but is often a part of a business’s activities.
The goal of civil litigation is to find the truth. An attorney’s highest duty is to the administration of justice. Attorneys are ethically bound to represent their clients with zealous advocacy. A grand jury acts as a body of citizens to prevent abuse by prosecutors. A petit jury sits in trials as the trier of fact to ascertain the truth through their observations of the presented evidence. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/03%3A_Litigation.txt |
4.1 Introduction
LEARNING OBJECTIVES
1. Understand alternative dispute resolution (ADR) methods.
2. Learn the benefits and drawbacks of different methods of dispute resolution.
Imagine that someone has a legal claim against a supplier, employer, or a business where he or she is a customer. What will happen? They probably don’t want to immediately initiate litigation because litigation is very expensive and time consuming. Besides, they may want to continue doing business with the supplier, employer, or business. Perhaps the matter is of a private nature, and they do not want to engage in a public process to determine the outcome. They would like the dispute to be resolved, but do not want to engage in a public, time-consuming, expensive process like litigation to do it.
A common method of dispute resolution that avoids many of the challenges associated with litigation is alternative dispute resolution. Alternative dispute resolution (ADR) encompasses many different methods of resolving disputes outside of the judicial process. Some ADR methods vest power to resolve the dispute in a neutral third party, while other strategies vest that power in the parties themselves.
Figure 4.1 Alternative Dispute Resolution Continuum
The most common methods of ADR are negotiation, mediation, and arbitration. ADR is often used to resolve disputes among businesses, employers and employees, and businesses and consumers.
ADR methods are used outside of the courtroom, but participation in ADR has important legal consequences. For instance, parties that have agreed by contract to be subject to binding arbitration give up their constitutional right to go to court. The Federal Arbitration Act (FAA) is a federal statute that requires parties to participate in arbitration when they have agreed by contract to do so, even in state court matters. The FAA preempts state power to create a judicial forum for disputes arising under contracts with mandatory arbitration clauses. The FAA encompasses transactions within the broadest permissible exercise of congressional power under the Commerce Clause in the US Constitution. This means that the FAA requires mandatory arbitration clauses to be enforceable for virtually any transaction involving interstate commerce, which is very broadly construed. This is an example of federal preemption exercised through the Supremacy Clause in the US Constitution.
Counselor’s Corner “Alternative dispute resolution.” The term suggests that litigation is the primary means of dispute resolution and that mediation, arbitration, and other means are “alternatives.” But, actually, negotiation is the primary means of dispute resolution and the others are the alternative means—with litigation being the last (legal) alternative. In negotiation and mediation, the participants make decisions based on their values and predispositions, needs, criteria for satisfying those needs, pertinent information they are aware of, and available ways to satisfy their needs. Negotiation is the most used means of resolving disputes. It is an invaluable life skill. Don’t wing it—learn how to do it well. ~Russell C., judge
4.2 Negotiation
Imagine that Han is a tent manufacturer. Han’s supplier of tent fabric routinely supplies him with appropriate water-resistant fabric to construct tents, so that he can make and sell them. After many years of a good working relationship, Han’s fabric supplier delivered nonconforming goods. Specifically, the fabric delivered was not water-resistant, despite the need for water-resistant fabric to make tents. However, when Han notified the supplier of the problem, the supplier denied that the fabric was nonconforming to his order. Han refused to pay for the goods. The fabric supplier insisted on payment before future delivery of any additional fabric. Without water-resistant fabric, Han cannot continue to make tents.
This is an example of a business to business dispute. Despite the problem, Han wants to continue working with this supplier, since they have a good, long-standing relationship. This problem seems to be a “hiccup” in the regular business relationship so they want to resolve this dispute quickly and without hard feelings. It is very unlikely that Han will immediately hire an attorney to file a formal complaint against his supplier. However, that does not change the fact that there is a dispute that needs to be resolved.
One of the first strategies that Han and his supplier are likely to use is negotiation. Negotiation is a method of alternative dispute resolution in which the parties retain power to resolve their dispute. No outside party is vested with decision-making power. Negotiation requires the parties to define the conflict and agree to an outcome. Often, this can take the form of a compromise. Note that a compromise does not mean that anyone “loses.” If both parties are satisfied with the result of the negotiation and the business relationship can continue moving forward, then both parties will likely consider the settlement a “win.”
Benefits to negotiation as a method of ADR include its potential for a speedy resolution, the inexpensive nature of participation, and the fact that parties participate voluntarily. Drawbacks include the fact that there are no set rules, and either party may bargain badly or even unethically. In a negotiation, there is no neutral third party to ensure that rules are followed, that the negotiation strategy is fair, or that the overall outcome is sound. Moreover, any party can walk away whenever it wishes. There is no guarantee of resolution through this method. The result may not be “win-win” or “win-lose,” but no resolution at all.
In addition, the parties may not have equal bargaining power. If Han’s business and the supplier are both dependent on each other for roughly equal portions of their businesses, then they are most likely relatively equal with respect to bargaining power. However, if Han has a small business but his supplier has a large business, then negotiation is potentially unbalanced, since one party has a much more powerful bargaining position than the other. For example, if Han needs that particular type of fabric, which is only available from one supplier. But the supplier does not need Han’s business because he do not provide a significant amount of its profit. This would be an example of unequal bargaining power.
4.3 Mediation
Mediation is a method of ADR in which parties work to form a mutually acceptable agreement to resolve their dispute with the help of a neutral third party. Like negotiation, parties in mediation do not vest authority in a third party to decide the dispute. Instead, this authority remains with the parties themselves, who are free to end mediation if it is not working. Often, when parties end mediation, they pursue another form of ADR, such as arbitration, or they choose to litigate their claims in court. Like negotiation, mediation seeks a “win-win” outcome for the parties involved. Additionally, mediation is confidential, which may be attractive to people who wish to avoid the public nature of litigation. Discussions during a mediation are not admissible as evidence if the parties proceed to litigation. This encourages parties to be open with each other when trying to resolve their dispute. Finally, the mediation process is usually much faster than litigation, and the associated costs can be substantially less.
Unlike negotiation, a third party is involved in mediation. Indeed, a neutral mediator is crucial to the mediation process. Mediators act as a go-between for the parties, seeking to facilitate the agreement. Mediators do not provide advice on the subject matter of the dispute. Mediators might not possess any subject-matter expertise concerning the nature of the dispute. The value of mediators, however, is their training and experience in conflict resolution, which they use to facilitate an agreement between the parties.
Advantages of Mediation Drawbacks of Mediation
• Parties often enter into a legally binding contract that embodies the terms of the resolution immediately after a successful mediation. Therefore, the terms of the mediation can become binding if they are reduced to a contract.
Mediation is often required by courts as part of the litigation process. In an effort to reduce the court’s docket and encourage the parties to settle their own disputes, parties to lawsuits often must mediate their disputes after discovery and before trial. If the parties cannot settle their dispute with the help of a mediator, the case will proceed to trial before a judge or jury who will determine the outcome of the case.
4.4 Arbitration
Arbitration is a method of ADR in which parties vest authority in a neutral third-party decision maker to hear their case and issue a decision, which is called an arbitration award.
An arbitrator presides over arbitration proceedings. Arbitrators are neutral decision makers who are often experts in the law and subject matter at issue in the dispute. Arbitrators act like judges during trials. For instance, they determine which evidence can be introduced, hear the parties’ cases, and issue decisions. They may be certified by the state in which they arbitrate, and they may arbitrate only certain types of claims. For instance, the Better Business Bureau trains its own arbitrators to hear common complaints between businesses and consumers (B2C). However, their decisions do not form binding precedent like appellate court decisions.
Participation in the arbitration proceeding is sometimes mandatory. Parties must arbitrate if they signed a contract requiring mandatory arbitration for that type of dispute. Arbitration is also mandatory when state law requires it.
Voluntary arbitration is frequently used in business disputes. Sometimes parties simply agree that they do not want to litigate a dispute because they believe that the benefits of arbitration outweigh the costs of litigation, so they choose arbitration in hopes of a speedy and relatively inexpensive outcome.
In binding arbitration, the arbitration award is final. Therefore, appealing the merits of a binding arbitration award to court is not available. An arbitration award may be converted to a judgment by the court, thereby creating the legal mechanism through which the judgment can be collected. This process is called confirmation.
Although courts review arbitration awards, their review is very limited and all doubts are resolved in favor of the validity of the award. Courts review whether (1) the arbitration award covered matters beyond the issues submitted; (2) the arbitrator failed to apply the law correctly; and (3) fraud occurred. Courts do not review the merits of the award.
Like any other form of dispute resolution, arbitration has certain benefits and drawbacks. Arbitration is an adversarial process like a trial, and it will produce a “winner” and a “loser.” Arbitration is more formal than negotiation and mediation and, in many ways, it resembles a trial. Parties present their cases to the arbitrator by introducing evidence. After both sides have presented their cases, the arbitrator issues an arbitration award.
The rules of procedure during arbitration are often less formal or less restrictive on the presentation of evidence than in litigation. Arbitrators decide which evidence to allow, and they are not required to follow precedents or to provide their reasoning in the final award. In short, arbitration adheres to rules, but those rules are not the same as the rules for litigation.
Arbitration can be more expensive than negotiation or mediation, but it is often less expensive than litigation. Parties must pay the costs of the arbitrator, and they often hire attorneys to represent them. Additionally, in mandatory arbitration clause cases, the arbitration may be required to take place far from one of the parties. This means that a party may have to pay travel costs during the arbitration proceeding. Arbitration is also faster than litigation.
A common issue is whether mandatory arbitration is fair in certain circumstances. It’s easy to imagine that arbitration is fair when both parties are equally situated. For example, business to business (B2B) arbitration is often perceived as fair, especially if businesses are roughly the same size or have roughly equal bargaining power. This is because they will be able to devote approximately the same amount of resources to resolve the dispute, and they both understand the issues involved.
However, issues of fairness often arise in business to employee (B2E) and business to consumer (B2C) disputes, particularly where parties with unequal bargaining power have entered into a contract that contains a mandatory arbitration clause. In such cases, the weaker party has no real negotiating power to modify or to delete the mandatory arbitration clause, so that party is required to agree to such a clause if it wants to engage in certain types of transactions. In B2E contexts, unequal bargaining power alone is insufficient to hold arbitration agreements unenforceable.
In B2C cases, different issues of fairness exist. As noted previously, when the parties possess unequal power, these issues can be magnified. Consumers tend to fare better in litigation than in arbitration. Incentives exist to favor businesses over consumers in the arbitration process, including the lack of appeal rights to the courts, the limits on consumers’ remedies, prohibitions against class-action suits, limitations on access to jury trials, limitations on abilities to collect evidence, and greater out-of-pocket expenses.
Not all binding arbitration clauses have been upheld by courts in B2C cases. The FAA does not prevent the courts from applying state law, including the unconscionability of contract terms. In other words, if the terms of the contract make it unreasonable to enforce the arbitration provision, then a party may still bring claims to court for resolution.
Similarly, arbitration agreements may be rescinded on the same grounds as other contracts. Fraud, mutual mistake, and lack of capacity are grounds for voiding arbitration contracts. Revocation is also possible in the event of death or bankruptcy of one of the parties, as well as destruction of the subject matter of the underlying contract.
4.5 Concluding Thoughts
ADR is the body of dispute-resolution methods outside of the litigation process. ADR is often faster, less expensive, and more private than litigation. For this reason, ADR may be the preferred dispute resolution method, particularly when an ongoing relationship between parties is desired. Common methods of dispute resolution are negotiation, mediation, and arbitration. Mandatory arbitration clauses are common in contracts, and such clauses are usually enforceable against the parties even if they wish to litigate their claims. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/04%3A_Alternative_Dispute_Resolution.txt |
5.1 Introduction
LEARNING OBJECTIVES
1. Explore how the US Constitution creates a limited government through the separation of powers and through checks and balances among the three branches of government.
2. Learn how the US Constitution resolves conflicts between state and federal laws.
3. Explore how the US Constitution grants Congress the power to regulate interstate commerce.
4. Understand how the US Constitution protects the civil liberties of business entities.
Our first national constitution was the Articles of Confederation. The Articles granted limited authority to the federal government, including the power to wage wars, conduct foreign policy, and resolve issues regarding claims by the states on western lands. Many leading statesmen, known as Federalists, thought the Articles created a federal government that was too weak to survive. The lack of power to tax, for example, meant that the federal government was frequently near bankruptcy. Larger states resented the structure under the Articles, which gave small states an equal vote as larger states. Finally, the Articles reserved the power to regulate commerce to the states, meaning each pursued its own trade and tariff policy with other states and with foreign nations. Because the federal government was too weak to function, the Articles were abandoned and the current Constitution was adopted in 1787.
Counselor’s Corner The Constitution is the fundamental law of our nation and is extremely powerful. It’s also beautiful in its simplicity. The Constitution in action, though, is often messy. People’s rights conflict with each other. Branches of government clash over which has the power to act. Federal and state governments argue over who has ultimate authority to govern. But as long as we continue to cherish the values instilled in the document, the Constitution will remain a living protection against tyranny. We must protect it at all costs if we expect it to protect us. Tyranny starts when our dedication to Constitutional principles ends. ~John K., judge
5.2 Federalism and Preemption
Much of the Constitution deals with the allocation of power among three separate and coequal branches of government. Substantively, much more attention is paid to the limitations on the power given to each of the three branches than to any positive grant of rights. The Constitution is a document of prohibition, outlining what government cannot do as opposed to what government must do. This is the result of the Founders’ distrust of authoritarian regimes.
Separation of Powers
The Constitution provides for the separation of powers, which requires each branch of government to play its own unique role in governing the people.
Figure 5.1 Separation of Powers of the Branches of the Federal Government
Article I of the Constitution establishes the legislative branch through a bicameral legislature. The House of Representatives, with elections every even-numbered year, has 435 members, with representation determined proportionately by state population as determined by a census every decade. The most populous state, California, has fifty-three representatives, while several states have only one representative. The House is led by the Speaker of the House, typically from the party that holds the majority seats in the House. The House is generally thought to represent the most contemporary views of the American public, with its large body of members and frequent elections.
As a check on the majority will, and on the power of larger states, the Senate is a smaller body with one hundred members (two from each state) and with less frequent elections (every six years). The Senate is meant to be a deliberative body to ensure debate of significant issues and prevent hastily rushed law. The makeup of the Senate means that citizens from smaller states, representing many fewer people, may frustrate the will of the majority of Americans. The Constitution places the power to legislate with both chambers, but the House retains the exclusive right to originate bills raising revenue (taxation), while the Senate maintains the exclusive right to ratify treaties.
Article II of the Constitution establishes the executive branch of government. It sets forth some of the mechanisms for becoming president—and is the only place in the Constitution that prescribes a specific oath of office. Article II grants the president power to be the primary architect of foreign affairs, including the power to negotiate treaties and appoint ambassadors. The president is also commander-in-chief of the armed forces. The president is mainly responsible for enforcing the laws of the nation. Through prosecutorial and police functions, the president ensures that the will of the people, as expressed through Congress, is carried out.
Article III of the Constitution establishes the judicial branch of the federal government. The judicial branch plays a critical role in interpreting the Constitution and outlining the powers of the legislature and executive branches. The power to adjudicate disputes is given to the Supreme Court and any other lower courts established by Congress. Federal courts have the power to hear disputes under the Constitution, federal laws and treaties. Also, if disputes arise between citizens of different states, a federal court may have diversity jurisdiction. Federal judges are nominated by the president and confirmed by the Senate. Federal judges serve for life, which helps insulate them from political pressures.
Checks and Balances
The Constitution establishes a system of checks and balances among the legislative, executive, and judicial branches. Under this system, each branch of government restrains the power of the other two branches of government. For example, the president may veto a bill passed by Congress. And Congress can override a presidential veto by a two-thirds vote.
Figure 5.2 Checks and Balances of the Federal Government
The judicial branch has the power of judicial review of executive and legislative actions to determine whether they violate the Constitution. Although not expressly written in the Constitution, judicial review was established in 1803 in a landmark case, Marbury v. Madison. Judicial review also includes review of state action for violations of the US Constitution. As a result, judicial review ensures that the US Constitution is the supreme law of the land and that the judicial branch has the authority to interpret the Constitution.
Federalism
Another aspect of the separation of powers is the separation of power between the federal and state governments, known as federalism. To avoid tyranny, the Constitution grants certain powers to Congress, reserving all other powers to the states. This is a result of the Founders’ distrust of a central government and their effort to address the failures of the Articles of Confederation. These powers are listed in Article I, Section 8 and are called enumerated powers.
Congress has the power to borrow money, lay and collect taxes, regulate interstate commerce, establish a uniform law on bankruptcy and naturalization, make money and establish its value, punish the counterfeiting of US money, and establish a uniform system of weights and measures. Congress also has the power to establish post offices and to protect intellectual property in copyrights and patents. Congress can create lower courts under the Supreme Court created in Article III and to define crimes committed on the “high seas” and against the “law of nations.” Congress is also given fiscal responsibility over the armed forces.
State Police Powers
The Constitution reinforces that states have police power, which is the authority to regulate public safety, health, welfare, and morals. States may grant more civil rights to its citizens than the federal government does. For example, some states have passed anti-discrimination laws that protect more minority groups than are recognized by the federal government. States are permitted to do so as long as the exercise of their power does not violate the US Constitution. Generally, this means the state legislation must be reasonable and applied fairly rather than arbitrarily.
Concurrent Powers
The federal and state governments have some of the same powers, which are called concurrent powers. For example, both federal and state governments may tax businesses and individuals. States are permitted to tax, but only if the activity taxed has a nexus to the state. A transaction (such as a sale) that takes place inside the state creates a nexus for a sales tax. Working in the state typically creates a nexus for state or local income tax to apply, and owning real property creates a nexus for real estate tax to apply.
Figure 5.3 Venn Diagram of the Powers of the Federal and State Governments
What happens, however, if a state’s citizen purchases goods from a seller out of state? Traditionally, buyers do not pay sales tax to the government directly—rather, they pay the sales tax to the seller, who collects the tax on behalf of the government and turns it over to the government at regular intervals. As the popularity of e-commerce has skyrocketed, more and more states are reexamining how to tax transactions from out-of-state sellers by compelling those sellers to collect the applicable state sales tax. In June 2018, the US Supreme Court ruled that states may impose sales tax on e-commerce sales on businesses that do not have a physical presence within the states’ boundaries. If the business has a clear connection to state consumers and generate a certain threshold of sales, a state can collect sales tax.
Preemption
What happens when state and federal laws exist on the same subject matter and they contradict each other? Under the Constitution’s Supremacy Clause (Article VI, Section 2), the Constitution, federal laws and treaties are the “supreme law of the land” and judges in every state “shall be bound” by those laws. This means that federal laws are superior to state laws. Therefore, when a federal law conflicts with a state law, the federal law prevails.
When Congress states its intent to regulate an area completely, this is called express preemption. Implied preemption occurs when Congress intends to completely regulate an area but does not say so explicitly. Instead, Congress passes laws that “occupy the field” so much that no room for state regulation exists. Finally, some areas of the law allow both state and federal governments to regulate together. For example, both federal and state governments have laws to protect consumer rights.
Constitutional Rules Between the States
There are several important Constitutional provisions that ensure our federalist system works properly. The first is the Privileges and Immunities Clause in Article IV. This Clause ensures that people in different states are treated equally by the government. For example, the federal government cannot pass laws that subject citizens in the West to more regulations than citizens in the East. Federal laws must be applied equally across the nation. The Founders included this provision to encourage travel and business between the states.
Another important Constitutional provision is the Full Faith and Credit Clause in Article IV. This Clause requires states to “respect the public acts, records, and judicial proceedings of every other state.” This is important for businesses because it ensures that state courts respect the judgments of courts from other states. Therefore, a judgment won in Colorado may be enforced in another state, without relitigating the underlying issues. This facilitates business because litigation can be finalized without subjecting a company to endless liability across states.
5.3 The Commerce Clause
The most important Constitutional provision related to the federal regulation of business is the Commerce Clause, which grants Congress the power to “regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes” (Article I, sec. 8). Over time, the Commerce Clause has been interpreted to apply to more and more businesses and industries. In addition to business transactions across state lines, the Commerce Clause now applies to business activity within one state that substantially affects or impacts commerce in other states. The growth of e-commerce, the internet, and federally-insured banks results in most businesses today being subject to federal regulation under the Commerce Clause.
Dormant Commerce Clause
States cannot interfere with Congress’s power to regulate interstate commerce. This concept is known as the Dormant Commerce Clause. This clause restricts the states’ abilities to regulate commerce, rather than the federal government’s.
A state law that discriminates against out-of-state commerce, or places an undue burden on interstate commerce, violates the dormant commerce clause. For example, if a state required out-of-state corporations to pay a higher tax or fee than an in-state corporation, that is unconstitutional. However, this prohibition against out-of-state discrimination does not prevent a state from exercising its police power to protect state citizens, as long as the power is exercised evenly and equally. For example, a state may weigh trucks on highways to ensure they do not exceed maximum weight rules, even if the trucks came from out of state, as long as all trucks on the highways are weighed.
5.4 Business and the Bill of Rights
During the debate surrounding the Constitution, there was much discussion about whether an explicit protection of civil liberty was necessary. Some believed that the common law system adequately protected civil liberties, so a written declaration of rights wasn’t necessary. Others believed that a written declaration of rights was necessary to protect the people from government overreach. In 1791, the first ten amendments to the Constitution were ratified and became known as the Bill of Rights.
When we speak of civil liberties protected in the Constitution, we often think of how these liberties apply to people. Although the Constitution does not contain the word “corporation,” Congress has defined “person” to include “corporations” so many civil rights also apply to business entities.
It’s worth making some observations about civil liberties in general. First, there are no absolute rights, in spite of the wording of any specific amendment. For example, the First Amendment states that “Congress shall make no law abridging the freedom of speech.” In fact, there are many laws that limit the freedom of speech. People aren’t allowed to libel or slander someone, for example, or incite a crowd into a riot. Instead of absolute rights, courts have to constantly balance competing interests in deciding where the limits of individual rights lie. The right of the public to know information about the lives of politicians and other high-profile figures, for example, must often be balanced by the right those citizens have to their own privacy.
Second, while the Constitution sets up a system of government based on principles of representative democracy, the Bill of Rights exists to protect the minority, not the majority. Other than the right to vote, the civil liberties protected by the Constitution extend to all persons physically on US soil, not just citizens or legal immigrants. Persons visiting the United States temporarily, such as tourists and students, as well as undocumented aliens, are also entitled to the full protections of the US Constitution.
Third, the extent of civil liberty protections vary from time to time. Society evolves with progress and challenges. The Founders could not contemplate a digital world where an act of defamation on social media can spread to millions of people in a matter of minutes. The Eighth Amendment illustrates how time shifts the meaning of a right. The Eighth Amendment prohibits “cruel and unusual” punishment. The Supreme Court, in defining what “cruel and unusual” is, looks to “evolving standards of decency” in making the determination—in other words, what is cruel and unusual today may have been normal in years past.
Finally, major portions of the Bill of Rights apply equally to the states as they do the federal government. When adopted, the amendments were meant to restrict the federal government only. For example, the First Amendment states “Congress shall make no law respecting an establishment of religion.” States were not similarly restricted, and many states established official churches. After the Civil War, the Constitution was amended to include the Fourteenth Amendment, which prevents any state from depriving citizens of their rights without “due process of law.” Gradually, the Supreme Court developed a doctrine called incorporation, by which the limitations on government behavior in the Bill of Rights were extended to apply to the states as well. While many portions of the Bill of Rights apply to the states, not all of it does. There is no requirement, for example, that states use a grand jury system to indict criminals. There is also no requirement that states provide juries in civil trials.
First Amendment
Figure 5.4 Language of the First Amendment
The First Amendment contains several important clauses pertaining to speech and religion. The two different clauses on religion may conflict with each other in some circumstances. On the one hand, the First Amendment prohibits the government from establishing any religion—this is called the Establishment Clause. On the other hand, the First Amendment prohibits the government from restricting the free exercise of religion—this is called the Free Exercise Clause. In theory, this allows individuals the right to freely practice their religion while prohibiting the government from doing so. Conflict arises when people choose to practice their religion freely and openly on government property, such as in a public school or city hall.
As is often true in Bill of Rights cases, courts have had to fashion a test to draw the line between the Establishment and Free Exercise Clauses. The use of public funds for religious purposes and the public display of religious life is generally acceptable as long as the primary motivation is not to advance a specific religion. A city that wishes to display a Christmas tree or nativity scene, for example, is permitted to do so as part of a general holiday-themed cultural display that also includes a menorah.
The First Amendment also protects the right to freedom of speech. While many nations believe in the right of citizens to think and speak freely, the United States is fairly unique in enshrining those principles into constitutional law.
Not all speech is protected by the First Amendment, and the type of speech drives its level of protection. Political speech, which relates to matters of public interest, receives the most protection. Political dissent, displeasure with the government, party membership, and even speech advocating the overthrow of government, all deserve extraordinary protection under the First Amendment.
Figure 5.5 Spectrum of First Amendment Protection of Speech
On the other end of the spectrum is speech that deserves no protection under the First Amendment at all, such as speech that incites a panic (e.g. yelling “Fire” in a crowded theater when there is no fire). Defamation, libel and slander are all actionable torts. Obscene speech and fighting words are also not protected under the First Amendment.
In the middle of the spectrum is commercial speech, which relates to business transactions. Commercial speech is entitled to some protection under the First Amendment as long as it is not false or misleads consumers. If the information is false or misleading, it is not protected at all. Under an intermediate level of scrutiny test, freedom of commercial speech is not violated as long as (1) there is a substantial government interest in restricting or regulating speech; (2) the restriction directly advances that interest, and (3) the restriction is no more extensive than necessary.
The prior restraint doctrine prohibits formal censorship before the publication of speech. In other words, the government cannot restrict speech or publications before their actual expression. Prior restraints violate the First Amendment unless the speech is obscene, is defamatory, or creates a clear and present danger to society.
The US Supreme Court has ruled that corporations are “persons” entitled to First Amendment rights to speech and religion. In striking down federal and twenty-two state restrictions on corporate spending on political campaigns, the Supreme Court held that corporations are persons and therefore entitled to engage in political speech. Since corporations are unable to literally “speak,” they speak through spending money, and thus restrictions on how corporations may spend money during political campaigns are unconstitutional. Similarly, Congress defined “persons” to include corporations, companies, associations, firms, partnerships, societies, and joint stock companies. As a result, those types of businesses have religious rights that allow them to opt out of providing healthcare insurance to their employees that violates the businesses’ religious beliefs.
Not all protected speech is protected all the time in all places. The government is permitted to place reasonable time, place, and manner restrictions on speech to maintain important governmental functions. These restrictions are generally upheld if they further an important or substantial governmental interest, they are content neutral, and any restriction on First Amendment freedoms is no greater than that necessary to further governmental interests (i.e. the restriction is not overbroad). Thus, for example, courts have upheld restrictions on posting signs on city-owned utility poles, as well as picketing and protest permit requirements.
Fifth Amendment
Figure 5.6 Langue of the Fifth Amendment
Another important restriction on governmental authority actually appears twice in the Constitution. The due process clause appears in both the Fifth Amendment (“No person shall…be deprived of life, liberty or property without due process of law”) and the Fourteenth Amendment (“Nor shall any State deprive any person of life, liberty, or property, without due process of law”). The Fifth Amendment applies to the federal government and to the states. At its core, due process means “fundamental fairness and decency.” The clause requires that all government action that involves the taking of life, liberty, or property be done fairly and for fair reasons. Notice that the due process clause applies only to government action—it does not apply to the actions of private citizens or entities such as corporations.
Due process contains two components. The first is called procedural due process. Procedural due process requires that any government action that takes away life, liberty, or property must be made fairly and using fair procedures. Procedural due process includes: (1) notice that the government is going to act and why; (2) a hearing prior to the governmental action; and (3) the ability to appeal the determination made at the hearing. This ensures those affected by a government action have a fair chance to oppose it.
The second type of the due process is substantive due process. Substantive due process focuses on the content of government legislation itself. Generally speaking, government regulation is justified whenever the government can articulate a rational reason for the regulation. In certain categories, however, the government must articulate a compelling reason for the regulation. This is the case when the regulation affects a fundamental right, which is a right deeply rooted in American history and implicit in the concept of ordered liberty. The government must also set forth compelling reasons for restricting the right to vote or the right to travel. Substantive due process is often used as a basis for any lawsuit challenging government procedures or laws that affect an individual’s or company’s civil liberties.
Governments have the power of eminent domain, which is the power to take privately owned property and convert it for public use. The Takings Clause of the Fifth Amendment prohibits the government from taking private property for public use without just compensation. A law or regulation that denies all beneficial use of property is a taking that requires compensation. A common issue in eminent domain cases is what constitutes “just compensation.” What the value of the property was before the government announces its intent to take the property or after? Property includes land, intellectual property, and personal property.
Fourteenth Amendment
Figure 5.7 Language of the Fourteenth Amendment
The Equal Protection Clause of the Fourteenth Amendment states that “No state shall deny to any person within its jurisdiction the equal protection of the laws.” In other words, it requires the government to treat people equally. This clause incorporates Constitutional protections against the states in addition to the federal government.
The Equal Protection Clause is implicated anytime a law limits the liberty of some people but not others. It scrutinizes government-sponsored discrimination. While the word “discrimination” has a negative connotation, not all discrimination is illegal. For example, a criminal law discriminates against those who steal. The Equal Protection Clause seeks to determine what forms of discrimination are permissible.
To establish a guideline for courts to use in answering equal protection cases, the US Supreme Court has established three standards of review when examining statutes that discriminate: minimal scrutiny, intermediate scrutiny, and strict scrutiny.
Under the minimal scrutiny test, the government needs only a rational basis for the law—the law simply has to be reasonably related to some legitimate government interest. If the law is based on some rational basis, then the law passes equal protection. Thus, a law that imprisons thieves easily passes minimal scrutiny, since there are many rational reasons to imprison thieves. The majority of cases that are scrutinized under minimal scrutiny pass review.
The intermediate scrutiny test applies to cases where the government discriminates on the basis of gender. Under this test, the government has to prove that the law in question is substantially related to an important government interest. Using this test, courts have invalidated gender restrictions on admissions to nursing school, laws that state only wives can receive alimony, and a higher minimum drinking age for men.
The strict scrutiny test is used when the government discriminates against a suspect class. Under this test, the government has to prove that the law is justified by a compelling governmental interest, that the law is narrowly tailored to achieve that goal or interest, and that the law is the least restrictive means to achieve that interest. The standard is reserved for only a few classifications: laws that affect “fundamental rights” such as the rights in the Bill of Rights and any government discrimination that affects a “suspect classification” such as race or national origin. In practice, the government has a hard time meeting this burden.
Test Relationship Governmental Interest Likely Result
Strict Scrutiny Necessarily relates Compelling Governmental action is likely unconstitutional
Intermediate Scrutiny Substantially relates Important Case-by case determination
Rational Basis Reasonably relates Legitimate Governmental action is likely constitutional
There are a few cases where the Supreme Court has held that racial discrimination may be permissible even under strict scrutiny. For example, cases challenging affirmative action policies in higher education have held that admission preferences for underrepresented racial groups does not violate the Constitution. The Supreme Court has found that diversity in higher education is a compelling state interest, and that schools could consider race in deciding whether to admit students, as long as race is a “potential plus factor” considered with other factors.
5.5 Concluding Thoughts
The US Constitution is the most important and fundamental law in the nation. The Constitution establishes our government structure, identifies the powers of the branches, and identifies our fundamental rights. In this age of e-commerce, the vast majority of businesses are engaged in interstate commerce and are, therefore, regulated by Congress under the Commerce Clause. The Dormant Commerce Clause prevents states from unfairly burdening interstate commerce. Although the Bill of Rights is often thought of as applying to individuals, it also grants civil liberties to businesses.
The Constitution is mainly a structural document, setting forth the allocation of power among the three branches of the federal government and the limitations on that power. It is concerned mainly with what the government cannot do, as opposed to what the government must do. Article I of the Constitution establishes a bicameral legislature, with the House of Representatives and Senate. Both chambers must agree before legislation can be passed. Article II of the Constitution establishes the executive power in the president, who must enforce the laws passed by Congress. Power is also divided between state and federal governments under federalism. The Supremacy Clause states that when there is a conflict between state and federal law, federal law wins. If there is no direct conflict, the state law survives unless Congress expressly preempts state law or occupies the field. The Constitution also provides rules to facilitate state laws across state lines.
The Bill of Rights provides key civil liberties to all people on US soil. These liberties are not absolute. Many of the restrictions on government activity found in the Bill of Rights also apply to the states through incorporation.
The First Amendment prohibits the government from establishing religion and from restricting the free exercise thereof. The First Amendment also prohibits the government from restricting the freedom of speech. Political speech is protected to the fullest extent by the First Amendment, while obscene and defamatory speech is not protected at all but subject to the doctrine of prior restraint. Generally speaking, the government may impose reasonable time, place, and manner restrictions on the delivery of speech.
Procedural due process requires that the government use fair procedures anytime it seeks to deprive a citizen of life, liberty, or property. Substantive due process requires the government to articulate a rational basis for passing laws or, when fundamental rights are involved, to articulate a compelling reason to do so. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/05%3A_The_Constitution.txt |
6.1 Introduction
LEARNING OBJECTIVES
1. Define international law.
2. Understand sovereignty and the principles of international jurisdiction.
3. Know what types of laws apply to businesses operating internationally.
4. Understand the types of international jurisdiction.
According to the Small Business Association, 96 percent of the world’s customers live outside of the United States. The international market is lucrative but the international legal environment is different from the US legal environment. Therefore, it is important to be familiar with the basic concepts of doing business in the global economy.
Any business that operates across a national border is an International Business Entity (IBE). IBEs may be large, such as Samsung, or they may be small, such a souvenir stand that sells products across the border at Niagara Falls. When an IBE conducts business in another nation, it must comply with applicable laws in its nation of origin, in all nations where it does business, and applicable international laws. For example, if the Molson Coors Brewing Company, which is headquartered in Colorado, wants to sell its products in Mexico, it would need to comply with all applicable US, Mexican, and international laws, such as the US-Mexico-Canada Agreement (USMCA). This includes local and state laws within both the US and Mexico.
US Laws Foreign Laws International Laws
• International law consists of rules and principles that apply to the conduct of nations, international organizations, and individuals across borders. There are two types of international law: public and private.
Public international law governs the relations among governments and international organizations. It includes the law of war, the acquisition of territory, and the settlement of disputes among nations. Public international law also includes agreements governing property rights, trade, outer space, and natural resources, such as the seas and mineral rights. For businesses, public international law is important because it defines human rights, such as the prohibition against child labor, slavery, and trafficking in people and stolen goods.
Private international law applies to private parties engaged in international commercial and legal transactions. Essentially, private international law identifies what law applies to an agreement and how the parties will settle any disputes with parties in other nations.
Counselor’s Corner US nationals and businesses need to understand that they are subject to the laws of the nations where they travel and operate. For example, many US nationals do not understand that they are restricted in what they can say and publish within China. The US Constitution’s freedom of speech does not apply when visiting or working in other nations, especially communist ones. It is worth the time to understand the culture of the nation a business wants to work in before investing too much time and resources into developing operations there. Culture is just as important as finances when developing a business plan to expand into another nation. If the culture is not one that the business is comfortable with, then it should look at business opportunities elsewhere. ~Wei Z., attorney
6.2 The Nature of International Law
A sovereign state is a political entity that governs the affairs of its own territory without being subjected to an outside authority. Nations are sovereign states. Sovereign states have sovereign immunity, which is the principle that courts of one nation lack the jurisdiction to hear cases against foreign governments. In the US, this principle is enacted in the Foreign Sovereign Immunities Act (FSIA) which prohibits US courts from hearing cases against foreign governments. Two exceptions are: (1) when the foreign government waives its right to immunity and agrees to the jurisdiction of the US court; and (2) when the foreign government is engaged in commercial, not political, activity.
In domestic law, or law that is applicable within the nation where it is created, some authority has the power to create, apply, and enforce a rule of law system. There is a legitimate law-creating authority at the “top,” and the people to be governed at the “bottom.” This is a vertical structure of law, because there is some “higher” authority that imposes a rule of law on the people. In the United States, laws are made by the legislative branch (statutory law), by the judicial branch (common law), and by the executive branch (executive orders, rules, and regulations). This authority is derived from the US Constitution.
Figure 6.1 Vertical Nature of Domestic Law
It’s important to note, however, that not all law can be conceived as a vertical structure. Some, such as international laws, are best thought of as a horizontal structure. Treaties have a horizontal structure because sovereign nations are parties to international treaties. Since each nation is sovereign, that means that one nation is not legally dominant over another.
Figure 6.2 Horizontal Nature of International Law
If a party to a treaty has breached the agreement, enforcement can be difficult because no overarching power “above” the parties to a treaty exists. For this reason, many horizontal laws, like treaties, contain provisions that require the parties to submit to a treaty-created dispute resolution panel or other neutral tribunal, such as the International Court of Justice (ICJ).
Another common challenge in international law is that the laws are applicable only to parties who voluntarily choose to participate in them. This means that a sovereign nation cannot generally be compelled to submit to the authority of the international law if it chooses not to participate. Compare this with domestic law. Everyone within the United States is subject to the jurisdiction of certain state and federal courts, whether they voluntarily choose to submit to the jurisdiction or not. This is why fleeing criminals can legally be caught and brought to justice through extradition.
6.3 Sources of International Law
There are two main sources of international law: customary international law and treaties. It is important for all companies to understand the laws that apply to their activities so they can avoid criminal and civil liability.
Customary International Law
A custom is a widely accepted way of doing something. Before treaties and conventions started to become common during the 1900s, custom was the primary way international law was created. Customary international law is a body of international rules that has become binding through the pattern of consistent, long-standing behavior through a sense of legal obligation. For example, granting diplomatic immunity to visiting heads of state is customary international law. Historically, customary international law governed the rules of war, treatment of prisoners of war, and human rights. After World War II, many areas of customary law became the basis for UN Conventions. While customary international law still exists, the modern trend is to reduce legal obligations to writing and have nations expressly agree to their terms.
Treaties
A treaty is an agreement between two or more nations governed by international law. In essence, a treaty is a contract between sovereign nations. A bilateral treaty is an agreement between two nations. A multilateral treaty is an agreement between three or more nations. A convention is a multilateral treaty on a specific issue that concerns issues of worldwide importance, such as human rights, property rights, and international trade rules. For businesses, one of the most important conventions is the UN Convention on Contracts for the International Sale of Goods (CISG). This convention sets the global standard for international trade.
Treaties are adopted when the parties agree to its final form. Then the treaty needs to be ratified by the nations’ governments. To take effect in the US, treaties must be approved by two-thirds of the Senate. At that point, the treaty becomes part of US law. Finally, a treaty enters into force when it becomes legally binding on the parties. This may be a specific date identified in the treaty or when it is ratified by the parties.
Although many treaties may impact businesses, a few are particularly important to international trade.
GATT
The General Agreement on Tariffs and Trade (GATT) is a multilateral treaty to promote international trade by reducing or eliminating trade barriers, such as tariffs and quotas, between the member nations. GATT has been negotiated on and off since the 1940s as nations have sought to grow their economies through global commerce. In 1995, GATT members created the World Trade Organization (WTO) to stimulate international commerce and resolve trade disputes.
GATT and WTO are founded on three principles:
1. Free trade. The major purpose of the treaty is to reduce trade barriers to increase global trade.
2. Most Favored Nation Status. Member nations agree to treat every other member nation equally. If one nation receives a special discount on customs duties, then the discount must be extended to all other member nations.
3. National Treatment. Member nations agree to treat imported goods the same as domestic ones after they have entered the nation. In other words, members cannot discriminate against foreign goods by imposing additional taxes after being subject to import taxes and duties.
The WTO resolves trade disputes between member nations and has the power to impose trade sanctions for non-compliance with GATT. If a member nation refuses to comply with a WTO ruling, affected members may retaliate by imposing punitive tariffs or other sanctions. For example, in the famous “banana battle,” the US and four Latin American nations filed a complaint with the WTO alleging that the European Union (EU) placed unfair restrictions on imported bananas and showed favoritism to their former colonies by buying bananas from them in violation of GATT. The WTO agreed and granted the US and the Latin American nations the right to impose sanctions on EU imports to their nations. The banana battle ended in 2009 after 20 years of trade restrictions.
CISG
The United Nations Convention on Contracts for the International Sale of Goods (CISG) promotes international trade by making sales law uniform and predictable across international boundaries. The US and most of its trading partners (except the United Kingdom) have adopted CISG, which results in the convention governing over two-thirds of the world’s trade. Some of its provisions include:
• CISG applies to contracts for the sale of commercial goods between merchants. It does not apply to the sale of goods to consumers for personal use.
• CISG applies automatically to contracts between parties located in different signatory nations. The convention does not depend on nationality; it depends on location.
• Contract parties can opt out. Parties can contract to be governed by a nation’s laws instead of CISG but they must expressly state their intention to not be bound by CISG.
• CISG does not require a written contract.
• CISG requires parties to negotiate in good faith and to modify contracts in the case of unforeseen circumstances.
• A buyer can avoid payment only after giving the seller notice and an opportunity to remedy the problem.
Regional Trade Agreements
Regional trade agreements promote international commerce by reducing trade barriers among member nations that are located near each other. One of the most famous is the European Union (EU) but more than half of international trade is covered by regional trade agreements throughout the world. An important trade bloc agreement is the Association of South East Asian Nations (ASEAN), which is a ten-nation trade bloc in Southeast Asia. ASEAN + 3 includes the ASEAN nations, as well as China, Japan and South Korea.
The US is part of the United States-Mexico-Canada Agreement (USMCA), which was formerly the North American Free Trade Agreement (NAFTA). USMCA reduces trade barriers among the three nations and updated NAFTA provisions, especially as it relates to e-commerce, labor, and intellectual property rights. These agreements create tremendous opportunities for businesses because they lower the costs associated with importing and exporting within the region.
Trade Regulations
Companies wishing to export or import products are subject to federal trade regulations. To export simply means to transport products to another nation. Export controls prohibit or restrict certain products from leaving a nation.
Companies wishing to import products are also subject to import controls. Import controls take many forms including tariffs, quotas, bans and restrictions. The US Department of Homeland Security Customs and Border Protection Agency (CBA) has a primary role in import control administration and regulation. For example, it inspects imports to classify them and to establish their tariff schedule.
Tariffs are import taxes that apply to certain goods imported from other nations. They make the imported product more expensive and keep the cost of domestic products attractive to consumers. CBA customs officers classify the imported goods, which determines the applicable tariff. The importer is responsible for complying with all import laws.
Quotas are simply limits on the quantity of particular imported goods. To protect domestic industries, a nation may limit the number of a competitor’s goods that are sold within the nation.
Bans apply to goods that are illegal to be imported, because they are dangerous to public safety, health, the environment, or national interests. For example, it is illegal to import items of cultural heritage from other nations without permission.
Along with the CBA, the US International Trade Commission investigates import injuries to the United States, such as dumping and subsidized imports. Dumping occurs when a foreign producer sells products for less than the cost of manufacturing. Subsidized imports are produced overseas for which a government has provided financial assistance. When dumping or subsidized imports materially injure or threaten to injure domestic producers, the United States may impose a countervailing duty for subsidized products or anti-dumping duty for dumped products. These duties, which are particular types of tariffs, reduce the negative impact that such practices could have on US companies. Safeguards are limited duration growth restrictions that are imposed when domestic markets are threatened or injured from imports. This allows for domestic markets to adjust to the surge from the import market. For example, the United States imposed safeguards on Chinese textiles in response to actual or threatened market disruption of the US textile industry.
6.4 US Laws that Apply to US Nationals Abroad
Extraterritoriality is the power of a nation’s laws to reach activities outside of its physical borders. In other words, it is the power of a nation to impose its laws in other nations. Congress expressly applies several important laws to US nationals working abroad.
US citizens working for US companies overseas are protected by US federal employment laws, such as Title VII of the Civil Rights Act and the Americans with Disabilities Act. This means that US companies may not illegally discriminate against US employees because those employees happen to work for the company on foreign soil rather than within the United States.
Business practices abroad are also regulated by the US government. For example, price-fixing conducted abroad by US companies is a violation of the Sherman Antitrust Act. Similarly, the Alien Torts Claims Act allows non-citizens to bring suit in US federal court against US businesses or citizens that have committed torts or human rights violations in foreign nations.
The Foreign Corrupt Practices Act
The Foreign Corrupt Practices Act (FCPA) is an anti-corruption law that prohibits the payment of bribes by US companies and their employees to foreign officials. Violation of this law is a criminal offense. It does, however, permit grease payments, or facilitating payments. Grease payments are only allowed to individuals who are not decision makers. For example, a small payment to a clerk to process paperwork, after a project has already been approved, is a grease payment.
US citizens are also prohibited from conducting transactions with terrorists or terrorist organizations. Conducting transactions with prohibited persons, entities or businesses can result in serious criminal violations, which carry significant financial penalties and long prison sentences.
6.5 Concluding Thoughts
Tremendous opportunities exist for companies that wish to operate in international markets. However, the international legal environment requires careful planning to avoid costly mistakes associated with violations of trade regulations, the formation of international contracts, and criminal and civil liability. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/06%3A_International_Law.txt |
7.1 Introduction
LEARNING OBJECTIVES
1. Understand the roles and functions of administrative agencies.
2. Explore judicial review of agency actions.
3. Learn how administrative agencies impact the daily operation of businesses.
An administrative agency is a governmental body with the authority to implement and administer particular legislation. They also are called government agencies or regulatory agencies.
The day-to-day operations of businesses across industries are shaped primarily by the actions of administrative agencies. This is because Congress and state legislatures often create agencies to regulate and enforce important legislation. Agencies exist at all levels of government and have considerable power to achieve their regulatory objectives.
Counselor’s Corner The most important thing about interacting with any government agency is not to ignore the communication sent to you by that agency. If an agency asks you for information, send it. If the agency asks you to do something, or provide documentation, or to respond to a request, do that thing, provide that documentation, and respond to the request. The agency is not making those requests aimlessly, or to cause you angst and frustration. The agency is doing so because its own rules and regulations require it to gather more information, which the agency needs from you. Your reluctance or failure to respond will only cause delay, or have negative consequences. So, ignore those letters at your peril. ~Sara C., attorney
7.2 Creation of Administrative Agencies
Administrative agencies are created by Congress or state legislatures through an enabling act. An enabling act is a statute that creates an administrative agency and determines the scope of power granted to that agency. Some enabling acts are quite general and grant the agency a lot of discretion. Other enabling acts are more limited and identify the specific type of power an agency has.
While the legislative branch creates administrative agencies, they are usually part of the executive branch because their primary purpose is to enforce the law. Agencies in the executive branch are called executive agencies. At the federal level, these agencies are within the president’s cabinet. The president is granted the power to appoint and oversee the leadership of executive agencies, including replacing existing leadership when the president is sworn into office. A governor has similar power over executive agencies at the state level.
An independent agency is an agency, commission, or board that is not under the direction of the president or governor. Congress and and state legislatures create independent agencies when they want to insulate the work of the agencies from politics and to address concerns that go beyond the scope of ordinary legislation. These agencies are responsible for keeping the government and economy running smoothly, especially when different political parties come to power. Examples of independent agencies include the Federal Trade Commission and the Central Intelligence Agency.
Independent agencies are often run by boards or commissions made up of five to seven members, who are from both major political parties, as well as political independents or smaller political parties. The term of board members and commissioners is usually four to nine years, with terms being staggered to prevent complete turnover all at once.
Figure 7.1 Differences Between Executive and Independent Agencies
Congress passed the Administrative Procedures Act (APA) to ensure the rights of businesses and individuals are protected when interacting with federal agencies. The APA is a very complex statute that controls all aspects of agency activity to guarantee uniformity and fairness across agencies. For example, the APA establishes the mechanisms for rulemaking, conducting adjudications, and giving notice to the public. The APA also establishes the process for judicial review of agency decisions. Most states have similar statutes to regulate state and local agencies.
Figure 7.2 Organizational Chart of Federal Agencies
7.3 Agency Functions
Administrative agencies carry out their purpose through the exercise of power in three ways that mirror the three branches of government:
1. Agencies engage in rulemaking, which is a quasi-legislative function;
2. Agencies engage in enforcement, which is a quasi-executive function; and
3. Agencies engage in adjudication, which is a quasi-judicial function.
Figure 7.3 Roles and Responsibilities of Administrative Agencies
Rulemaking
The enabling statute dictates the types of rules an agency can make to implement and enforce the legislation for which it is responsible. Generally, administrative rules are characterized as internal, procedural, interpretive, and legislative.
Types of Rulemaking Description
Internal Policies and procedures adopted for in-house operations
Procedural Policies and procedures related to how the agency functions & interacts with businesses and individuals
Interpretive Guidelines issued by the agency to businesses and individuals about how to comply with the law
Legislative Regulations that have the full force of law because they are an extension of the underlying statute
Legislative rulemaking may be formal or informal. Formal rulemaking is agency rulemaking that, when required by the enabling statute, must be on the record after an opportunity for an agency hearing, and must comply with certain procedures, such as allowing evidence and the cross-examination of witnesses. Formal rulemaking provides an opportunity to publicly and thoroughly debate the propriety of a suggested rule. However, this process is very expensive and is sometimes subject to political delays.
Informal rulemaking occurs when the agency publishes a proposed regulation and receives public comments on it, after which the regulation can take effect without the necessity of a formal hearing on the record. Informal rulemaking is the most common procedure followed by an agency when issuing substantive rules because it is less expensive and more efficient.
Agencies will sometimes blend the the two types of rulemaking into a hybrid rulemaking approach. This type of rulemaking requires notice and a hearing on a proposed rule but the hearing is not as extensive as in formal rulemaking and cross-examination of witnesses is not available.
Enforcement
Agencies are empowered to enforce administrative rules and the underlying legislation identified in the agency’s enabling act. Unlike law enforcement investigations, agencies do not need probable cause to initiate an investigation. Generally, agencies are authorized to investigate simply to ensure the rules are being followed. For example, the Internal Revenue Service may audit a business’s taxes without any suspicion of wrongdoing.
Agencies are limited in their power to subpoena evidence in the form of testimony from witnesses and in obtaining documents and evidence. To be lawful, an agency’s subpoena must:
• Establish that the purpose of the investigation is legitimate;
• Establish that the agency has the power to conduct the investigation;
• Describe the requested information;
• Explain the relationship between the purpose of the investigation and the requested information; and
• Show that the requested information does not create an unreasonable burden on the business or individual in possession of it.
Businesses do not have all the Constitutional protections as individuals do, especially when it comes to agency investigations. In particular, a business cannot assert a Fifth Amendment right against self-incrimination to prevent agencies from obtaining business records. If an agency subpoenas documents, a business is required to turn them over, even if doing so exposes the business and individuals to potential criminal liability.
Adjudication
Adjudication is the legal process of resolving a dispute. In an agency context, this is the trial-like procedure or hearing used by agencies to enforce their actions and determine whether a business or individual has violated the law or regulations.
Adjudication can be either formal or informal. Formal adjudication is like a trial and is usually overseen by an administrative law judge (ALJ). The ALJ will decide what evidence is relevant and admissible, hear testimony, and determine the outcome of the dispute in a written finding. If appropriate, the ALJ also will determine a penalty.
Like the judiciary, agencies have an internal appeal process for adjudication. If a party wants to appeal a hearing officer or ALJ’s decision, the case will be reviewed internally by the agency. Often, appeals boards will consist of three to five agency experts who review the determination.
7.4 Judicial Review of Agency Actions
The APA provides for judicial review of almost all agency decisions. However, before going to court, a business or individual must try to get the agency to reconsider its action. To this end, two requirements must be satisfied:
1. Administrative remedies must be exhausted; and
2. The party must have standing.
Exhaustion of administrative remedies is the doctrine that, if an administrative remedy is provided by statute, a party must seek relief first from the agency before judicial relief is available. The purpose of this doctrine is to ensure that courts will not be burdened by cases in which judicial relief is unnecessary. Often courts cite the agency’s subject matter expertise as a reason to allow it to reconsider its action and fix errors, especially common ones that may impact more than just the party involved in the hearing.
Figure 7.4 Exhaustion of Administrative Remedies Flowchart
Standing is the requirement that only individuals and entities with a personal stake in the outcome of a controversy may seek judicial review. Standing is discussed more in Chapter 3. With respect to agency actions, this is often a litigated issue when advocacy groups want to challenge an agency’s decision but were not a party to the agency’s actions.
Because agencies have significant discretion in regulating their areas of expertise, judicial review of agency actions is limited. A court will review an agency’s actions in five situations:
Basis for Judicial Review Description
Agency exceeded its authority Agency acted beyond the authority given to it in the enabling act
Agency incorrectly interpreted the law Agency misunderstands or misapplies the law; courts are the legal experts
Agency made a procedural error Agency failed to follow the APA or its own procedural rules
Agency violated the Constitution Agency violated the Constitutional rights of businesses or individuals
Agency made arbitrary or capricious decision Agency’s decision is neither based on the facts nor grounded in the law
7.5 Public Access to Agency Information
Accountability and transparency are concerns when governmental entities have a lot of discretion and limited judicial oversight. To ensure that the government remains responsive to the people as required by the Constitution, Congress has passed a series of laws to protect the rights of businesses and individuals.
The Freedom of Information Act (FOIA) was passed by Congress in 1966 to give a mechanism for private citizens to request information from the federal government. The central purpose of FOIA is to open up the workings of government to public scrutiny to keep the government accountable to the people and electorate.
The process is simple. A business or individual sends a letter to the head of an agency requesting information regarding a particular subject. The agency then has ten days to respond. If the agency denies the request, the party may either appeal the decision within the agency or sue in federal court for the information.
Not all information is subject to disclosure under FOIA. FOIA has nine exceptions:
• National security and foreign policy;
• Internal personnel rules and practices of an agency;
• Information that Congress prohibits the disclosure of;
• Trade secrets and confidential commercial or financial information;
• Documents protected by the attorney-client privilege;
• Personnel and medical files that would constitute an unwarranted invasion of personal privacy;
• Some law enforcement information;
• Documents related to the regulation of financial institutions; and
• Geological and geophysical information and data, including well maps.
The media makes about ten percent of FOIA requests, which is part of investigative reporting. However, most requests come from businesses, attorneys, and individuals. Unless an exception applies, the government must disclose the requested information. This has become a tool for businesses seeking advantage over their competition.
For example, AT&T received a federal grant to promote communications in school. AT&T self-reported to the Federal Communications Commission (FCC) that it may have overcharged the government for its services. This resulted in an investigation into AT&T’s services and billing practices. Several months after AT&T and the FCC reached a settlement in which AT&T reimbursed the FCC \$500,000, a trade association representing some of AT&T’s competitors made a FOIA request to the FCC for documents related to the investigation and settlement. AT&T tried to block the request, arguing that it was an unwarranted invasion of personal privacy. In a unanimous decision, the US Supreme Court held that corporations do not have a personal privacy right like individuals do. As a result, the FCC disclosed the information to AT&T’s competitors.
Over the years, FOIA has been amended and supplemented through complementary legislation. Businesses and individuals have the right to correct information that was submitted to an agency, as well as the right to specific reasons regarding any information that is withheld or redacted under FOIA. In addition, many agency meetings must be open to the public.
Most states have passed legislation similar to FOIA requiring state and local governments to disclose information to the public.
7.6 Concluding Thoughts
The vast majority of governmental work is done through administrative agencies. Given their functions, they are often referred to as the “Fourth Branch” of government. Agencies exist at all levels of government and have a lot of discretion in implementing and enforcing laws. Most businesses and individuals have contact with the government through agencies so it is incredibly important to understand how they work to be successful in business and avoid legal consequences. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/07%3A_Administrative_Law.txt |
8.1 Introduction
LEARNING OBJECTIVES
1. Understand what crime is and learn about common business crimes.
2. Compare and contrast the differences between criminal law and civil law.
3. Understand the constitutional protections given to those accused of committing a crime.
4. Explore the exceptions to the Fourth Amendment’s warrant requirement.
A crime is a social harm that the law punishes. At the most basic level, criminal statutes reflect the rules that must be followed for a civil society to function. Like individuals, businesses can be both victims and perpetrators of crime.
Crime affects businesses both from outside and inside the organization. Criminal activity “from the outside” may include property damage, theft, shoplifting, corporate espionage, fraud, and arson. Threats “from the inside” may include crimes such as embezzlement, computer crimes, and fraud. Moreover, businesses must also protect themselves from the bad judgment and behavior of their employees. If an employee acting within the scope of employment commits a crime from which the business will benefit, then the business can be convicted of the crime, too. Businesses may actively perpetrate crime, through a bad corporate culture or through organized crime, such as money laundering.
Counselor’s Corner Criminal convictions result in more than loss of liberty. Having a conviction on your record can mean inability to obtain certain jobs, to gain admission to college, to vote, and to rent or lease a home. Convictions affect a person’s life for much longer than the actual sentence imposed. Make sure you hire an attorney if you are ever faced with a criminal charge. Know your rights and understand the specific laws applicable to your field. When in doubt, consult with an attorney, accountant, or other professional in your field. ~Krista S., attorney
8.2 The Nature of Criminal Law
When crime occurs in the context of business, some people think that no one is “really” injured. When an insurance company has to pay for a claim arising from a crime, the insurance company is injured, as are the victim and society at large. Crime undermines confidence in the social order and public safety. No crime is victimless.
In general, a crime requires someone to (1) commit a criminal act, known as actus reus, and (2) possess the required criminal state of mind, or mens rea. Therefore, intent to commit a crime, without more, is not enough to convict someone. For example, if an accountant thinks about stealing money from her company but does not take any steps to do it, then no crime has been committed. Similarly, if an accountant makes a mistake and transfers money inappropriately between accounts, he has not committed fraud unless he had the required criminal state of mind.
Strict liability crimes are an exception to the mens rea element. Strict liability crimes are acts that the legislature defines as social wrongs that do not need proof of the defendant’s intent to complete the act. For example, speeding while driving a motor vehicle, possession of child pornography, and sale of tobacco and alcohol to minors all carry criminal liability without the government needing to prove the defendant’s intent.
Criminal Law versus Civil Law
Criminal law differs from civil law in several important ways.
Criminal Law Civil Law
• Because crimes are public injuries, they are punishable by the government. It is the government’s responsibility to bring charges against criminals. In fact, private citizens may not prosecute each other for crimes. When a crime has been committed, the government collects the evidence and files charges against the defendant. When someone is charged with committing a crime, he or she is charged by the government in an indictment.
Our civil tort system allows victims to bring a civil suit against someone for injuries inflicted upon them. Indeed, criminal laws and torts often have parallel causes of action. Sometimes these claims have the same or similar names. For instance, a victim of fraud may bring a civil action for fraud and may also be a witness for the government during the criminal trial for fraud.
Burden of Proof
In a criminal case, the defendant is presumed to be innocent unless he or she is proven guilty. This presumption of innocence means that the government must prove the case against the defendant before it can impose punishment. If the government cannot prove its case, then the person charged with the crime must be acquitted. This means that the defendant will be released, and he or she may not be tried for that crime again. This important protection from double jeopardy is guaranteed by the Fifth Amendment.
The prosecution has the burden to prove its case beyond a reasonable doubt. This means that the evidence must be so compelling that no reasonable doubt exists as to the defendant’s guilt. The defendant does not have to prove anything, because the burden is on the government to prove its case. It is useful to think of the criminal standard of proof—beyond a reasonable doubt—as something like 95 percent certainty, with 5 percent doubt. Perhaps there is some doubt about the precise time of day or the victim’s exact words to the defendant. However, there is no doubt about the essential elements of the crime, such as the defendant’s identity as the perpetrator of the crime, his or her mens rea, and the actus reus.
Figure 8.1 Burden of Proof in Criminal Trials
Compare this to the standard of proof in a civil trial, which requires the plaintiff to prove the case only by a preponderance of the evidence. This means that the evidence to support the plaintiff’s civil case is greater than the evidence that does not. Preponderance of the evidence could mean 51 percent in favor of the plaintiff’s case, and 49 percent in doubt. Therefore, it is much more difficult to prosecute a criminal defendant than to bring a successful civil claim. Since a criminal action and a civil action may be brought against a defendant for the same incident, these differences in burdens of proof can result in verdicts that seem, at first glance, to contradict each other. For example, O.J. Simpson was acquitted of murder in a criminal trial because the government did not prove to the jury that he committed the crimes beyond a reasonable doubt. However, a different jury found O.J. Simpson liable for wrongful death in a subsequent civil action.
Figure 8.2 Burden of Proof in Civil Trials
This extra burden reflects the fact that the defendant in a criminal case stands to lose much more than a defendant in a civil case. Although no one wants to lose assets in a civil case, the loss of liberty through imprisonment is a more significant loss. Therefore, more protections are given to a criminal defendant than are given to defendants in civil proceedings. Because so much is at stake in a criminal case, our Constitutional due process requirements are very high for defendants in criminal proceedings.
Due process procedures vary depending on the type of penalty that can be levied against someone. For example, in a civil case, the due process requirements might simply be notice and an opportunity to be heard. If the government intends to revoke a professional license, then the defendant might receive notice by way of a letter, and the opportunity to be heard might exist by way of written appeal. In a criminal case, however, the due process requirements are higher. For example, a criminal defendant is entitled to confront all witnesses against him or her, and to see the evidence the prosecution intends to introduce at trial. More protections must be in place because a criminal case carries the potential for the most serious penalties.
Classification of Crimes
Felonies versus Misdemeanors
Crimes are generally classified as either felonies or misdemeanors. Felonies are serious crimes punishable by a year or more in prison. These type of crimes include fraud, arson, homicide, and most other crimes that are mentioned in news headlines. Misdemeanors are less serious crimes that are often punishable by fines, probation or time served in jail pending conviction. Examples of misdemeanors include trespassing, vandalism, and failure to report for jury duty.
White-Collar Crime Versus Blue-Collar Crime
White-collar crime is a term used to describe nonviolent crimes committed by people in their professional capacity, or by organizations. These crimes are committed for financial gain, often through deception. White-collar crimes are not typical street crimes, like burglary or robbery, and they are not personal crimes, like murder or rape. White-collar criminals frequently commit their crimes on the job, in broad daylight, while sitting at a desk. For example, Bernie Madoff was sentenced to 150 years in prison for stealing \$20 billion in a Ponzi scheme that had \$65 billion in fabricated gains.
Blue-collar crime is a generic term used to describe crimes that are more traditional street crimes. In business, property crimes (rather than crimes against people) are a primary concern. A property crime is a crime involving damage to property, while a person crime is a crime involving injury to a person’s body. Examples of blue-collar crime that often affect businesses include shoplifting, vandalism and destruction of property.
8.3 Constitutional Rights and Defenses
A person accused of a crime has rights guaranteed by the US Constitution to ensure the federal government does not unfairly prosecute them. The Bill of Rights–especially the Fourth, Fifth, Sixth, and Eighth Amendments–list the rights of criminal defendants. The Fourteenth Amendment makes these rights applicable to defendants accused of crimes by state governments. In addition, most states have constitutions that have similar protections.
Fourth Amendment
Figure 8.3 Language of the Fourth Amendment
The Fourth Amendment prohibits illegal searches and seizures. If evidence is obtained in violation of the Fourth Amendment, it cannot be used against the defendant in a court of law. For Fourth Amendment requirements to be met, law enforcement officers (the Executive Branch) must obtain a search warrant from a judge (the Judicial Branch) to search a specific area or person for specific items. A search warrant is issued only when a judge determines that probable cause exists. Probable cause exists when the known facts and circumstances would lead a reasonable person to believe that an item sought by the warrant is contraband, is stolen, or is evidence of a crime.
If a valid search warrant is issued, then law enforcement may search the area identified in the warrant for the named item(s) or person. Even if there was no warrant, the items found may still be admissible as evidence. This is because several exceptions to the requirements for a search warrant exist to help law enforcement protect the public and stop crimes as they occur.
Warrant Exception Example
• Two other common exceptions are the automobile exception and stop and frisk exception. The automobile exception means that the passenger compartment of an automobile may be searched if the car has been lawfully stopped. When a police officer approaches a stopped car at night and shines a light into the interior of the car, the car has been searched. No warrant is required. If the police officer spots something that is incriminating, it may be seized without a warrant. Similarly, if someone is stopped lawfully, that person may be frisked without a warrant. This is the stop and frisk exception to the warrant requirement. Both of these exceptions are based on officer safety, but are often labeled based on the circumstances of the search.
In the business context, it is also important to note that some administrative agencies may conduct warrantless searches of closely regulated businesses, such as junkyards, where stolen cars may be disassembled for parts that can be sold.
Fifth Amendment
Figure 8.4 Language of the Fifth Amendment
The Fifth Amendment guarantees four important rights:
1. The right to avoid self-incrimination;
2. The right to due process so that all court proceedings are fundamentally fair;
3. The right to be indicted by a grand jury for capital offenses and infamous crimes; and
4. The right to be free from double jeopardy.
The Fifth Amendment guarantees that people can choose to remain silent. No one can be compelled to testify against himself or herself or to make self-incriminating statements. If a person does not want to cooperate with the government’s investigation and prosecution of a crime, he or she does not have to. During trial, the prosecution cannot comment on a defendant’s silence and it cannot be used as evidence of guilt against the defendant.
The prohibition against double jeopardy means that a person cannot be tried twice for the same offense by the same governmental body. This prevents the government from harassing individuals with endless prosecutions until they find the “right” jury that is willing to convict. It also requires the government to do its job well the first time it prosecutes a case.
Sixth Amendment
Figure 8.5 Language of the Sixth Amendment
The Sixth Amendment entitles a criminal defendant to:
1. A speedy trial;
2. A trial by jury;
3. A public trial;
4. An attorney; and
5. The right to confront witnesses.
The purpose of the Sixth Amendment is to ensure transparency in criminal proceedings so the government cannot selectively prosecute dissidents or employ unfair tactics. Defendants are entitled to an attorney during any phase of a criminal proceeding where there is a possibility of incarceration. This means that if a defendant cannot afford an attorney, then one is appointed for him or her at the government’s expense.
Eighth Amendment
Figure 8.6 Language of the Eighth Amendment
The Eighth Amendment prohibits cruel and unusual punishment and excessive fines and bail. Simply put, the Eighth Amendment is an anti-torture amendment. It also prohibits jails from being used against the poor as was commonly practiced in Europe at the time the Constitution was written.
Defenses
Under the exclusionary rule, any evidence the government acquires illegally may not be used at trial. This rule prevents governmental misconduct during the investigation of crimes. The theory is simple: if law enforcement and prosecutors know that illegally obtained evidence cannot be used in court, they will not be tempted to make improper searches or engage in other illegal behavior. The exclusionary rule is one of the most powerful limits on the police power of the government.
Because the exclusionary rule is intended to prevent law enforcement from intentionally overstepping its authority, an exception exists to the rule for when the police act in good faith. Therefore, the exclusionary rule does not protect individuals and businesses from all governmental errors. Instead, it prevents intentional misconduct.
If someone is subject to a custodial interrogation, he or she must first be informed of their Miranda rights. These rights are usually stated as:
You have the right to remain silent. Anything that you say can and will be used against you in a court of law. You have the right to an attorney. If you cannot afford an attorney, one will be provided to you by the state. Do you understand your rights?
The purpose of the Miranda warnings is to ensure that people understand their constitutional rights so they make informed decisions about whether to speak with law enforcement.
Entrapment is another defense available to people accused of crimes. Entrapment means that the criminal intent originated with the police, and therefore the mens rea of the crime cannot be placed on the defendant. Essentially, the rule against entrapment limits the ability of the police to play the role of criminals during undercover investigations. For example, if the police provide a drug dealer with the opportunity to sell drugs to an undercover agent, there is no defense of entrapment because the dealer had the mens rea to commit a crime regardless of the identity of the buyer. However, if the police knock on someone’s door who is not known to be a drug dealer and continues to demand drugs until the person cannot resist and sells the police drugs, then entrapment occurs.
8.4 Common Business Crimes
Each jurisdiction has the power to define what a crime is. Therefore, criminal laws can vary between states and federal governments. However, there are some common crimes that affect businesses across jurisdictions.
Fraud is the use of deception to acquire money or property. Securities fraud is when someone uses deception to circumvent the regulations or statutes interpreted by the US Securities and Exchange Commission (SEC) to acquire money or property. Goldman Sachs was charged with securities fraud when it misrepresented material facts to investors to gain financially.
Financial institution fraud is fraud against banks and other similar institutions, such as credit unions. The IRS investigates financial institution fraud. Cases of financial institution fraud can involve people who commit money laundering and those who falsify tax documents, or profit and loss statements, to gain funding from banks.
A Ponzi scheme is a fraudulent pyramid scheme, where innocent people pay in to participate. Those at the top of the pyramid may receive something that appears to be a return on their investment (ROI), but those at the bottom do not. Those who operate Ponzi schemes generally solicit investors, and those who invest in such schemes are expecting a legitimate ROI. However, the head of the Ponzi scheme keeps his early investors happy by bringing in new investors, whose money he gives to the old investors as their ROI. This allows the Ponzi scheme to continue, because it appears from the outside that investors are receiving a legitimate ROI. The problem is that the capital contributions eventually disappear, since they are never invested but are simply used by the head for his own purposes, including paying investors with fake ROI payments as necessary. Pyramids will eventually collapse under their own unsustainable structure. Bernie Madoff was convicted of running the largest known Ponzi scheme that defrauded investors of approximately \$65 billion.
Embezzlement occurs when someone takes property that was in his or her possession lawfully and then converts it to his or her own use. Embezzlement often happens by people who are in a position of trust over the assets of another person. This includes financial advisors, brokers, accountants, lawyers, and guardians. Embezzlement strategies can involve forgery, which is counterfeiting a document or someone else’s signature.
Embezzlement differs from larceny, because larceny requires the trespassory taking of property with the intent to deprive the owner of the property. In other words, in a larceny, the thief is not supposed to have possession of the property to begin with. For example, larceny includes shoplifting and basic theft of personal property.
It is illegal to make false statements or engage in a cover up during dealings with the federal government. Making False Statements is a crime that is often easier to prove against a defendant than a more complex crime that is being investigated. For example, Martha Stewart was investigated for insider trading. Although the insider trading charges were dismissed, Martha Stewart was convicted by a jury of making false statements because she lied to officers during the investigation. As a result, she served five months in prison.
RICO
The Racketeer Influenced and Corrupt Organizations Act (RICO) is a federal statute that was passed to prevent gangsters from taking money earned illegally and investing it in legitimate businesses. Although RICO was written to target traditional organized crime, less than 10 percent of RICO cases filed have been against the mafia. Instead, 75 percent of RICO cases involve business fraud.
A racket is a dishonest or fraudulent scheme, which usually is an organized criminal activity. The two most common rackets are protection rackets and fencing rackets. In a protection racket, a criminal offers to protect the victim from violence or destruction of property. If the victim refuses to pay for protection, then the criminal will engage in violence against the victim or destroy his or her property. In a fencing racket, a criminal will steal property from a victim then offer to resell it to them. The victim must pay for the return of his or her own property.
RICO punishes those engaged in three or more racketeering activities over a ten-year period when funds from those activities were used to maintain, operate, or acquire a legitimate business. Racketeering activities include embezzlement, mail fraud, wire fraud, loan-sharking, bookmaking, money laundering, counterfeiting, smuggling, blackmailing, arson, and other similar crimes. RICO is now used against insurance companies, stock brokerages, tobacco companies, banks, and other large commercial enterprises. If convicted, a defendant can be punished with large fines and a prison sentence of up to twenty years.
RICO also has a civil provision allowing a competitor to file RICO charges, which come with triple damages if the suit is successful. In other words, a civil plaintiff can recover a judgment for three times the harm actually suffered, as well as attorneys’ fees.
Art Cohen vs. Donald J. Trump was a civil RICO class action lawsuit filed in 2013, accusing Donald Trump of fraudulently misrepresenting the nature of Trump University. Within weeks of winning the presidential election in 2016, Trump settled this case and two others for \$25 million in damages to the plaintiffs.
Many states also have organized crime statutes. State penalties often are much more severe under the organized crime statutes than they would be if the accused worked alone. For this reason, businesses and individuals need to be careful to protect themselves from another’s wrongful conduct.
8.5 Concluding Thoughts
Crime has an enormous impact on society, including business. Crime is a very important consideration in the business world. Businesses can be both victims and perpetrators of crime. Although jurisdictions may define crimes differently, there are some types of crime that businesses often face, including fraud, embezzlement, and larceny. Successful businesses must be vigilant to protect themselves from those who wish to harm them, both from inside and out.
Crime is a public injury. Criminal law can be classified both by the nature of the punishment and the type of offense it is. Criminal law differs from civil law in important ways, including who brings the claim, the burden of proof, due process, and penalties. The most important distinction is the elevated burden of proof in criminal cases. The prosecution must prove that a defendant committed a crime beyond a reasonable doubt.
Those who are accused of committing a crime are protected by the US Constitution. Important constitutional protections include the prohibition against illegal searches and seizures, self-incrimination, and cruel and unusual punishment. If the government obtains evidence illegally, it cannot use it against a defendant in a criminal trial. Criminal defendants have the right to a public and speedy trial, an attorney, and to remain silent. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/08%3A_Criminal_Law.txt |
9.1 Introduction
LEARNING OBJECTIVES
1. Define torts.
2. Understand intentional torts, and how to defend against an accusation of one.
3. Explore negligence.
4. Explain strict liability and how product liability affects manufacturers.
A tort can be understood as a civil wrong to a person or property other than breach of contract. A tort is any legally recognizable injury arising from the conduct (or sometimes failure to act) of persons or corporations. There are several key differences between torts and contracts, which are also different than crimes:
Contract Tort Crime
Obligation The parties agree to a contract; which imposes duties on them Civil law imposes duties Legislatures pass laws prohibiting certain conduct
Enforcement Party to contract or beneficiary sues for breach of contract Injured party sues for tort claims Government prosecutes
Consequences Monetary damages Monetary damages; injunction Criminal conviction may include fine, imprisonment, & restitution
Some conduct can be both a crime and a tort. If Allie punches Bentley without provocation, then Allie has committed both the tort of battery and the crime of battery. In the tort case, Bentley could sue Allie in civil court for money damages (typically for his medical bills). That case would be tried based on the civil burden of proof—preponderance of the evidence. That same action, however, could result in Allie being charged with criminal battery. If convicted beyond a reasonable doubt, Allie may have to pay a fine or go to jail.
The standard of proof in a criminal case (beyond a reasonable doubt) is far higher than the standard of proof in a civil case (a preponderance of evidence). Therefore, victims of crimes often wait to bring related tort claims against a defendant until after the criminal trial is over. If the defendant is convicted of a crime, it is easier and less expensive to prove liability at a civil trial.
Torts can be broadly categorized into three categories, depending on the level of intent demonstrated by the tortfeasor (the person committing the tort). If the tortfeasor acted with intent to cause the damage or harm, then an intentional tort has occurred. If the tortfeasor didn’t act intentionally but failed to act as a reasonable person, then negligence occurs. Finally, strict liability occurs where the tortfeasor is held responsible regardless of intent.
Figure 9.1 Tort Liability Diagram
Counselor’s Corner Not every injury or harm gives rise to a legal claim. You can’t sue someone just because your feelings are hurt or something bad happened. Even though you may have been through something harmful, if the law doesn’t recognize the injury as something you can recover for, you don’t have a legal claim. Lawsuits are meant to address really bad injuries or really bad behavior. Many things that drive us crazy when dealing with other people are things that we just have to learn to deal with. Or resolve in another forum. ~Heather C., attorney
9.2 Intentional Torts
In an intentional tort, the tortfeasor intends the consequences of his or her act, or knew with substantial certainty that certain consequences would result. This intent can be transferred. For example, if someone swings a baseball bat at someone else but the person ducks and the bat hits a third person, the person hit is the victim of a tort even if the person swinging the bat had no intention of hitting the person actually injured.
It is useful to think of torts based on the type of rights being protected.
Theory of Liability Description
Interference with Personal Freedom
Assault Causing the apprehension or fear of immediate harmful or offensive contact
Battery Application of force that results in harmful or offensive contact with a person’s body
False Imprisonment Intentional confinement or restrain of a person’s movements without justification or consent
Intentional Infliction of Emotional Distress Intentionally or recklessly causing another person severe emotional distress through extreme or outrageous acts
Interference with Property Rights
Trespass to Land Unauthorized entry onto land that is visibly enclosed & owned by another
Trespass to Personal Property Taking or harming another’s personal property without permission
Conversion Wrongful possession or disposition of property as if it were one’s own with the intent to do so permanently
Nuisance Condition or situation that interferes with the use or enjoyment of property
Interference with Economic Relations
Disparagement False & injurious statement that discredits or detracts from the reputation of another’s property, product or business
Interference with Contractual Relations Intentional inducement of a party to break an existing contract
Interference with Prospective Advantage Intentional interference with a potential business relationship
Misappropriation Using another’s property dishonestly for one’s own use
Wrongful Communications
Defamation Harming the reputation of another by making a false statement
Slander Spoken defamation
Libel Written defamation
Invasion of Privacy Violating someone’s right to be left alone or to restrict public access to confidential information through:
• appropriating the person’s name or likeness;
• invasion of physical solitude;
• publicly disclosing private facts; or
• false light
Fraud Intentional misstatement of a material fact that is relied upon by a third party
Interference with Personal Freedom
Assault is the threat of force on another that causes that person to have a reasonable apprehension or fear of immediate harmful or offensive contact. Actual fear or physical injuries are not required for assault. It is also not necessary for the tortfeasor to intend to cause apprehension or fear. If someone points a realistic-looking toy pistol at a stranger and says “give me all your money” as a joke, it is still assault if a reasonable person would have had apprehension or fear in that situation. The intentional element of assault exists here, because the tortfeasor intended to point the realistic-looking toy at the stranger.
Battery is the application of force to another that results in harmful or offensive conduct. It includes any non-consensual touching, even if physical injuries are not present. In battery, the contact or touching does not have to be to the person. Grabbing someone’s clothing or possessions they are holding is battery. Notice that assault and battery are not always present together. Assault can occur without physically touching the victim. Similarly, a surgeon who performs unwanted surgery or inappropriately touches a patient who is sedated has committed battery but not assault because the patient did not feel fear or apprehension.
When someone is sued for assault or battery, several defenses are available. The first is consent. Boxers have consented to being battered when competing. Self-defense and defense of others also may be available defenses, as long as the self-defense is proportionate to the initial force.
False imprisonment occurs when someone intentionally confines or restrains another person’s movement or activities without justification. The protected interest is the right to travel and move freely without impediment. This tort requires actual and present confinement. False imprisonment is challenging for retailers and other businesses that interact regularly with the public, such as hotels and restaurants. The shopkeeper’s privilege allows businesses to detain suspected thieves until law enforcement arrives. The detention must be reasonable, however. Store employees must not use excessive force in detaining the suspect, and the justification, manner, and time of the detention must be reasonable.
Intentional infliction of emotional distress occurs when a tortfeasor intentionally or recklessly causes another person severe emotional distress through extreme and outrageous acts. A plaintiff has to prove the defendant’s actions would be outrageous to a reasonable member of the community. The standard is objective. It is not enough for the plaintiff to believe the defendant acted outrageously.
Although the standard for outrageous conduct is objective, the measurement is made against the particular sensitivities of the plaintiff. Exploiting a known sensitivity in a child, the elderly, or pregnant women can constitute intentional infliction of emotional distress. Businesses must be careful when handling sensitive employment situations to avoid potential liability. This is especially true when firing or laying off employees. Such actions must be taken with care and civility. Similarly, bill collectors and foreclosure agencies must be careful not to harass, intimidate, or threaten people.
Interference with Property Rights
Intentional torts can also be committed against property. Trespass to land occurs when someone enters onto, above, or below the surface of land that is visibly enclosed without the owner’s permission. The trespass can be momentary or fleeting. Soot, smoke, noise, odor, or even a flying arrow or bullet can all become the basis for trespass. These can also be the basis for nuisance claims. Nuisance is a condition or situation that interferes with the use or enjoyment of property. Nuisance claims can be public (applying to community areas such as parks or the environment) or private (applying to privately owned property such as houses).
Trespass can be innocent or willful. An innocent trespass occurs when someone enters another’s property by mistake or when they believe they have permission but do not. Willful trespass occurs when someone intentionally enters another’s property knowing they do not have permission to be there.
There are times when trespass is justified. Someone may have a license to trespass, such as a meter reader or utility repair technician. There may also be times when it may be necessary to trespass—for example, to rescue someone during an emergency.
Some states do not require the land to be visibly enclosed to be protected from trespass. Therefore, residential homes in urban and suburban areas do not always need a fence around the property to be protected from trespass.
Trespass to personal property is the unlawful taking or harming of another’s personal property without the owner’s permission. The tort of conversion is the wrongful possession or disposition of property as if it were one’s own with the intent to do so permanently. It is the civil equivalent to the crime of theft. An employer who refuses to pay an employee for work commits conversion. Similarly, conversion occurs when a business returns personal property to the wrong customer.
Interference with Economic Relations
Torts can also take place against goods or products instead of people. Disparagement is a false and injurious statement that discredits or detracts from the reputation of another’s property, product, or business. To recover, the injured party must prove that the statement caused a third party to take some action resulting in economic loss to the plaintiff. In other words, the victim of the statement must prove that it lost customers or goodwill as a result of the false statement made about its business or products. These types of false statements are considered unfair competition and, therefore, are unlawful.
Similarly, unfair competition can also be in the form of interfering with a competitor’s contracts. Tortious interference with contractual relations prohibits the intentional interference with an existing valid and enforceable contract by intentionally inducing one of the parties to break the contract, causing damage to the relationship between the contracting parties. This occurs when a business tries to break up a competitor’s contract with vendors, suppliers, or customers in an effort to harm them.
There are four elements to prove intentional interference with contractual relations:
1. A contract exists between the plaintiff and a third party;
2. Defendant knew of the contract;
3. Defendant improperly induced the third party to breach the contract or made performance of the contract impossible; and
4. Plaintiff was injured.
Similarly, tortious interference with prospective advantage is an intentional, damaging intrusion on another’s potential business relationship, such as the opportunity to obtain customers or employment. Fair competition does not give rise to this tort. However, if a business engages in fraud, intimidation, or threats to drive away potential customers from its competitors, then it is liable. Tortious interference with prospective advantage applies to conduct before a contract exists.
Misappropriation occurs when a person or business uses someone else’s property dishonestly for one’s own use. Misappropriation is a very broad tort because it covers any likeness or identifying characteristic, as well as property such as patents, copyrights, and trademarks. It also applies to a business’s name and goodwill.
Wrongful Communications
Another intentional tort is defamation, which is the act of harming the reputation of another by making a false statement to a third party. Spoken defamation is considered slander, while written defamation is libel. To be liable for defamation, the words must be made to a third party, which may include emails, text messages, and social media. The First Amendment provides strong protection for news organizations, and courts have held that public figures must show actual malice before they can win a defamation lawsuit. This means celebrities and famous individuals must prove the media knew that it was publishing false information, or that it published the information with reckless disregard for the truth. Truth is a complete defense to defamation.
The invasion of the right of privacy is essentially the violation of a person’s right to be left alone and to restrict public access to personal information, such as tax returns and medical records. There are four forms of this tort:
Form of Invasion of Privacy Description
1. Appropriating a person’s name or likeness Using someone’s name, photograph, or other identifying characteristic for commercial purposes without permission
2. Invasion of physical solitude Window peeping, eavesdropping, using drones to video private areas, going through garage to find confidential information, etc.
3. Public disclosure of private facts Disclosure of a private citizen’s finances, medical conditions, or personal relationships through a public medium such as social media
4. False light Using publicity to place a person in false light in the public eye, such as objectionable hobbies or attributing beliefs and opinions to the person that he or she does not hold
Fraud is the intentional misstatement of a material fact that is relied upon by a third party to the detriment of the targeted party. It requires the tortfeasor to misrepresent facts (not opinions) with knowledge that they are false or with reckless disregard for the truth. An “innocent” misrepresentation is not enough—the defendant must know he or she is lying. Fraud can arise in any number of business situations, such as lying on a résumé to gain employment, lying on a credit application to obtain credit, or in product marketing. Here, there is a fine line between puffery, or seller’s talk, and an actual lie. If an advertisement claims that a particular car gets a certain gas mileage or meets emissions standards, then fraud occurs if those statements are untrue. Conversely, an advertisement that promises “unparalleled luxury” is only puffery since it is opinion.
9.3 Negligence
Everyone has the duty to act reasonably and to exercise a reasonable amount of care in their dealings and interactions with others. Breach of that duty, which causes injury, is negligence. Negligence is distinguished from intentional torts because there is a lack of intent to cause harm.
The definition of negligence is purposefully broad. Negligence is the failure to exercise the standard of care that a reasonably prudent person would have exercised in a similar situation. This legal standard is to protect people against unreasonable risk of harm.
To succeed on a negligence claim, a plaintiff must prove five elements:
1. The defendant owed a duty of care to the plaintiff;
2. The defendant breached that duty;
3. The defendant’s conduct was the actual cause of the plaintiff’s injuries;
4. The defendant’s conduct was the proximate cause of the plaintiff’s injuries; and
5. The plaintiff was damaged.
Duty of Care
First, the plaintiff has to demonstrate that the defendant owed it a duty of care. The general rule is that people are free to act any way they want, as long as they do not harm others. This means strangers are generally not responsible for caring for each other unless a special relationship exists. For example, parents owe their children a duty of care and doctors owe their patients a duty of care because of their underlying relationship. In a business context, businesses owe a duty of care to their customers and managers owe a duty of care to their employees. Some business relationships involve a fiduciary duty, which is a duty to act with the utmost faith, trust, and candor towards another. Doctors, lawyers, accountants, and corporate officers all have fiduciary duties towards their patients, clients, and shareholders.
It is important to understand that businesses and individuals owe a general duty to the community as a whole. Drivers owe other drivers and pedestrians a duty of care not to cause accidents. However, drivers are not required to report accidents or to stop and help others when they are not involved because they do not owe a duty of care to strangers.
Businesses have a duty to warn and protect customers from crimes committed by other customers. When a business knows about, or should know about, a high likelihood of crime occurring, then the business must warn or take steps to protect its customers. These businesses include bars frequented by biker gangs, hotels where frequent sexual assaults occur, and any business with escalating violence on their premises.
Businesses also owe a duty to exercise a reasonable degree of care to protect the public from foreseeable risks that the owner knew or should have known about. There are many foreseeable ways for customers to be injured in retail stores, including objects falling from shelves, spilled liquids, and icy entryways. If a store knows about a hazardous condition, or should have known about it, then the store must quickly warn customers and remedy the situation.
Breach of Duty of Care
Once a duty has been established, plaintiffs have to prove that the defendant breached that duty. A breach is demonstrated by showing the defendant failed to act reasonably. It is important to keep in mind that the reasonable person is an objective standard. The reasonable person is never sleep-deprived, angry, or intoxicated. He or she is reasonably careful and considers consequences carefully before acting. A jury does not put themselves in the shoes of the defendant to determine what they would have done in that situation. Nor do they take into account the defendant’s subjective situation, such as being intoxicated or sleep-deprived at the time.
In practical terms, the presence of injury or harm is usually enough to satisfy the “breach of duty” requirement. Often the harm is the evidence of the breach because it would not have occurred if the defendant had acted as they should.
Breach of the duty of care can be both an action (such as causing a car accident) or it can be a failure to act (such as not clearing ice from the sidewalk). These are fact-specific determinations because what a reasonable person would do in a given situation varies.
There are two special doctrines that establish breach of duty of care in limited circumstances. The first, res ipsa loquitur, means “the thing speaks for itself” in Latin and holds that a breach of a party’s duty of care may be inferred from the events that occurred. It is used in cases where:
1. The injury would not have occurred unless someone was negligent;
2. The defendant had exclusive control over the property causing injury; and
3. The plaintiff had no role in causing the harm.
For example, if a patient discovers surgical equipment inside his or her body after surgery, the patient does not have to prove which person in the operating room negligently left the equipment. Instead, the plaintiff can sue the surgeon under the res ipsa loquitur doctrine because the surgeon is in charge of the surgery room. When res ipsa loquitur is raised, the burden shifts to the defendant to prove that he or she did not cause the harm.
Figure 9.2 X-Ray Image of Scissors Left Inside a Patient
The second doctrine is negligence per se. Legislatures sometimes pass laws defining negligence under certain circumstances. If a defendant violates the statute or ordinance, then the defendant is legally negligent. To recover under this theory, a plaintiff has to prove:
1. The defendant broke the law;
2. The plaintiff is in the class of people intended to be protected by the law; and
3. The violation of the law caused plaintiff’s injuries.
Negligence per se is often argued in car accidents where the defendant is ticketed for reckless driving by the police, as well as dog bite cases where the victim has physical injuries. When defending against negligence per se claims, defendants may argue:
1. They were unable to comply with the law through reasonable care;
2. It was an emergency situation not caused by them; or
3. Complying with the law would have presented a greater risk of harm.
Actual Cause
The third element of negligence is actual causation, which is also known as but-for causation. This form of causation is fairly easy to prove. But for the defendant’s actions, would the plaintiff have been injured? If yes, then but-for causation is proven. For example, if a customer slips on ice on a store’s property, would the plaintiff been injured but for the store’s failure to remove the ice? This is the form of causation that most people describe in their daily interactions. Because the store did not remove the ice, the customer slipped and was injured.
Proximate Cause
The second form of causation asks whether the defendant’s actions were the proximate cause of the plaintiff’s injury. Sometimes the chain of events results in the injury being too remote from the defendant’s conduct to be legally recoverable. In other words, proximate cause means that the act or omission must be related closely enough to the injury to justify imposing legal liability. Proximate cause places a limit on a defendant’s responsibility to immediate (or foreseeable) harm. This ensures that no intervening causes of the plaintiff’s injuries exist.
A customer slips on ice on a store’s property and breaks a leg. On the way to the hospital in an ambulance, there is a car accident and the customer is killed. Although the customer would not have been in the ambulance if she had not fallen on the store’s property, the store would not be responsible in a wrongful death claim. The car accident is an intervening event that breaks the causal chain. Put another way, the car accident was not a foreseeable consequence of the store’s failure to remove ice on its premises.
Proximate cause prevents actual causation to be taken to a logical but extreme conclusion. At some point, the law has to break the chain of causation to hold parties to a reasonable amount of liability for their actions.
Damages
The final element in negligence is legally recognizable injuries, or damages. If someone walks on a discarded banana peel and does not slip, then no tort occurs. Only when someone has been injured are damages awarded.
There are two types of damages awarded in tort law. The first, compensatory damages, seek to compensate the plaintiff for his or her injuries. Compensatory damages can be awarded for medical injuries, economic injuries (such as loss of property or income), and pain and suffering. They can also be awarded for past, present, and future losses. While medical and economic damages can be calculated using available standards, it is far more difficult to assign a monetary value to pain and suffering. Juries often use the severity and duration of the injury and its impact on the plaintiff’s life to calculate damages.
The second type of damages is punitive damages, which are intended to deter the defendant from engaging in similar conduct in the future. The idea behind punitive damages is that compensatory damages may be inadequate to deter future bad conduct, so additional damages are necessary to ensure the defendant corrects its ways. Punitive damages are available in cases where the defendant acted with willful and wanton negligence, a higher level of negligence than ordinary negligence. There are constitutional limits to the award of punitive damages.
Defenses to Negligence Claims
A defendant being sued for negligence has two main defenses: (1) assumption of risk by the plaintiff; and (2) comparative negligence.
Assumption of Risk
The first defense is assumption of risk. If the plaintiff knowingly and voluntarily assumes the risk of participating in a dangerous activity, then the defendant is not liable for injuries incurred. However, a plaintiff can only assume known risks. A skier assumes the known risks of downhill skiing, including falling, avalanches, and skiing in poor conditions. However, a skier who is injured from a defective chair lift does not assume the risk of injury as a result of a manufacturing defect.
A related doctrine, the open and obvious doctrine, is used to defend against lawsuits by persons injured while on someone else’s property. For example, if there is a spill on a store’s floor and the store owner has put up a sign that says “Caution—Slippery Floor,” yet someone decides to run through the spill anyway, then that person would lose a negligence lawsuit because the spill was open and obvious.
Both the assumption of risk and open and obvious defenses are not available to the defendant who caused a dangerous situation in the first place.
Comparative Negligence
The second defense to negligence is when the plaintiff’s own negligence contributed to his or her injuries. Most jurisdictions, including Colorado, follow the comparative negligence rule. Under this rule, the jury determines the percentage of fault of all the parties for the plaintiff’s injuries. If the jury finds the plaintiff responsible for some of his or her own injuries, then any compensatory damages are reduced by that percentage. For example, if a customer is 40 percent at fault for his injuries, then the compensatory damage award will be reduced by 40 percent. The reasoning for this rule is to hold people and businesses accountable for their own negligence.
Figure 9.3 Recovery of Damages under Comparative Negligence
This rule applies only to compensatory damages, and not punitive damages. Because punitive damages are meant to deter the defendant from committing future bad acts, the purpose would be undercut if the amount of punitive damages was reduced, too.
9.4 Strict Liability
Intentional torts require some level of intent to be committed, such as the intent to batter someone. Negligence torts require carelessness or neglect. Some torts require neither intent nor carelessness. In strict liability, it is irrelevant how carefully the defendant acted. If someone is harmed in a situation where strict liability applies, then the defendant is liable regardless of lack of intent.
Strict liability applies when restaurants and bars serve alcohol to minors or visibly intoxicated persons. This is dangerous because there is a high risk that drunk patrons will injure others if they drive. Sale of tobacco and firearms to minors are also strict liability crimes, as well as possession of child pornography.
Ultrahazardous Activity
An ultrahazardous activity is an undertaking that cannot be performed safely even if reasonable care is used while performing it, and it does not ordinarily happen in the community. Ultrahazardous activities include using dynamite, transporting dangerous chemicals, keeping wild animals, and using nuclear and radioactive materials. Some states have passed laws defining offshore drilling for oil and gas as an ultrahazardous activity as well.
Defendants engaged in ultrahazardous activities are almost always liable for resulting harm. Plaintiffs do not have to prove duty of care or breach of duty of care. The “reasonable person” test is also irrelevant, as well as the issue of whether the harm was foreseeable.
Product Liability
Product liability cases address situations in which products, not people, cause injury. Plaintiffs can raise either negligence or strict liability claims for injuries caused by products. There are three main product liability theories: design defect, manufacturing defects, and failure to warn.
Design defects occur when the foreseeable risk of harm can be reduced or avoided by the adoption of a reasonable alternative design. In other words, the manufacturer poorly designed a product that caused injuries which could have been avoided. The law does not require products to be perfect. Litigation in these cases centers on what is a foreseeable risk and whether there was a reasonable alternative. As a result, plaintiffs must show that an alternative design was reasonable.
For example, Takata manufactured airbags that were installed by most major car manufacturers. After many airbags failed to deploy in car accidents, leading to severe injury and death, Takata recalled its airbags. Takata is strictly liable for injuries caused by its defective design.
Manufacturing defects occur when a product fails to conform to the manufacturer’s design for the product. In other words, the product may have been designed adequately but the manufacturer allowed a dangerous product to leave the plant. These claims often involve allegations of failure to adequately inspect products before distribution.
For example, a light bulb factory is strictly liable for manufacturing a batch of faulty bulbs that explode when turned on due to some glitch in the production process.
Failure to warn occurs when the defect is not in the product itself but in the instructions (or lack of them). The plaintiff argues that the manufacturer failed to warn users about the dangers of normal use or a foreseeable misuse. However, there is no duty to warn about obvious dangers.
Defenses to Product Liability
There are several defenses to product liability claims.
First, strict liability applies only to commercial sellers. If an individual sells her car to another person, she would not be strictly liable for selling an unreasonably dangerous product if it had Takata airbags.
Second, plaintiff’s assumption of risk can be a defense. The user must know of the risk of harm and voluntarily assume that risk. Someone cutting carrots with a sharp knife voluntarily assumes the risk of being cut by the knife. However, if the knife blade unexpectedly detaches from the knife handle because of a design or production defect, no assumption of risk occurs.
Third, product misuse is another defense to strict product liability. If the consumer misuses the product in a way that is unforeseeable by the manufacturer, then strict liability does not apply. Modifying a lawn mower to operate as a go-kart, for instance, is product misuse.
A final related defense is known as the commonly known danger doctrine. If a manufacturer can convince a jury that the plaintiff’s injury resulted from a commonly known danger, then the defendant may escape liability.
9.5 Concluding Thoughts
Tort law significantly impacts businesses, regardless of industry. Businesses must not engage in activities with the intention to harm employees, customers, and the public. They also must act reasonably to avoid injuries caused by their negligence. Similarly, manufacturers can be strictly liable for design defects, manufacturing defects, and failure to warn consumers. Because many businesses are seen to have “deep pockets,” they are often targeted by plaintiffs when injured by their products and services.
Intentional torts occur when the tortfeasor intends the consequences of his or her act or knew with substantial certainty what the consequences would be. Businesses are affected by intentional torts and need to be careful not to commit them against their employees, customers, and members of the public. It is useful to categorize intentional torts based on the types of rights being protected, such as preventing injuries to persons, property or privacy.
Negligence imposes a duty on all persons to act reasonably and to exercise due care in dealing and interacting with others. Negligence has five elements. First, the plaintiff must demonstrate the defendant owed the plaintiff a duty of care. Second, there must be a breach of that duty. A breach occurs when the defendant fails to act like a reasonable person. The plaintiff must also demonstrate that the defendant caused the plaintiff’s injuries. Both causation-in-fact and proximate causation must be proven. Finally, the plaintiff must demonstrate legally recognizable injuries, which include past, present, and future economic, medical, and pain and suffering damages. Defendants can raise several affirmative defenses to negligence, including assumption of risk and comparative negligence.
In areas where strict liability applies, the defendant is liable no matter how carefully it tried to prevent harm. Carrying out ultrahazardous activities results in strict liability for defendants. Another area where strict liability applies is in the serving of alcohol to minors or visibly intoxicated persons. A large area of strict liability applies to the manufacture, distribution, and sale of unreasonably dangerous products. Products can be unreasonably dangerous because of a production defect, design defect, or both. A product’s warnings and documentation are a part of a product’s design, and therefore inadequate warnings can be a basis for strict product liability. Assumption of risk, product misuse, and commonly known dangers are all defenses to strict product liability. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/09%3A_Torts.txt |
Learning Objectives
• Explain what constitutes a contract.
• Understand how a contract is formed.
• Know the defenses to performance of a contract.
• Understand breach of contract and its consequences.
• Identify remedies for breach of contract.
10: Contracts
Although businesses tend to use the terms “agreement” and “contract” interchangeably, legally the terms have very different meanings. An agreement is a mutual understanding between two or more parties about their rights and duties toward each other. A contract is a legally enforceable agreement between two or more parties. All contracts are agreements, but not all agreements are contracts.
When contracts are broken, or breached, the injured party can seek damages. In contracts, this usually means an amount that would make that party whole again.
Generally speaking, contracts are a form of private law, because the terms of the contract are binding on the parties to the contract but not anyone else. Parties may enter into contracts for whatever they wish and under any terms that they agree on. In other words, parties may assent to agreements even if those agreements represent bad bargains.
Contracts may restrict parties’ future activity. For example, a non-compete clause in an employment contract may be enforceable in the future against an employee after termination of employment.
However, contracts that are illegal or against public policy are not enforceable.
Contract law performs three significant economic functions:
1. It helps individuals and businesses exchange goods and services efficiently.
2. It reduces the costs of economic transactions because parties do not need to negotiate a variety of rules and terms with each separate transaction.
3. It alerts the parties to problems that have arisen in the past, making it easier to avoid potential pitfalls.
Counselor’s Corner We live in a world of contracts, which are the bread and butter of business transactions. However, many consumers, employees, and small businesses are afraid to read and understand contracts. That fear allows others to take advantage of them. Take the time to read contracts provided to you. Ask questions about anything you don’t understand before you sign. Have the courage to revise and edit contracts to ensure your interests are protected. Or even write your own. It’s not hard and the more you do it, the more confidence you will have to negotiate business transactions and protect your interests. ~Darnell T., attorney
10.02: Contract Elements
There are three required elements of a contract: offer, acceptance, and consideration. It is important to note that some states and legal scholars expand this list to include whether the subject matter is legal, whether the parties have capacity to enter into a contract, and whether the law requires the contract to be in writing to be enforceable. However, these are best understood as defenses to contract formation, especially in light of the fact that the only elements that all states agree on are offer, acceptance, and consideration.
Offer
All contracts start when an individual or business proposes a deal. It might involve buying or selling goods, performing services, or making an exchange. An offer is a conditional promise to do or refrain from doing something now or in the future. In other words, it is willingness to enter into a contract.
Offers can be formal or informal. In some industries, such as retail and restaurants, offers are often posted on menus, signs, and advertisements. For example, a sign hanging above a cash register listing menu items and their prices is the restaurant’s offer to sell customers those items at those prices.
There are not a lot of legal requirements about what an offer must contain, but there are some things that cannot be a legal offer:
Type of Invalid Offers Definition Example
Illusory Promise No offer exists because there is no duty to perform “If I decide to buy a new car, I’ll give you my old one.”
Pre-existing Duty A party cannot leverage an existing duty to get more out of someone else “I agree to teach you business law for \$100 even though you have already paid tuition for the course.”
Forbearance An offer cannot be a promise not to pursue a legal claim that is known to be invalid (Note: if the claim is valid, then forbearance may be a valid offer) “I know the accident was completely my fault but I promise not to sue you.”
Past Consideration An offer cannot be based on past actions I paint your house. Two months later you say that you will pay me \$500 for doing it. If you change your mind and decide not to pay me, I cannot enforce your promise because it was in consideration of a past event.
Once made, offers can be terminated in a number of ways. An offer that has been properly communicated continues to exist until it:
1. Is rejected;
2. Is replaced by a counteroffer;
3. Lapses or expires;
4. Is revoked; or
5. Is terminated by operation of law.
Unless it states a specific time, an offer remains open for a reasonable time. A lapsed offer is an offer that is no longer valid because a reasonable time to accept it has expired. An expired coupon is an example of a lapsed offer.
Acceptance
To constitute an agreement, there must be an acceptance of the offer. Legally, acceptance is an implied or express act that shows willingness to be bound by the terms of an offer. To be effective, both parties must understand and agree to be bound by the contract.
Acceptance can be both express or implied. Express acceptance occurs when a party states that they accept the offer. Acceptance may be implied based on the parties’ conduct. For example, a retailer offers to sell a product to consumers for the price listed on the shelf. A consumer may accept that offer by handing the cashier the item and money to pay for it. The consumer does not need to say anything to complete the transaction. But the consumer must do something to accept. Silence, without more (such as handing over payment), is not acceptance. This is because silence may be evidence that the consumer either does not know about the offer or has rejected it.
A common problem in the business community is knowing what constitutes acceptance and what is negotiation. If an acceptance changes, adds, or modifies terms of the offer, it is a counter-offer and no contract is formed. The original party may decide to accept, reject, or propose another offer as a result. Although this sounds straightforward, with today’s fast-paced communications, parties may respond to part of an offer, negotiate various parts of the contract simultaneously, or agree to terms in installments. As a result, there may be confusion about what the full terms of a contract are.
Offer and acceptance form mutual assent, which is also called “meeting of the minds.” This is the parties’ intention to enter into a binding contract on the terms they agreed upon. If parties do not agree on the essential terms, then there can be no meeting of the minds to enter into a contract. This is the basis for many of the defenses to contract formation.
Consideration
Consideration is the bargained-for exchange of something of value that shows the parties intend to be bound by the contract. There are two elements to consideration:
1. Something of value
2. Is exchanged between the parties.
The “something” that is promised or delivered must be a legal detriment. A legal detriment is giving up a legal or property right.
Consideration may be concurrent or a promise to perform in the future. However, it cannot be “past consideration” based on something that has occurred before the formation of the current contract. In other words, an act or promise made before the current contract is not adequate consideration because it was not given in exchange for the current promise.
When bargained-for consideration is not present, a court may validate a promise based on promissory estoppel. Promissory estoppel is the principle that a promise made without consideration may nonetheless be enforced to prevent injustice if the promisor should have reasonably expected the promisee to rely on the promise, and the promisee actually relied on the promise to his or her detriment. Promissory estoppel is an equitable doctrine used as a substitute for consideration that allows the imposition of contractual liability to prevent unfairness.
To establish promissory estoppel, a party must show:
1. A definite promise;
2. The party making the promise should have expected that the other party would rely on the promise;
3. A reasonable person would have relied on the promise;
4. The party relied on the promise and it resulted in a substantial detriment; and
5. Basic justice and fairness require that the promise be enforced. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.01%3A_Introduction.txt |
Bilateral and Unilateral Contracts
In a bilateral contract, both parties make a promise of performance. These contracts are also called mutual or reciprocal contracts. Bilateral contracts are the most common form of contracts. They include ordering food in a restaurant, buying gas for vehicles, purchasing goods and services, etc.
A unilateral contract, on the other hand, is a contract where one party makes a promise that the other party can accept only by doing something. For example, a business offers a reward for information leading to the arrest of a thief. A person cannot collect the reward money by promising to give information–he or she must perform under the contract by providing the information.
Express and Implied Contracts
An express contract is a contract in words (orally or in writing) in which the terms are spelled out directly. The parties to an express contract, whether written or oral, clearly intend to make a legally enforceable agreement. For example, an agreement to buy a car for \$1,000 and to take title next Monday is an express contract.
An implied contract is a contract that is inferred from the parties’ actions. Although no discussion of terms took place, an implied contract exists if it is clear from the conduct of the parties that they have an agreement. A delicatessen patron who asks for a “turkey sandwich to go” has made a contract and is obligated to pay when the sandwich is made. By ordering the food, the patron is implicitly agreeing to the price, whether posted or not.
Quasi-contract: Contract Implied in Law
Both express and implied contracts embody an actual agreement of the parties. A quasi-contract, by contrast, is an obligation imposed by law to avoid unjust enrichment of one person at the expense of another. In fact, a quasi-contract is not a contract at all. It is a judicial remedy in which the court decides what a contract should look like between the parties to prevent injustice. For example, a carpenter mistakenly believes a homeowner hired him to repair her porch, when it was actually the neighbor who hired him. One morning the carpenter arrives and begins work. Rather than stop him, the homeowner lets him proceed, excited to get her porch fixed for free. Although no contract exists because there was no offer, acceptance or consideration, the law will imply a contract between the carpenter and homeowner for the value of the work.
Enforceability
A contract that is fully enforceable and reflects the parties’ intent is valid. Conversely, an unenforceable contract is a contract where the parties intend to form a valid bargain but the court declares that it cannot be enforced for legal reasons. For example, Ramesh owes Jai money, but Jai has waited too long to collect it and the statute of limitations has run out. The contract for repayment is unenforceable and Jai is out of luck unless Ramesh makes a new promise to pay or actually pays part of the debt.
An agreement that is lacking one of the legal elements of a contract is void because it never was a contract. In other words, it is not legally enforceable because it is not a contract at all. An agreement that is illegal is also void. For example, a promise to commit a crime in return for payment is void because neither side can enforce the agreement in court.
By contrast, a voidable contract is a contract that can be annulled. It is a contract that is unenforceable by one party but enforceable by the other. For example, a minor may “avoid” a contract with an adult; meaning the adult may not enforce the contract against the minor if the minor refuses to carry out the bargain. The adult must comply if the minor wishes the contract to be performed. A contract may be voidable by both parties if they are both minors. Usually, the parties to a voidable contract are entitled to be restored to their original position.
A voidable contract remains a valid contract until it is voided. Thus, a contract with a minor remains in force unless the minor decides he does not wish to be bound by it. When minors become adults, they have two choices:
1. Ratify the contract–that is, agree to be bound by it; or
2. Disaffirm the contract–that is, disavow or avoid it.
Ratification may be explicit or implicit. For example, by continuing to make payments or retaining goods for an unreasonable period of time, a party may ratify the contract. If a party has not disaffirmed the contract while still a minor, she may do so within a reasonable time after becoming an adult.
Degree of Completion
An executory contract is a contract that has yet to be completed. Most executory contracts are enforceable. If some, but not all, of the terms of the contract have been performed, the contract is called partially executed. A contract that has been completed or carried out fully by both parties is called an executed contract. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.03%3A_Types_of_Contracts.txt |
Performance simply means undertaking the legal duties imposed by the terms of the contract.
But how do we know whether the contract terms have been performed? Sometimes it’s easy to determine. For instance, if someone offers to sell his scooter for four hundred dollars, a purchaser agrees, and they exchange the scooter for the money, then the contract has been fully performed. A contract was formed, the parties performed their obligations under it (known as complete performance), and they are subsequently discharged from further duties arising under the contract. Complete performance results in an executed contract.
When a party fails to perform under the terms of the contract without a legally justifiable reason, the party is in breach of contract. Not all breach of contract situations give rise to litigation. Some breaches are minor and may be overlooked by parties, especially if there is a long-term business relationship between them. Others may be major and give rise to significant issues between the parties.
In a service contract, the standard used to judge performance is substantial performance. This means that the performing party acted in good faith and conveyed enough benefit to the other party under the contract that any breach may be remedied by money damages. A material breach in a service contract occurs when a party has not substantially performed under the terms of the contract. A minor breach occurs when the party has substantially performed but has not strictly performed.
Performance to the standard of personal satisfaction can be enforced if the contract expressly requires it. This means that contract performance is evaluated subjectively, either by one party to the contract or by a third-party beneficiary specified in the contract. If the subject of the contract is something for which approval is dependent on someone’s subjective opinion, like personal taste, then assessment can be made on a subjective standard providing this standard is clearly specified in the contract. These contracts often occur in the entertainment industry, as well as the building of custom homes.
Conditions
A condition is an act or event (other than the lapse of time) that must occur before performance under a contract becomes due. Conditions determine when a party must perform.
Type of Condition Description
Condition precedent A condition must occur before a party’s performance is required
Concurrent condition Each party’s performance is dependent on the other party’s performance
Subsequent condition A condition follows the duty to perform that completely eliminates or discharges a duty to perform
Constructive condition Equitable doctrine that serves as an implied-in-law condition to prevent injustice
A condition precedent is an act or event that must occur before a duty of immediate performance of a promise arises. For example, an inspection of property is a condition precedent to the sale of a home.
A concurrent condition occurs when mutually dependent conditions must be performed at the same time by the parties. For example, delivery of goods and payment in a cash sale are concurrent conditions.
A subsequent condition is an event that discharges a duty of performance that becomes absolute. They are rare and tend to occur in the insurance industry. For example, an insurance company may require notice within thirty days of a claim. The insurance company does not have a duty to pay until the insured gives notice. Notice is the subsequent condition that triggers the insurance company’s performance.
A constructive condition is a condition contained in an essential contractual term that, though omitted by the parties from their agreement, a court has supplied as being reasonable in the circumstances. It is an equitable doctrine that serves to imply conditions to prevent injustice. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.04%3A_Performance_and_Breach_of_Contract.txt |
A party may have a valid reason for breaching, or not performing, a contract. These reasons are known as defenses to contract. Many of the defenses to contracts go to the heart of whether an agreement ever existed. In other words, if a party does not voluntarily consent or there was no “meeting of the minds,” then a valid contract was never formed.
Illegality
Illegal contracts are unenforceable because they are void. There are two common types of illegalities: (1) statutory violations, and (2) violations of public policy. An example of a statutory violation is where a company in the US wants to avoid import regulations and quotas by purchasing Cuban cigars through an intermediary in Mexico. If the US buyer pays the Mexican intermediary for the cigars but does not receive them, the buyer cannot sue the intermediary for breach of contract. The law will not provide a remedy to someone who intends to violate the law.
Examples of violations of public policy often occur in an employment context. An employer that tries to bind its employees to unreasonable non-compete agreements violates the public policy of freedom to work. Another common example is contracts with professionals who do not maintain a current license in their field. If they are not legally licensed for the work they perform, they are not entitled to payment for their services. Here, the public policy is that the law does not want to encourage a black market for services outside of government regulation.
Incapacity
If someone lacks mental capacity to understand the terms of the agreement, there cannot be a true meeting of the minds to form a contract. Capacity is the mental state of mind sufficient to understand that a contract is made and its legal consequences.
Incapacity can be permanent, such as from mental illness, physical illness, or insanity. Incapacity may also be temporary, such as being intoxicated, under the influence of drugs, or underage (i.e. under eighteen years old).
Undue Influence
Undue influence occurs when one party overpowers the free will of another by use of superior power or influence. In other words, it is unfair persuasion. Undue influence is not a normal level of persuasion. Rather, it occurs when a party agrees to a contract that they would not have otherwise consented to without the unreasonable pressure of the other party. For example, an elderly person who is isolated from others due to poor health and living conditions may be lonely and eager for company. If a caretaker exerted influence over the elder to the extent that he or she could no longer exercise free will, then undue influence occurs. Contracts and transactions in which elders transfer most or all of their wealth to others are frequently reviewed for undue influence.
Duress
Duress occurs when there is a threat to a person, family or property. Economic pressure may constitute duress if it is wrongful and oppressive. Cases involving duress often occur in emergency situations. For example, when someone is required to sign legal paperwork in an emergency room before receiving medical treatment for themselves or their children.
If a person enters into a contract under duress, he or she is able to get out of the contract after the emergency situation is over. Duress essentially overcomes a person’s free will to voluntarily choose to enter into the contract.
Unconscionability
Unconscionability occurs when the contract contains markedly unfair terms against the party with less bargaining power or sophistication than the party who created the terms and induced the other party to sign it. Common cases involving unconscionability claims occur when one party is an experienced business dealer, while the other party is an average consumer. If the business dealer uses a very small font and inserts terms into the contract in a way that intentionally misleads the consumer into signing on unfair terms, then the contract may be deemed unconscionable.
Statute of Frauds
The Statute of Frauds requires certain contracts to be in writing and signed to be enforceable. The Statute of Frauds originated in England in 1677 to prevent fraud when one party tries to claim a contract existed when it did not. The Statute of Frauds requires a written contract for:
1. Real property interests;
2. Marriage;
3. Payment of another’s debt;
4. Contracts that cannot be completely performed within one year;
5. Contracts for the sale of goods of five hundred dollars or more; and
6. Acting as another’s executor/administrator.
Statute of Limitations
The statute of limitations is an affirmative defense that can be raised by a defendant to argue that a lawsuit is being brought too late. This means that if a dispute arises under a contract, then the plaintiff must bring a lawsuit concerning that dispute within a certain time period. States have different statutes of limitations. If a contract has a choice of law provision, then that state’s statute of limitations will apply to disputes related to the contract.
Mistake
In the context of contracts, a mistake is the situation in which the parties did not mean the same thing or when one or both parties formed untrue conclusions about the subject matter of the contract. In other words, a mistake is an erroneous belief.
Mutual mistake refers to something that is a mistake by both parties that relates to an essential term of the contract. For example, a contract to buy property that is not actually owned by the seller would be a mutual mistake, if the seller believed in good faith that he owned the property. When mutual mistakes occur, either party may rescind the contract.
Unilateral mistake occurs when only one party is laboring under a mistake. Mistake does not mean bad bargaining. Courts will not step in to save parties from bad bargaining absent evidence of undue influence or unconscionability. In general, parties cannot rescind the contract when unilateral mistakes occur except when the mistake makes the contract unconscionable, the error is apparent to the other party, or when significant mathematical errors occur.
Figure 10.1 Types of Mistakes Affecting Contracts and Their Remedies
Misrepresentation and Fraud
Misrepresentation and fraud are also defenses to contract. Misrepresentation is when a party makes a false statement that induces the other party to enter into the contract. Fraud is a closely related concept, and it simply means that one party has used deception to acquire money or property. Fraud may also be a basis for criminal charges, depending on the circumstances leading to the contract.
Commercial impracticability
Commercial impracticability is a defense that can be used when fulfilling a contract has become extraordinarily difficult or unfair for one party. For example, a sales contract relating to the sale of goods destroyed by a natural disaster would fall under this defense. It becomes impossible for the seller to deliver goods that no longer exist, and would be unfair to enforce damages against the seller for breach of contract. This is also called frustration of purpose or impossibility in some jurisdictions.
Bankruptcy
Sometimes a party to a contract files for bankruptcy protection. The bankruptcy court will determine which debts the bankrupt party must pay and which are dischargeable. Contract obligations are suspended temporarily through the bankruptcy court’s automatic stay. In other words, the debt does not have to be paid during the course of the bankruptcy. At the conclusion of the bankruptcy, if the contract obligation is determined to be a dischargeable debt, then the debt will not have to be paid. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.05%3A_Defenses_to_Contracts.txt |
Contracts are by law assignable and delegable. This means that the rights conveyed by the contract may be transferred to another party by assignment, unless an express restriction on assignment exists within the contract, or unless an assignment violates public policy. Likewise, the duties imposed on a party may be transferred to another party by delegation, unless the contract expressly restricts delegation, there is a substantial interest in personal performance by the original party to the contract, or if delegation would violate public policy.
As a general rule, a party may assign contract rights without the consent of the other party. This is common in the construction industry where a general contractor may assign rights and delegate duties to subcontractors for specific work that needs to be performed under the main contract. For example, the general contractor may delegate the duty to perform electrical work to an electrician, as well as assign the right to be paid for the work performed.
In delegation and assignment, the original contracting party is not “off the hook” if it transfers its duties or rights to another party. For instance, a subtenant assumed the rights and duties imposed on the original tenant in a lease. If the subletting tenant does not pay the rent, the original tenant is still liable.
The way to excuse oneself from legal liability under a contract is through novation. Novation is essentially a new contract that transfers all rights and duties to a new party to the contract and releases the previous party from any further obligation. It is the procedure in which one party is dismissed completely from the contract because a third party is substituted. In this situation, the dismissed party no longer has any liability under the original contract. To be effective, all parties must agree to the novation.
Third Party Beneficiaries
Assignment and delegation under a contract should not be confused with rights of third party beneficiaries. A third party beneficiary is someone who is not a party to the contract but stands to benefit from it. Life insurance policies are a classic example of contracts with third party beneficiaries. The insurance company and the insured are parties to the contract. But the person who receives payment upon the death of the insured is the third party beneficiary.
Third party beneficiaries can either be intended or incidental. An intended beneficiary is someone who the parties intend to receive the benefit of the contract. For example, the named beneficiary of a life insurance policy. The beneficiary does not need to know about the contract to have his or her rights vest.
An incidental beneficiary is someone who benefits from a contract but was not intended by the parties to benefit. For example, if a business pays for a professional to landscape its property, the neighbors are incidental beneficiaries to the landscaping contract. They benefit from the improved appearance and property values, but the business did not enter the contract with an intent to benefit them. Incidental beneficiaries do not have a legally enforceable interest in the contract.
10.07: Parol Evidence Rule
Courts often must interpret the meaning of a contract. When the contract is written, courts will look within the “four corners” of the document and apply the contract as written. The Parol Evidence Rule is the principle that a writing intended by the parties to be a final embodiment of their agreement cannot be modified by evidence that adds to, varies, or contradicts the writing. This rule usually prevents a party from introducing evidence of negotiations that occurred before or while the agreement was being reduced to its final written form.
However, there are several important exceptions that allow oral statements to be admitted:
1. Subsequent modifications;
2. Evidence of intentional misrepresentations by a party;
3. Correcting errors in drafting;
4. Clarifying ambiguities and filling in gaps; and
5. Supplements to a partially integrated contract.
As a result of the parol evidence rule, businesses should do their due diligence to ensure any written contracts fully and adequately include the essential terms of their agreement. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.06%3A_Assignment_Delegation_and_Third_Party_Beneficiaries.txt |
The four main remedies for breach of contract are damages, specific performance, rescission, and restitution. The purpose of contract remedies is to compensate the non-breaching party for the losses suffered. In other words, remedies must put the non-breaching party in the position it would have been if there had been no breach.
Damages
Damages are the money paid by one party to another to discharge a legal liability.
Types of Monetary Damages Purpose
Compensatory To make the non-breaching party “whole” as if breach did not occur
Consequential To cover indirect but foreseeable losses flowing from the breach
Incidental To cover direct losses flowing from the breach & to avoid further loss
Nominal To recognize legal breach although no actual damages resulted
Punitive To punish and deter future wrongful behavior; only available if breach itself is a tort
Liquidated To allow parties to determine value of contract in case of breach
Compensatory Damages
Compensatory damages are paid to compensate the non-breaching party for the loss suffered as a result of the breach. It is the general category of damages awarded to make the party whole. Compensatory damages include out-of-pocket losses and costs associated with the loss of the bargain. They are the primary damages in contract breach cases and are a direct, foreseeable result of the breach of contract.
Consequential Damages
A basic principle of contract law is that a person injured by breach of contract is not entitled to compensation unless the breaching party, at the time the contract was made, had reason to foresee the loss as a probable result of the breach.
Consequential damages are damages that flow as a foreseeable but indirect result of the breach of contract. For example, a roofer takes longer to fix a leaky roof than specified in a contract. The delay results in a retailer remaining closed for an additional week until the roof is repaired. The loss of sales from that week are consequential damages.
Consequential damages often include:
• Loss of profits due to the interruption of normal business practices;
• Loss of customers due to delays or cancellations; and
• Cost of replacement goods or services.
Incidental Damages
Incidental damages are damages that are paid to the non-breaching party in an attempt to avoid further loss on account of the breach. These damages include additional costs incurred by the non-breaching party after the breach in a reasonable attempt to avoid further loss, even if that attempt was unsuccessful.
For example, an electrician contracts to install light fixtures in a warehouse within seven days. The electrician enters into a purchase agreement with a supplier to buy the fixtures which are to be delivered within three days. On the fifth day, the supplier notifies the electrician that it cannot fill the order, breaching the contract. Because he cannot fulfill his contract with another supplier in time, the electrician breaches his contract with the warehouse and has to refund the warehouse its money. The losses incurred by the electrician to the warehouse are a direct result of the supplier’s breach of contract, and are incidental damages.
Incidental costs often include:
• Inspection of items;
• Transportation or care of items;
• Expenses or commissions incurred in connection with incident or delay of items; and
• Storing of defective items until the supplier can retrieve them.
The difference between incidental and consequential damages is the cause of the expense or loss. Incidental damages are the direct result of one party’s breach of contract. Consequential damages are more indirect, being incurred not as a result of the breach itself, but due to the end result of the breach.
Nominal Damages
If the breach of contract caused no actual loss, the non-breaching party may be awarded nominal damages. Nominal damages are a token amount of money paid when the breach has caused no actual loss. Nominal damages are often awarded symbolically by juries when they find legal liability but believe the breach was minor or could have been accommodated in another way. For example, a buyer could have purchased the same commodity at the same price without spending any extra time or money.
Punitive Damages
Punitive damages are awarded to a non-breaching party in excess of any loss suffered to punish the breaching party. Punitive damages are awarded when the defendant acted willfully and maliciously, and the purpose is to deter similar future bad conduct. Punitive damages are not usually available for breach of contract claims, unless the breach of contract itself constitutes a tort. In other words, punitive damages may be available when the contract breach itself is fraudulent or malicious. Punitive damages have been awarded against insurance companies that have refused to honor disability payments and that have acted in bad faith in denying legitimate claims.
Liquidated Damages
Liquidated damages are damages agreed upon by parties to a contract to be paid in the event of a breach. Because the parties are often in the best position to know the value of their contract, they can negotiate a fixed sum or method to calculate damages in the event of a breach. To be enforceable, liquidated damage provisions must apply equally to all parties, be negotiated fairly at the time the contract is executed, and must bear a reasonable relation to the probable damage in case of a breach.
Equitable Remedies for Breach of Contract
Equitable remedies involve a request for relief that does not include money damages. Equitable remedies are useful for when money does not provide adequate relief to the non-breaching party.
Equitable Remedy Purpose Description
Specific Performance The object of the contract is unique & the loss cannot be easily compensated through money Party must perform under terms of contract
Rescission Contract was executed based on mutual mistake or fraud Parties are put back into position they were in before contract was made
Restitution Parties must return any benefit received Benefit or item unjustly obtained is returned
Specific Performance
Specific performance is a judicial order directing a party to deliver the exact property (real or personal) under the terms of a contract. Specific performance is an alternative remedy to damages and may be issued at the discretion of the court. Specific performance is granted when money damages are not an adequate remedy. For example, sale of specific real property (real estate is always unique), artwork, antiques, and heirlooms.
To warrant specific performance, a contract must be clear, definite, complete, and free from fraud and duress.
Specific performance is generally not available for service contracts. This is because ordering someone to perform a contract against their will is a type of involuntary servitude banned by the Thirteenth Amendment of the US Constitution. However, courts have occasionally entered injunctions prohibiting entertainers from performing at alternative venues until they perform at the venue under their original contract. These cases are in response to unethical forum shopping in the entertainment industry, and are very limited in nature.
Rescission
Rescission occurs when one party seeks to undo a contract and return to the position it was in before the contract was made. Rescission often occurs when fraud and mutual mistake occur and enforcing the contract would be unjust. Rescission may also be available when one party materially breaches the contract to such an extent that requiring the other party to perform would be unjust.
A party seeking rescission must notify the other party within a reasonable time after discovery of the facts that are the basis for rescission. The reason is that restoring the parties to their pre-contractual positions is easiest before too much time and performance has passed. Failure to rescind a contract in a timely manner may be held to affirm the contract or waive a breach of contract.
Restitution
Restitution is restoring property to the original owners. In other words, parties must return any benefit received under the contract. Therefore, only to the extent that the injured party conferred a benefit on the other party may the injured party be awarded restitution. Restitution often follows rescission of a contract. The purpose of restitution is to prevent a party from being unjustly enriched when a contract has been legally annulled.
10.09: Concluding Thoughts
Contracts are a fundamental part of business. It is important to understand how contracts are formed, performed, and executed in order to be successful. This understanding also includes understanding what performance is required, what defenses are available when someone breaches a contract, and what remedies are available in the event of a breach. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/10%3A_Contracts/10.08%3A_Remedies.txt |
Learning Objectives
• Explore the differences between the Uniform Commercial Code and common law contract principles.
• Understand important provisions of the Uniform Commercial Code and how they apply to merchants who sell goods.
• Learn when the Uniform Commercial Code applies to mixed contracts.
11: Sales Contracts
One of the drawbacks of federalism is that states can implement different laws. This was a serious problem as the US economy grew beyond local and state-based industries to economies of scale during the Twentieth Century because it hampered economic growth. In response, business leaders demanded consistent laws to facilitate trade across the nation, especially for the sale of goods across state lines.
The Uniform Commercial Code (UCC) is a proposed set of laws developed by legal experts and business leaders to govern commercial transactions, including sale of goods, secured transactions, and negotiable instruments. The UCC was created in 1952 and its advocates lobbied the states and territories to adopt it. The UCC has been adopted in some form by all fifty states, the District of Columbia, and US territories. Interestingly, it is the only “national” law not enacted by Congress.
This chapter will focus on important provisions that relate to sales contracts that have been adopted by most, if not all, states.
Counselor’s Corner When writing something for work, I offer the following advice. First, take time to review and edit your writing. You will be surprised at the number of typos that can be discovered when you give your work fresh eyes. Don’t be afraid to reach out to others to review your work as well. Excellence in writing will help to convey your message clearly and credibly. Second, write with honesty. If your reader doubts the sincerity of your work, the message you are trying to convey will be lost. The strongest advocates I have encountered are the most honest ones. Third, be clear and concise. Tell your reader a story but give them the information they need in an organized fashion. ~Tiffany M., attorney
11.02: Scope of the UCC
The UCC deals with commercial transactions from start to finish. The power of the UCC is that if the parties do not have a contract with express terms, then the UCC “fills the gaps” with legal requirements. For example, if the parties do not negotiate the terms of delivery, then the UCC states where and when delivery should occur. This is incredibly beneficial to businesses because it provides legal certainty and consistency across jurisdictions. If parties have a dispute, or unforeseen circumstances result in a breach of contract, the parties can resolve the problem without having to litigate the issue in court. This saves businesses a lot of time, money and resources, as well as helps them maintain good working relationships.
The UCC also addresses four important problems that merchants struggled with under the common law:
Problem Common Law UCC Example
Contract Formation Mirror Image Rule: Offer must be followed by acceptance showing meeting of the minds on all essential terms Contract can be made in any manner that shows agreement and some terms, including price and time of delivery, may be left open (§2-204 & §2-305) Jimena writes Ahn that she needs a new computer. Ahn delivers the computer and Jimena starts to use it. Under the common law, there is no contract because price was not discussed. Under the UCC a contract exists for a reasonable price.
Required Writing All essential terms must be in writing Any writing that intends to be a contract is enforceable; “merchant” exception can create a contract against party that does not object to writing within ten days (§2-201) Home Depot sends a purchase order to a wholesaler. The wholesaler receives the order but does not respond. Under the common law, no contract exists. Under the UCC, a contract exists after ten days that Home Depot may enforce against the wholesaler.
Additional Terms An acceptance with any additional terms is a counteroffer Additional and different terms are not necessarily counteroffers, may just be part of negotiation process (§2-207) A florist sends a preprinted order form to buy specific supplies from a manufacturer for a stated price. The manufacturer responds with its own preprinted form accepting the order but adding the term that unpaid balances incur interest. Under the common law, the additional term is a counteroffer and no contract is formed until the florist accepts it. Under the UCC, there is a valid contract that includes the interest term.
Modification To be valid, a modification must be supported by new consideration A modification does not need to be supported by new consideration (§2-209) Fred Farmer agrees to sell produce to Aponi for her restaurant. They agree to all essential terms, including goods, price, and delivery. The next day a hurricane floods the interstate doubling the delivery costs. Fred calls Aponi who agrees to pay half of the increased cost. Under the common law, the modification is void. Under the UCC, the modification is enforceable.
A common problem is determining when the UCC applies. The UCC does not apply to contracts related to the sale of land, intangible personal property, construction, or for services. The UCC applies to the sale of goods, which the Code defines as any moveable physical object except for money and securities. In other words, goods are tangible personal property.
Figure 11.1 Determination of when the UCC Applies to Sales Transactions
Mixed contracts are for both the sale of goods and services. For example, a contract for the sale of a dishwasher that includes the service of installation is a mixed contract. The UCC only applies to mixed contracts when the primary purpose of the contract is the sale of goods. In the dishwasher example, the UCC applies because installation would not occur without the sale of the dishwasher.
The UCC also does not apply if none of the parties are a merchant. In other words, the sale of goods between individuals is governed by the common law. If a sales transaction involves a merchant, then the UCC usually applies. A merchant is someone who routinely deals in the goods involved in the transaction or who, by his or her occupation, holds himself or herself out as having special knowledge with respect to the goods. Suppliers of services are not merchants.
The UCC provides merchants with rules that facilitate their business needs. For example, contract formation is more informal and flexible than under the common law. However, the UCC often holds merchants to a higher standard of conduct than non-merchants. Merchants are required to act in good faith and to observe reasonable commercial standards of fair dealing. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/11%3A_Sales_Contracts/11.01%3A_Introduction.txt |
The common law expects parties to form a contract by making an offer, with an acceptance that mirrors the offer and includes all material terms. Modern business transactions, however, frequently do not follow that pattern. As a result, UCC §2-204 provides that a contract may be formed in any manner that shows the parties reached an agreement.
The terms of sales contracts are supplied by three sources:
1. The express agreement of the parties;
2. Course of dealing, usage of trade, and course of performance; and
3. The UCC.
Express Agreement
The general rule is that parties are free to make their own sales contract. When parties agree on terms–especially for quality, quantity, price, delivery and payment–those terms control over UCC provisions. The parties’ freedom to contract, however, is not limitless. Parties cannot disclaim their obligation of good faith, diligence, and due care. Similarly, liquidated damages provisions must be based on the value of the contract and cannot be a penalty for breach of contract. Further, limitations on consequential damages cannot be unconscionable.
Course of Dealing, Usage of Trade & Course of Performance
The parties’ agreement may be based on their actions. Course of dealing is an established pattern of prior conduct between the parties to a particular transaction. If a dispute arises, the parties’ course of dealing can be used as evidence of how they intended to carry out the transaction. In other words, the current contract is interpreted based on past contracts.
Course of performance relates to the conduct of the parties under the contract in question after its formation. It occurs when a contract involves repeated performance and looks at how the parties have acted when performing this particular contract, not contracts in the past.
Usage of trade is a practice or custom in a particular trade used so frequently that it justifies the expectation that it will be followed in the current transaction. It is industry standards and customs related to a particular industry.
UCC Provisions
When sales contracts do not have all the necessary terms, the UCC “fills in the gaps” of the contract. The most important UCC gap-filler provisions relate to price, quantity, delivery, and time of performance.
Figure 11.2 UCC Gap-Filler Provisions
Provision Subject Description
§2-305 Price Price can be left open to be fixed at later time;
Reasonable price determined upon delivery
§2-306 Quantity “Output” and “Requirement” amounts can be determined at a later time;
No quantity that is unreasonably disproportionate to the estimate will be enforced;
Reasonable amount in keeping with normal or prior comparable output or requirements is implied
§2-507 & §2-308 Delivery Delivery occurs at seller’s place of business unless contract provides otherwise
§2-309 Time Reasonable time for performance
When these sources of contract terms are in conflict, the UCC applies the following hierarchy:
1. Express terms;
2. Course of performance;
3. Course of dealing;
4. Usage of trade; and
5. UCC gap-filler provisions.
The logic is that the parties are free to contract the terms they would like. In absence of an express agreement, the parties’ conduct shows their intent. In practical terms, usage of trade and UCC provisions often go hand-in-hand. For example, what constitutes “reasonable time” for performance is often based on relevant industry standards. Although the UCC identifies a hierarchy, in practice it is not rigidly applied by the courts when determining usage of trade and UCC provisions.
Additional and Different Terms
Under UCC §2-207, an acceptance that adds or alters terms will often create a contract. Unlike the common law that treats modifications as a counter-offer, the UCC has a more flexible concept of acceptance. This is to address the “battle of the forms” that happens when merchants buy and sell goods with pre-printed forms. Frequently buyers use pre-printed forms to place an order that are then acknowledged by the seller on its own pre-printed forms. These forms typically contain language favorable to the party sending it and rarely agree.
Section 2-207 still requires the parties to intend to create a contract. If the differing forms show that the parties never reached an agreement, then no contract exists.
However, if the acceptance contains an additional term, then a contract is usually formed. An additional term is a proposed contract term that addresses issues not included in the offer. Additional terms expand the offer to cover more essential terms to ensure a meeting of the minds.
If both parties are merchants, the additional terms usually become part of the contract unless:
1. The offer states that it cannot be accepted with additional or different terms;
2. The additional terms materially alter the offer; or
3. The party making the offer promptly rejects the additional terms.
A different term is a proposed contract term that contradicts the term(s) in the offer. Under the UCC, different terms cancel each other out. In most states, different terms are replaced by UCC gap-filler provisions. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/11%3A_Sales_Contracts/11.03%3A_Sales_Contract_Formation.txt |
A seller is expected to deliver what the buyer ordered. Conforming goods meet contractual specifications and satisfy performance requirements. Non-conforming goods are goods that fail to meet contractual specifications, allowing the buyer to reject the goods or to revoke acceptance.
A buyer has the right to inspect the goods before paying or accepting them. A buyer may also reject non-conforming goods by notifying the seller within a reasonable time.
If a buyer rejects the goods, the seller has the right to cure, which is the right to deliver conforming goods before the contract deadline. The UCC also allows the right to cure after the contract deadline in some situations. If the seller delivers conforming goods, then it is entitled to full payment under the contract.
If the seller breaches the contract, the buyer is entitled to cover. Cover is obtaining reasonable substitute goods because another party failed to perform under a contract. If the seller obtains reasonable substitute goods, the seller is entitled to the difference between the contract price and its cover price, plus incidental and consequential damages, minus expenses saved.
If the buyer breaches the contract, the seller may refuse to deliver the goods. If a buyer refuses to accept or pay for goods without justification, the seller may resell them to another party. When the resale is commercially reasonable, the seller may recover the difference between the resale price and the contract price, plus incidental damages, minus expenses saved.
If the buyer has accepted the goods and refuses to pay, or if the goods are conforming but resale is impossible, the seller may sue the buyer for the contract price. This is common when the buyer orders goods with unique specifications.
11.05: Warranties
A warranty is a contractual assurance that goods will meet a certain standard. An express warranty is a guarantee, created by the words or actions of the seller, that goods will meet certain standards. Under the UCC, a seller may create an express warranty in three ways:
1. With an affirmation of a fact or a promise;
2. With a description of the goods; or
3. With a sample or model.
To constitute a warranty, the seller’s words or actions must be part of the basis of the bargain. For example, if a salesperson says that a car’s timing belt was just replaced and will not need to be replaced for another 100,000 miles, and the buyer relied on that statement when deciding to buy the car, then the salesperson’s statement becomes an express warranty.
An implied warranty is a guarantee created by the UCC and imposed on the seller of goods. There are two main implied warranties: merchantability and fitness for a particular purpose.
The implied warranty of merchantability is a warranty that the goods are fit for the ordinary purposes for which they are used. To disclaim this warranty, a merchant must use the term “merchantability.” The novel or unusual use of goods is not protected by this warranty. If a buyer uses goods for something other than their intended purpose, the warranty does not apply.
The implied warranty of fitness for a particular purpose is a warranty that the property is suitable for the buyer’s special purpose. For the warranty to apply, the seller must know what the buyer’s purpose is and the buyer must rely on the seller’s judgment that the goods meet the buyer’s needs.
11.06: Concluding Thoughts
The UCC is a national law that was proposed by legal experts and business leaders to address the need for consistent laws related to the sale of goods across state lines. The UCC also applies to secured transactions and negotiable instruments, which are areas beyond the scope of this book. For individuals and businesses who buy or sell goods with merchants, it is important to understand how the UCC fills in gaps with terms that are not expressly contained in a contract, as well as to understand applicable warranties. The flexibility of the UCC facilitates business by making commercial transactions more consistent and predictable. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/11%3A_Sales_Contracts/11.04%3A_Performance.txt |
12.1 Writing Contracts
LEARNING OBJECTIVES
1. Learn how to write valid contracts.
2. Understand strategies for drafting contracts.
Knowing how to write legally enforceable contracts that protect their interests is a vital skill for businesses. In fact, most contracts are not written by attorneys. Individuals and businesses write contracts without legal help because they are trying to save time, money, and tension with others. However, hiring an attorney to write or review a contract to protect personal or business interests is sometimes necessary and worthwhile.
There are no magic words that a contract must have to be enforceable. Some are short and informal, while others are long and formal. No one style, format, or approach will always serve the parties’ needs. The only legal requirement that contracts must have are the elements of a contract: offer, acceptance, and consideration. This chapter offers some guidelines for business people to consider when writing their own contracts.
Counselor’s CornerIt has been said that a poorly drafted contract will work if everyone gets the benefit of their bargain. This may be true, but it does not excuse sloppy drafting. Address all essential matters, clearly, succinctly, and at once. Non-essential terms, inconsistent use of defined terms, and repetition create fertile ground for disputes. You cannot control how the other party will perform. However, you put yourself in the best position possible by ensuring that the intent, obligations and rights of all parties are stated clearly and unambiguously. ~Kathy K., attorney
12.2 Structure of Contracts
Written contracts can be organized in many different ways. However, having a structure can help keep information organized, clear, and easy to find. The best contracts have clear headings that accurately describe what is contained in that section. Using emphasis, such as bold and underlining, work better than italics alone for capturing the reader’s eye.
In general, contracts often contain a structure like this:
1. Title
2. Introduction of Parties and Purpose
3. Definitions of Material Terms
4. Covenants and Promises of Performance
5. Conditions
6. Breach and Its Consequences
7. Representations and Warranties
8. Standard (often called “Boilerplate”) Provisions
• Procedure to Modify Contract
• Rights of Assignment and Delegation
• Alternative Dispute Resolution
• Choice of Law and Forum
• Integration
• Severability
• Exculpatory Clause
• Force Majeure
• Attorney Fees
9. Signature Block
Not all contracts will contain all these elements and provisions. The parties’ needs and the purpose of the contract drive the structure of the document.
Title
Contracts have a title, often in bold or CAPITAL letters, at the top of the page. Titles should be as descriptive as possible. “Contract” or “Agreement” are not useful because they require the reader to read through the contract to know what it is about. The best contracts capture the nature of the document in the title. For example, “Employment Agreement Between Jane Doe and Stanford University.”
Introduction of Parties and Purpose
The introduction should name the parties and describe the nature of the contract. If background information is useful in explaining the parties’ interests and objectives, then it should be included here.
Definitions of Material Terms
Most business contracts contain some definitions, unless the subject matter and parties are clear. Definitions are useful because it is an area readers can reference to ensure compliance with the contract. For example, did the seller provide the specific goods as defined by the contract?
Definitions are not necessary for every term, though. If not defined, legal terms are given their legal meaning. And ordinary words are given their common, ordinary meaning. Therefore, businesses should define the material terms of the transaction: goods, services, quantity, quality, price, etc. Definitions that are specific to the industry are also helpful to include.
Covenants and Promises of Performance
A covenant is a formal promise to perform. This is the section of the contract where the parties state exactly how they will perform the contract. Buyer will pay a specific amount for the goods or service. Seller will deliver a specific item at a particular location.
To ensure clarity, the best contracts use active verbs in this section. For example, “Buyer will pay Seller ten dollars.” It is clear who will be paying whom, and how much is owed. Passive voice injects ambiguity, which can be problematic. For example, “Seller shall be paid ten dollars.” Will Buyer pay Seller the money or will someone else tender payment? If payment is not made, is Buyer in breach of contract?
Conditions
As discussed in Chapter 10, conditions are things that must occur before performance is due. Usually conditions must be expressly stated in a contract to be legally enforceable. The best contracts identify any conditions and delineate a timeline for when performance is due after the condition is met. For example, if an inspection of a property is a condition precedent of purchasing it, how long after the inspection is completed must the buyer perform?
Breach and Its Consequences
To constitute a violation of the contract, a breach must be material. A material breach is a substantial breach of contract that excuses aggrieved parties from further performance and affords them the right to sue for damages.
In contracts that require performance over a period of time, or payments in installments, it is helpful to define what constitutes a material breach. This clarifies when the non-breaching party can seek a remedy. The best contracts anticipate reasons for breach and identify consequences for them.
Acceleration Clause
An acceleration clause makes all future payments due immediately under the contract. Acceleration clauses often exists in contracts where periodic payments occur. For example, a contract to purchase a vehicle may require payment of all remaining money owed under the contract if the buyer misses a monthly payment. This allows the business that sold the vehicle or the bank that issued the loan to sue for breach of contract once, rather than filing a new lawsuit for each month.
Liquidated Damages
A liquidated damages clause allows parties to determine the amount of damages in the event of a material breach. Agreeing to the value of the contract before any breach occurs often saves time and money should the case be litigated. To be enforceable, the liquidated damages must apply to all parties equally, and be based on the value of the contract rather than act as a penalty.
Representations and Warranties
Representations are statements of fact made to induce someone to enter into a contract. Common representations by businesses include:
• They are properly licensed;
• They are insured;
• Their financial statements are accurate;
• They own all relevant assets;
• They have legal authority to enter into contracts.
Warranties in a contract are express promises that guarantee something in furtherance of the contract by one of the parties. For example, a seller warrants that the object being sold is as represented or promised.
Warranties differ from representations in four ways:
1. A warranty is an essential part of a contract, while a representation is usually only a collateral inducement;
2. A warranty is written in a contract; while a representation may be written or oral;
3. A warranty is conclusively presumed to be material, while a representation must be proven to be material by the party claiming breach; and
4. A warranty must be strictly complied with, while a representation must be substantially true.
Please note that express contract warranties are different from implied warranties under the Uniform Commercial Code (UCC). A party may disavow implied warranties under the UCC through a written contract.
Modification
Often with contracts that require an extended period for performance, modification becomes a concern. What happens if prices or deadlines need to be altered? Does that require a new contract or can the existing contract be modified? Good contracts often include a procedure for how to modify a contract. This may be as informal as writing changes directly on the original contract with the parties’ initials and date. Or it could be through a formal addendum procedure.
Regardless of the chosen procedure, it is a best practice for businesses to discuss modification procedures when entering into a contract. If the procedure is clear, less friction occurs when a party seeks modification.
Assignment and Delegation
In general, parties are free to assign and delegate their rights and duties under a contract. Parties can limit those rights or they can request notice if an assignment or delegation occurs. This is a provision that is often not needed unless a party has a concern about assignment, such as in the insurance industry.
Alternative Dispute Resolution
As discussed in Chapter 4, many businesses want to reduce their risk of litigation by participating in alternative dispute resolution (ADR). Mandatory arbitration clauses are common in consumer and employment contracts. Before including an ADR provision in a contract, parties should be fully comfortable with the option that they choose. If a party agrees to mediation or arbitration, a court will enforce that choice even if the parties change their mind.
Choice of Law and Forum
Choice of law provisions determine which state’s laws will be used to interpret the contract. Choice of forum provisions determine the state in which any litigation will take place.
This provision is often unnecessary for contracts involving individuals and entities in the same state. If the parties do not select that state law or location for litigation, the courts look to:
1. Where the contract was signed;
2. Where the contract is performed;
3. Where the parties are residents; and
4. The court’s jurisdictional rules.
Integration
An integration clause is a provision stating that the contract represents the parties’ complete and final agreement and supersedes all informal understandings and oral agreements relating to the subject matter of the contract. In other words, it is the agreement.
The purpose of an integration clause is to prevent the parties from later claiming that they agreed to additional or different terms than what the contract states. This means that any statements made before the parties signed the contract are not part of the contract and they will not be used to interpret the meaning of the contract.
Severability
A severability clause is a provision that keeps the remaining provisions of a contract in force if any portion of the contract is declared unenforceable by the court. It is also known as a savings clause because it “saves” the whole contract from being declared unenforceable.
For example, if a non-compete clause in an employment contract is declared unenforceable by a court, then the rest of the employment contract remains in effect.
Exculpatory Clause
An exculpatory clause is a provision relieving a party from any liability resulting from a negligent or wrongful act. They are often employed when the risk of injury exists. Exculpatory clauses cannot limit liability when a party acts with gross negligence, commits an intentional tort, or when public policy or state laws prohibit them. Exculpatory clauses have been struck down by courts in some cases where parties to a contract have greatly unequal bargaining power, especially when the party with greater power acts unethically or with gross negligence.
Force Majeure
A force majeure clause is a provision allocating risk to a certain party if performance becomes impossible as a result of an event that the parties could not have anticipated or controlled. Force majeure events are big, disruptive events such as natural disasters, war, terrorist attacks, and fires.
For example, if the subject matter of an international sales contract is destroyed by a hurricane, does the buyer or seller lose the money in the sale?
Attorney Fees
Business contracts often have an attorney fees clause that entitles a party successful in litigation over the contract to be reimbursed its attorney fees. This clause often has the effect of limiting frivolous lawsuits because it becomes more expensive for parties to litigate weaker claims. It may also give leverage to a winning party to prevent or end appeals of a court judgment.
Courts will usually enforce an attorney fees provision in a contract. However, courts review attorney fee awards for reasonableness. Therefore, the amount of fees usually must be deemed reasonable by a court or arbitrator before a party can collect under a contract.
12.3 Common Mistakes
Four of the most common mistakes when writing a contract are not understanding the content, vagueness, ambiguity, and typographical errors.
Not Understanding the Content
One common mistake is using free online resources without ensuring that they are appropriate for the circumstances. Just because it sounds official, a document generated by a computer algorithm may not be helpful. Better to read the contract and ensure that it accurately reflects the parties’ agreement.
Courts presume that parties have read a contract before signing it. Any mistakes in drafting go against the party who wrote the contract. In other words, if the contract is unclear, the party who did not write it gets the benefit of the doubt. The idea is that the party who wrote it should have done a better job, and the party who read and signed it should not be penalized as a result of someone else’s error. When writing a contract, better to keep it simple and clear.
It is also important to exclude provisions that are irrelevant to the contract. Contracts that are too long and contain irrelevant and contradictory terms are hard to understand. The best contracts are used as a reference between the parties during the period of performance. If a contract is too broad, too confusing, or contains too much irrelevant information, it hinders the effectiveness of the document.
Vagueness
In the context of contracts, vagueness means the language is imprecise, uncertain, and not clearly expressed. Vagueness is problematic because it could mean that the parties did not have a meeting of the minds because they were not talking about the same things.
Some business people think that keeping the contract “general” will facilitate a business transaction and that the details can be worked out later. However, if the parties are not in agreement up front, it is uncommon that things will work out smoothly later.
Another risk with vagueness is that it is not clear how a court will interpret the contract. If there are two or more reasonable interpretations, it is possible that the court will decide another interpretation is more reasonable. Again, mistakes in drafting are held against the drafter so if a court concludes that the vague term was a mistake, then it is hard to win in litigation.
Ambiguity
In contracts, ambiguity means an uncertainty of meaning or intention. Ambiguities can be either patent or latent. A patent ambiguity is where the language of the contract itself creates uncertainty because it is contradictory. For example, a contract states two different sale prices.
A latent ambiguity exists where the uncertainty arises during the performance of the contract. For example, the contract states that goods will ship via a carrier that has a common name and could be referring to different carriers.
Typographical Errors
Typographical errors are common in contracts. Some are harmless, some are embarrassing, and others are harmful. Although some typos are easy to ignore because they do not carry legal consequences, some can be fatal to the agreement.
Minor errors are called scrivener’s errors. The scrivener’s error doctrine permits typographical errors in a written contract to be corrected when clear and convincing evidence exists that the mistake does not reflect the intent of the parties.
However, errors related to dates, price, quantity, legal names of individuals and entities, and property descriptions (such as addresses and lot numbers) may not qualify as scrivener’s errors. Such errors may be fatal to the contract or may be enforced with adverse consequences against one of the parties.
12.4 Tips for Writing a Contract
Regardless of the purpose of the contract, some tips for writing good contracts include:
Naming the Parties
Be sure to use the correct name of the business entity or individual who is a party to the contract. This may seem obvious, but people often write the name of a representative of the entity rather than the legal name of the entity.
For sole proprietorships, it is appropriate to identify the party as Ling Chen doing business as Chen Bookkeeping. If the business is a Limited Liability Company (LLC), identifying an individual in the contract by name may remove any personal liability protection that a LLC provides. Similar issues may arise with a partnership if each individual is identified as a party to the contract.
Except for sole proprietors who do not have a separate business name, use the business entity’s name and not a personal name as a party to the contract. Otherwise, parties may lose the benefit of limited liability. There may also be tax consequences.
Define the Scope of the Work
Clearly define the scope of work or service being provided, and the proposed timeline to complete the work. Be specific. For example, instead of a broad “renovate the kitchen,” provide details of the cabinet designs, counter tops, and other materials and work to be provided.
If applicable, a time frame for each phase of the project is useful, along with procedures to follow if there are delays. This is especially helpful when delays occur as a result of a supply shortage or a third party. Breach of contract may not always be the fault of the parties. Having procedures in place in the case of delay often saves business relationships when things go wrong.
Specify Time and Amounts of Payments
Entering an hourly rate and projected time for completion, or the total amount of payment for a project, may be insufficient. Depending on the nature of the goods or services, the contract should include:
• Who is paying whom;
• How much is being paid;
• The method of payment (such as check, cashier’s check or bank transfer);
• Any portion of fees to be paid upfront;
• Any fees to be paid at project milestones;
• Payment for work completed if contract is canceled;
• Any late fees; and
• Hourly/per diem rate for time due to delays caused by the other party.
Termination Clause
Few contracts go on forever, so including an end date for the agreement or procedures for a party to cancel the contract are helpful. For example, parties often want to end the agreement if the other party fails to pay or misses too many important deadlines.
Termination procedures should be as specific as possible and include how much notice needs to be given, the type of notice required, and whether there is a time period where the other party may cure the deficiency.
Termination clauses should anticipate termination by all parties and address the parties’ rights based on which party requests termination and why.
Sign and Date the Contract
The signature block should name the business entity, then under the signature, the name and title of the person signing.
Figure 12.1 Signature Block Example
For example, Ahmad’s Construction, LLC By: __________ Khalid Ahmad, President
Each person signing the contract should date it next to his or her signature.
For partnerships, only general partners can sign a contract on the partnership’s behalf. For corporations, the president or chief executive officer is presumed to have authority to sign. For an organization or association, a board president would have authority, but it may require a vote of the governing board to approve the contract.
Minor Changes
Minor changes can be made directly to the contract. Both parties need to initial and date beside the changes to show that both parties agree to the change.
This is common when people buy property and the amount held in escrow changes (usually based on interest accrued) from the time the contract was prepared to the time it was signed.
Legal Terms
Courts interpret legal terms to have their legal meaning, regardless of the parties’ intent. Avoid using legal terminology unless all parties fully understand the legal definition and how it will be applied by the court. Again, simple and clear language is more effective than confusing legal jargon.
Allow for Flexibility
Contracts are usually the result of negotiation and the majority of them never end up in court. Contracts cannot cover every possible future situation but serve as a working document for the parties’ business relationship. When writing contracts, it is best to think of them as an agreement between parties that need some flexibility for the transaction(s) to take place. Life is dynamic and the best contracts give structure without being too rigid.
12.5 Concluding Thoughts
Writing valid contracts is an essential skill to be successful in business. Most contracts are not written by attorneys but they are critical to capturing an agreement between parties. Successful business people see contracts not just as a way to protect their interests, but also as a document that governs their business relationships with others. A well-written contract can be used throughout a transaction to guide the parties in their interactions and responsibilities. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/12%3A_Writing_Contracts.txt |
13.1 Introduction
LEARNING OBJECTIVES
1. Understand the principle of employment at will and the exceptions to the doctrine.
2. Learn important employment laws that affect businesses across industries.
3. Examine the laws that govern the relationship between employers and employees who belong to a union.
Until the early Twentieth Century, there were not many laws that regulated the employer-employee relationship. The belief was that the free market system would ensure that employers treat employees fairly or else they would not be able to attract and keep good workers. However, the reality of the Industrial Revolution proved that the traditional employment relationship favored the interests of the employers at the expense of workers, including children. As a result, Congress and state legislatures started passing employment and labor laws to protect the interests of employees. Today, employment law is a very robust area of the law that impacts businesses across industries.
Counselor’s Corner As working remotely is the norm now for many employees who formerly went in to work each day, debates have arisen regarding where employees are more productive—at home or back at the office? According to data gathered by various sources, most workers are more productive at home, including both those who enjoy and prefer this arrangement, and those who’d rather be in the office. According to data gathered by RescueTime, remote workers had a 4% increase in average daily time spent on their core work and an 18% decrease in time spent on communication, compared with employees in the office. Translated, working from home for many means spending more time on meaningful work and less time on communication, all without the commute. The latest Census data indicates that the average commute for Americans is 27 minutes each way, so almost an hour a day roundtrip. These data raise interesting questions about what the workplace will look like when it is safe for most workers to return to the office. ~Denise K., attorney
13.2 Employment At Will
In general, employees are free to quit a job at any time for any reason, with or without notice. Similarly, employers are free to end a worker’s employment at any time for any reason, with or without notice. This principle is called employment at will. This doctrine is based on the concept that employment is a form of an implied contractual relationship. Therefore, as long as both parties want to continue their contract to work together, the law presumes they will. When one party does not want to continue, then they may end their working relationship.
There are five major exceptions to the employment at will doctrine:
1. Contract;
2. Good cause;
3. Discrimination against an employee based on membership in a protected class;
4. Violation of public policy; and
5. Whistleblowing.
Figure 13.1 Exceptions to the Employment at Will Doctrine
Contract
Employers and employees may modify the employment at will doctrine through contract. In addition to formal, written employment contracts, courts have also enforced oral promises made during the hiring process. Promises made to job applicants are generally enforceable, even when the promises are not approved by the employer’s executives or upper management. Therefore, it is important when hiring employees that companies do not make promises that can be reasonably interpreted to be guaranteed employment or employment for a certain period of time.
Employee handbooks also may create implied contracts that modify the employment at will doctrine. Often handbooks state that the company follows a progressive discipline policy and that employees may only be fired for “just cause” or after receiving warnings, notice, hearing, or other procedures. Policies such as this create an implied contract that require businesses to follow the progressive discipline policy before terminating a worker’s employment, in absence of good cause.
Good Cause
The definition of “good cause” for terminating the employment of a worker varies from state to state. And businesses often define “good cause” in their policies. However, most states recognize the following as good cause to fire an employee without going through progressive discipline first:
• Theft;
• Fraud;
• Damage to company property;
• Being under the influence of illegal drugs or alcohol at work;
• Fighting;
• Threats against other employees or customers;
• Domestic violence;
• Having weapons on premises;
• Unethical behavior; and
• Willful or malicious misbehavior.
Poor performance also constitutes good cause for firing an employee. Employers need to be careful, however, to document the performance issues and to engage in progressive discipline when appropriate. If an employee has not been counseled that their performance is unsatisfactory, then the employee is more likely to bring a charge of wrongful discharge against the employer. Courts are more likely to rule that poor performance constitutes good cause when an employee has notice of the performance issue(s) and has a reasonable opportunity to fix them.
Discrimination Against a Protected Class Member
Anti-discrimination laws make it illegal to take adverse actions against a member of a protected class based on their membership in the class. A protected class is a group of people who are protected by laws that prohibit discrimination based on a personal characteristic, such as race, color, religion, gender, national origin, age or disability.
As discussed in Chapter 14, adverse actions include failure to hire, failure to promote, demotion, and termination of employment. That is not to say that someone who is a member of a protected class may never be fired. Rather, it is illegal to fire them because of their race, color, religion, gender, national origin, age or disability.
Violation of Public Policy
The public policy exception occurs when an employee is fired for:
• Refusing to perform an action that violates a law or public policy; or
• For exercising a legal right or advancing a public policy.
In other words, an employee can’t be fired for refusing to do something illegal or doing something legal that the employer does not want done. For example, an employee cannot be fired for not falsifying reports, for refusing to testify falsely in court, for filing a workers’ compensation claim, or for serving on a jury.
Whistleblowing
A whistleblower is an employee who reports the employer’s illegal behavior to a governmental or law enforcement agency. Many different laws have whistleblower provisions that encourage people who have knowledge of illegal activity to report it without fear of retribution or losing their jobs. Whistleblower protections apply to good faith reports of wrongdoing, even if it turns out that the activity is not illegal. However, whistleblower protection does not usually protect employees who make reports that they either know, or should have known, do not include illegal activity.
13.3 Common Employment Law Torts
Employees may assert various tort claims against their employers. Tort claims are often decided on the basis of generalized duties of care rather than specific types of conduct prohibited by law. Tort claims vary state to state but most states recognize the following claims between employers and employees:
• Negligent hiring, retention, and supervision;
• Negligent investigation;
• Negligent infliction of emotional distress;
• Intentional infliction of emotional distress (also called outrageous conduct);
• Tortious interference with contract and/or prospective business advantage;
• Defamation (libel and slander);
• Invasion of privacy; and
• Fraud.
Torts are discussed in more detail in Chapter 9. However, it is important for businesses to understand that they owe their employees and managers a duty of care. If they violate that duty, then they may be subject to legal liability.
13.4 Wage and Hour Laws
The Fair Labor Standards Act (FLSA) is a federal law that was passed in 1938 that nationalized standards for pay, record keeping and child labor for businesses with two or more employees that engage in interstate commerce. The FLSA prohibits “oppressive child labor,” which means that children under fourteen cannot work unless it is a family business, babysitting, newspaper delivery, entertainment, or agriculture. Fourteen and fifteen year olds are permitted to work limited hours after school in nonhazardous jobs, such as retail and restaurants. Sixteen and seventeen year olds may work unlimited hours in nonhazardous jobs.
Figure 13.2 FLSA Facts
The FLSA also provides for a national minimum wage and a standard forty hour work week. Under the FLSA, an employee who works more than forty hours is entitled to overtime pay. However, the Act provides exemptions to the overtime requirement. Employees who earn more than a certain amount and perform specific types of work are not entitled to overtime pay.
Exempt Categories to Overtime Pay under the FLSA
• Figure 13.3 Overtime under the FLSA
The Department of Labor (DOL) is charged with enforcing the FLSA and other federal wage and hour laws. As a general rule, federal wage and hour laws do not preempt state and local laws. Therefore, employers must comply with federal, state, and local laws regarding employees’ wages. Many state and local governments have set a higher minimum wage than is required federally. Therefore, businesses must ensure that they comply with all wage and hour laws applicable to them.
13.5 Family Medical Leave Act
The Family Medical Leave Act of 1993 (FMLA) is a federal law that guarantees employees up to twelve weeks of unpaid leave each year for childbirth, adoption, or a serious health condition of their own or their immediate family member. Under the FMLA, a qualifying family member is a spouse, child, or parent. Siblings, grandchildren, and in-laws are not usually qualifying family members. The FMLA applies to businesses with at least fifty workers that engage in interstate commerce.
Figure 13.4 FMLA
An employee must work for the company for at least one year before being eligible to take leave under the FMLA. The Act requires that employees who take leave be allowed to return to the same or equivalent job with the same pay and benefits.
What constitutes a “serious health condition” is a heavily litigated issue. In general, a serious health condition requires continued treatment by a health provider and results in at least three days of incapacitation. Sometimes this aligns with recognized disabilities but it does not always. Also, a condition such as migraines may incapacitate people to varying degrees. To avoid legal liability, businesses should request appropriate documentation from medical providers rather than relying on a subjective determination of what constitutes serious health conditions.
13.6 Occupational Safety and Health Act
In a heavily industrialized society, workplace safety is a major concern. To that end, Congress passed the Occupational Safety and Health Act (OSHA) in 1970. The Act requires employers to provide a workplace that is free from recognized hazards likely to cause death or serious physical harm to employees.
Employers must comply with specific health and safety standards for their industry. For example, standards for restaurants differ from standards for health care providers or those for the mining industry. Employers must also keep records of all workplace injuries and accidents, and under some circumstances must automatically report them to the government. Employees may also report violations.
The Occupational Safety and Health Administration (also known as OSHA) is an agency within the Department of Labor that is responsible for enforcing the Act. The Agency may inspect workplaces to ensure they are safe and impose fines for violations of the Act. The Act also provides for criminal penalties when the violations are willful.
Figure 13.5 Common OSHA Violations
States and local governments also have a variety of health and safety laws and regulations. Therefore, businesses must ensure that they comply with all laws applicable to them.
13.7 Employee Retirement Income Security Act
In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) to regulate employer-sponsored pension plans. ERISA requires employers disclose a large amount of information regarding the funding and vesting of pension plans. This Act was in response to fraudulent handling of pension plans that deprived employees of savings at the time of their retirement.
ERISA also applies to employer-sponsored medical, disability, and welfare benefit programs. Although the Act does not require employers to provide these types of benefits to their employees, if employers choose to do so, ERISA regulates what types of information employees are entitled to, along with their enforcement rights under the plans.
Figure 13.6 ERISA Areas of Regulation
13.8 Workers’ Compensation Laws
Workers’ compensation laws provide payment to employees for injuries incurred at work. In essence, workers’ compensation is a type of no-fault insurance system that every state has. The intent of these laws is to provide quick and efficient delivery of disability and medical benefits to injured workers at a reasonable cost to employers.
Figure 13.7 Workers’ Compensation
Workers’ compensation is the exclusive remedy for injury claims. In other words, if an employee makes a workers’ compensation claim, he or she may not sue the employer for his or her injury. The amounts provided for medical expenses and lost wages are often lower than an employee may receive in a successful lawsuit. However, the employee benefits from receiving payment upfront and does not have to risk the uncertain outcome of a lawsuit or pay attorney fees associated with litigation.
There are two exceptions to the exclusive remedy doctrine:
1. Intentional actions resulting in harm; and
2. Product liability claims against a manufacturer of a defective product.
State law varies with respect to types of workers who are excluded from coverage, as well as types and amount of compensation. All states cover medical costs, rehabilitation costs, and lost wages and benefits as a result of the injury.
In general, an employee may recover workers’ compensation benefits when:
1. The employer has complied with the state’s legal requirements;
2. The employee was acting in the course of his or her employment when injured;
3. The injury was proximately caused by his or her employment (i.e. the injury was not caused by off work activities); and
4. The employee did not intentionally injure himself or herself.
An employer may not retaliate against an employee who files a workers’ compensation claim.
13.9 Unemployment Compensation
Every state provides an unemployment compensation insurance program that is funded by a tax paid by employers. To draw from the program, an employee must:
• Have worked for the employer for a certain amount of time;
• Not have quit without good cause;
• Not have been fired for egregious behavior;
• Be capable of work; and
• Actively look for a new job.
Unemployment compensation is meant to help workers who are subject to lay offs and reductions in force while they look for new employment. It is generally not available to employees who voluntarily leave a job and want to continue receiving income from their former employer.
States have different formulas for calculating unemployment compensation, but in general benefits are a percentage of past earnings and are available for a limited period of time.
13.10 Labor Relations
Labor law affects the working relationship of employees who are represented by a union in their workplace. A union is an organization formed to negotiate with employers, on behalf of workers collectively, about job-related issues such as salary, benefits, hours, and working conditions. Labor law essentially creates a framework for employers, employees, and unions to create a contract unique to that business for the purpose of regulating the employment relationship and resolving disputes.
National Labor Relations Act
The first unions in the United States were formed after the Civil War and began to flourish during the Industrial Revolution. In 1935, Congress enacted the National Labor Relations Act (NLRA) to provide workers three important rights:
1. The right to organize;
2. The right to collectively bargain; and
3. The right to strike.
The NLRA also prohibits employers and unions from engaging in unfair labor practices. Unfair labor practices by employers include:
• Interfering with protected employee rights, such as the right to self-organize;
• Discriminating against employees for union-related activities;
• Retaliating against employees who invoke their labor rights;
• Refusing to engage in collective bargaining;
• Interfering with the administration of a union; and
• Discouraging employees from forming or joining a union.
Unfair labor practices by unions include:
• Causing an employer to discriminate against an employee who is not a union member;
• Engaging in an illegal strike or boycott;
• Requiring an employer to hire more employees than necessary (called featherbedding);
• Coordinating a secondary boycott (an action against a third party who deals with the employer but has no direct contact with the union);
• Refusing to engage in collective bargaining; and
• Charging excessive dues.
Most states also have laws that make it illegal for an employer to mandate union membership as a condition of employment.
The NLRA also states that supervisors are not employees and do not have a right to join a union. Supervisors are individuals with the authority to make independent decisions on hiring, firing, disciplining, or promoting other employees.
Under the NLRA, a validly recognized union is the exclusive representative of the employees. This means that the union represents all the employees, even if a particular worker is not a member of the union or has not paid dues. The employer may not bargain directly either with employees or with another organization representing the employees.
Unions have a duty of fair representation, which requires unions to treat all members fairly, impartially, and in good faith. A union may not favor some members over others and may not discriminate against members based on their membership in a protected class, such as race or gender.
Organizing a Union
A union trying to represent employees follows these steps:
1. Campaign Union organizers try to persuade employees to form a union. An employer may not restrict organizing discussions unless they interfere with business operations. An employer may present anti-union views but may not use threats or rewards to defeat a union drive.
2. Authorization Cards Union organizers ask employees to sign authorization cards stating that they want the union to represent them.
3. Petition If a union obtains authorization cards from 30% of the workforce, it may petition the NLRB for an election.
4. Election If more than 50% of the employees vote for the union, the NLRB designates it as the exclusive representative of the employees.
Figure 13.8 Process of Union Organizing
Collective Bargaining
Once a union is formed, the employer and union must negotiate to create a new employment contract that regulates employment conditions called a collective bargaining agreement (CBA). The bargaining unit is a group of employees authorized to engage in collective bargaining on behalf of all of the employees of a company or an industry sector.
The NLRA allows the parties to bargain almost any subject they wish but it requires them to bargain wages, hours, and other terms and conditions of employment. Conditions of employment include:
• Benefits;
• Retirement benefits;
• Order of layoffs and recalls;
• Production quotas;
• Work rules, such as safety practices; and
• Onsite food service and prices.
The parties are not required to reach an agreement but they are required to bargain in good faith. In other words, they must meet with open minds and make a reasonable effort to reach a contract.
Concerted Activity
Concerted activity is an action by employees concerning wages or working conditions. It is action taken by members of a union to gain a bargaining advantage. Concerted activity is protected by the NLRA and cannot be used as a basis for disciplining or discharging an employee.
The most common forms of concerted activity are strikes and picketing. A strike is an organized cessation or slowdown of work by employees to compel the employer to meet the employees’ demands. The NLRA protects the employees’ right to strike when:
• The parties are unable to reach a CBA;
• The employer engages in an unfair labor practice; or
• The employer is considering sending work elsewhere.
However, a strike is illegal when:
• The union does not provide the employer with sixty days notice (when issue is modifying or terminating a CBA);
• The union represents public employees;
• The union engages in a sit-down strike, in which employees stop working but physically block replacement workers from taking their places; and
• The union engages in partial strikes, in which employees strike intermittently to disrupt operations but prevent the employer from hiring replacement workers.
When unions go on strike, employers have the right to hire replacement workers to keep the business operating. If the union engages in an economic strike to obtain increased wages and benefits, the employer may hire permanent replacement workers. When an economic strike ends, the employer is under no obligation to lay off replacement workers to allow strikers to return to work. However, if and when the employer hires additional employees, it may not discriminate against the employees who went on strike. If the union engages in an unfair labor practices strike to protest an employer’s unfair labor practice, union members are entitled to their jobs after the strike ends.
Picketing is the demonstration by one or more employees outside a business to protest its activities or policies and to pressure it to meet the protesters’ demands. The power of picketing is to publicize a labor dispute and influence the public to withhold business from the employer. Picketing is usually lawful, as long as the picketers do not prevent other employees, replacement workers, or customers from entering the business.
Employers have their own form of legal pressure on union members called a lockout. A lockout occurs when an employer closes a business or prevents workers from entering the premises and earning their paychecks because of a labor dispute. By withholding work and wages, the employer tries to pressure the union to bargain less aggressively. Most lockouts are legal.
Grievance Procedure
One of the main benefits to union members is that they are able to participate in a grievance procedure when issues at work exist. A grievance is a formal employee complaint about a violation of a workplace policy or the collective bargaining agreement between the union and employer.
Figure 13.9 Grievance Procedure
The grievance procedure defines the rules and process for documenting, presenting, and resolving workplace disputes. The exact steps are usually defined in the collective bargaining agreement. However, most grievance procedures start with a discussion between the employee and his or her manager, often with a union representative present. Issues often are resolved informally at this step.
If the issue is not resolved, then the employee may write a formal grievance, which is then sent to management. After receiving a written grievance, management of the company investigates and discusses how to address the issues contained in the grievance. This process often involves the human resource department, union representatives, and consultation with legal counsel.
Management will then issue a written decision. If the union is not satisfied with the company’s response, it may decide to refer the grievance to the national union. If the national union decides to pursue the issue further, then arbitration before the NLRB or a private arbitrator often occurs.
13.11 Concluding Thoughts
Employment and labor laws regulate the employer-employee relationship. Although most laws are written to provide rights to employees, the laws try to balance the need of employers to run a profitable business with the right of employees to fair treatment. While the law does not always strike the right balance, it is helpful to understand that employers retain a lot of control in their day-to-day business operations and in establishing the business culture. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/13%3A_Employment_Law.txt |
14.1 Introduction
LEARNING OBJECTIVES
1. Understand the primary federal anti-discrimination laws.
2. Learn the procedure for bringing and defending against discrimination complaints.
3. Explore how businesses can protect themselves from discrimination claims.
The Civil Rights Movement of the 1960s resulted in several important federal laws that addressed discrimination. The first was the Equal Pay Act of 1963, which requires equal pay for equal work, regardless of the worker’s gender. Title VII of the Civil Rights Act of 1964 is probably the most well-known of the civil rights legislation. Title VII prohibits employment discrimination on the basis of race, color, religion, gender and national origin. Since the 1960s, more laws have been passed to refine what constitutes discriminatory practices and expand coverage to additional groups, such as people with disabilities.
Figure 14.1 Participants in the 1963 March on Washington
It is important for businesses to know and comply with these laws so they are not liable for discriminating against their employees, customers, and members of the public. State and local governments may pass laws that expand or provide protections to additional groups but they cannot reduce protections found in federal law.
Type of Discrimination Federal Anti-Discrimination Laws
Race Title VII of the Civil Rights Act of 1964
Color Title VII of the Civil Rights Act of 1964
Religion Title VII of the Civil Rights Act of 1964
National Origin Title VII of the Civil Rights Act of 1964;
Immigration Reform and Control Act of 1986
Gender Equal Pay Act of 1963;
Title VII of the Civil Rights Act of 1964;
Pregnancy Discrimination Act of 1978
Age Age Discrimination in Employment Act of 1967
Disability Americans with Disabilities Act of 1990;
Americans with Disabilities Amendments Act of 2008
Genetic Information Genetic Information Nondiscrimination Act of 2008
Counselor’s Corner We live in a multicultural society and our anti-discrimination laws are intended to address inequality in employment. While not perfect, they have addressed the some of the most blatant discriminatory practices. However, all employers (even those who see themselves as having “good intentions”) need to review their practices to ensure that they are not perpetuating systemic discrimination against protected classes of people. Although this may seem like a backburner issue to some employers, it will help protect them from legal liability (which is costly) and send a positive message to their employees about how they value them (which is invaluable). ~ LaTeesha S., attorney
14.2 The Equal Pay Act of 1963
The Equal Pay Act of 1963 seeks to eliminate the wage gap between men and women. In 1963, women earned roughly fifty-nine cents for every dollar men earned. In 2019, that number increased to seventy-nine cents. The Equal Pay Act requires employers to provide equal pay for equal work, and it applies to all employers. All forms of compensation are covered by the Act, including benefits such as vacation and compensation such as salary and bonuses.
Figure 14.2 Median Weekly Earnings by Gender and Educational Level from US Department of Labor
Victims do not need to file a complaint with the Equal Employment Opportunity Commission (EEOC) but may file an equal pay claim in federal court, as long as they do so within two years after learning of the inequality in pay or benefits. Victims typically also pursue Title VII claims at the same time they pursue Equal Pay Act claims.
The Equal Pay Act is difficult to enforce. Since demanding identical pay is virtually impossible due to differences in jobs and job performance, courts have essentially interpreted the law as requiring equal pay for substantially equal work. A common problem occurs when women voluntarily leave the workforce to raise children. This can result in a challenging comparison between a woman’s experience for pay purposes and her male counterparts, who may not have an interruption in their careers.
Figure 14.3 Participation Rates for Women Professionals from Equal Employment Opportunity Commission
14.3 Title VII of the Civil Rights Act of 1964
The Civil Rights Act of 1964 has broad significance for all racial minorities, religious organizations, and women. The bill has several provisions, but the most important for businesses is known widely as “Title VII.” It applies to employers with more than fifteen employees. Its aim is to eliminate discrimination on the basis of:
• Race;
• Color;
• Religion;
• Gender; and
• National origin.
Discrimination on any of these bases is illegal. These acts may be a refusal to hire, a failure to fully compensate, a failure for opportunities for advancement, a demotion, a temporary layoff, a termination of employment, or any other term or condition of employment.
Figure 14.4 Employment Discrimination Claims Made to the Equal Employment Opportunity Commission
Race and Color
Race discrimination involves treating someone unfavorably because he or she is of a certain race or because of personal characteristics associated with race, such as hair texture, skin color, or certain facial features. Color discrimination involves treating someone unfavorably because of skin color or complexion.
Race and color discrimination also can involve treating someone unfavorably because the person is married to, or associated with, a person of a certain race or color. Race and color discrimination can occur within the same racial group.
Figure 14.5 Participation Rates for African Americans Professionals from Equal Employment Opportunity Commission
Religion
The prohibition against religious discrimination protects anyone who has sincerely held religious or moral beliefs. Therefore, Native American tribes are protected, as well as major religions such as Buddhism, Christianity, Hinduism, Islam, and Judaism. In general, employees cannot be required to participate in religious activities as a condition of employment, unless the place of employment is a church, synagogue, mosque, or temple.
Employers must reasonably accommodate an employee’s religious beliefs or practices as long as it does not cause an undue hardship on the employer’s operation of its business. Typically, this involves being flexible in schedule changes and leaves for sabbath observance or religious holidays. Issues of dress and appearance are often grounds for charges of religious discrimination. For example, if a Muslim woman wears a hijab, or traditional headscarf, then she should be permitted to do so unless it places an undue hardship on business operations.
Gender
The prohibition on gender discrimination means that employers cannot categorize certain jobs as single-sex only unless a bona fide occupational qualification (BFOQ) applies. Customer preferences or market realities are not the basis for BFOQ. However, an example of a legitimate BFOQ is hiring female security officers to monitor women’s changing areas for loss prevention in retail stores.
Gender discrimination also includes making stereotypical assumptions about women simply because they might be the primary caregiver to children at home. If there are two equally qualified job applicants, for example, and both have young children at home, it would be illegal to give preference to the male candidate over the female candidate. Once a female employee has children, it would be illegal to assume that she is less committed to her job, or would like to work fewer hours. It’s important to note that these protections extend to men as well. If an employer voluntarily provides time off to new mothers, for example, it must extend identical benefits to new fathers.
Figure 14.6 Pew Research Center Results Regarding Gender Discrimination at Work
In 2019, unmarried childless women earned 95 percent of what men did, while married mothers earned 75 percent (averaging to 79 percent as discussed above). This discrepancy has led to an increase in family responsibility discrimination claims under Title VII. This includes claims that mothers are given less-appealing assignments than fathers based on misconceptions about being less qualified or lacking commitment to the job.
The Pregnancy Discrimination Act of 1978 amended Title VII to make it illegal to discriminate on the basis of pregnancy, childbirth, or related medical conditions. This means employers cannot refuse to hire a woman because she is pregnant or is considering becoming pregnant, or because of prejudices held by coworkers or customers about pregnant women. A female worker who becomes pregnant is entitled to work as long as she can perform her tasks, and her job must be held open for her while she is on maternity leave. Furthermore, pregnancy-related benefits cannot be limited only to married employees.
Gender discrimination can also take the form of workplace sexual harassment. Courts have generally recognized two forms of sexual harassment. The first, known as quid pro quo, involves asking for sexual favors in return for job opportunities or advancement. Courts reason that if a male worker asks a female worker for sex in return for favorable treatment, it is because that worker is female, and therefore a Title VII violation has occurred. If a supervisor fires a subordinate for breaking up with him or her, then quid pro quo harassment has taken place. The second is hostile work environment, which is discussed in more detail below.
National Origin
Discrimination on the basis of national origin involves treating workers unfavorably because of where they are from (specific nation or region) or ethnicity. It is illegal to discriminate against a worker because of his or her foreign accent unless it seriously interferes with work performance. Workplace “English-only” rules are also illegal unless they are required for the job being performed.
The protected class of national origin means that it is illegal to discriminate against noncitizens. Therefore, employers should not ask job applicants about their nation of origin. Instead, they are permitted to ask whether the applicant is authorized to work in the US. If they applicant answers “yes,” then the employer cannot ask for evidence of authorization until the applicant is hired and completes the Employment Eligibility Verification (I-9) Form.
Title VII creates only five protected classes. Other characteristics, such as obesity, attractiveness, and political affiliation, are not protected classes. Note too that Title VII does not prohibit all discrimination. Employers are free to consider factors such as experience, business acumen, personality, and even seniority, as long as those factors are related to the job in question. Title VII requires employers to treat employees equally, but not identically.
Prohibited Activities
There are four types of illegal activities under Title VII:
1. Disparate Treatment;
2. Disparate Impact;
3. Hostile Work Environment; and
4. Retaliation.
To prove a disparate treatment case, a plaintiff must show that he or she was treated differently because of his or her race, color, religion, gender or national origin. In other words, disparate treatment is intentional discrimination. Winning a disparate treatment case is hard because it is unusual for a defendant to say explicitly that his or her intention is discriminatory. Evidence of discriminatory intent is often inferred through someone’s conduct. For example, a hiring manager refuses to hire women because he does not want to deal with maternity leave requests would be evidence of disparate treatment.
Disparate impact, on the other hand, applies when a rule or policy is not discriminatory on its face but negatively impacts a protected group when it is applied. In other words, disparate impact is unintentional discrimination. Business policies that raise suspicions of disparate impact include educational qualifications, written tests, intelligence or aptitude tests, height and weight requirements, credit checks, and subjective procedures such as interviews. Businesses that have these sorts of policies need to be very careful that the policies are directly related to, and necessary for, the job function under consideration.
Figure 14.7 Disparate Impact Cartoon
Proving a disparate impact case is not easy for victims of discrimination. It is not enough for the employee to use statistics alone to show a policy or practice has a disparate impact on the victim’s protected class. Victims must show that they were harmed from the discriminatory practice.
Employers also violate Title VII if they have a hostile work environment towards people in a protected category that affects their ability to work. These cases often involve allegations where a company or employees try to get a member of a protected group to quit through name calling, undesirable work assignments, slurs, and threats. Employers are liable for hostile work environment claims if the victim suffered a “tangible employment action” such as a demotion, undesirable reassignment, or termination of employment. Even if the victim did not suffer a tangible employment action, an employer may be liable unless it can prove (1) it used reasonable care to prevent and correct the inappropriate behavior, and (2) the victim unreasonably failed to take advantage of the company’s complaint procedures.
Hostile work environment claims often involve allegations of constructive discharge. Constructive discharge occurs when an employer makes the employee’s working conditions so intolerable that a reasonable employee would feel compelled to quit. Constructive discharge claims recognize that employees should not be forced to stay in situations that risk their physical, mental, and emotional safety.
Title VII also prohibits acts of retaliation against anyone who complains about, or participates in, any employment discrimination complaint. Employers need to be very careful about this provision, because while the employer may be innocent of the first charge of discrimination, taking any subsequent action after an employee has complained can be a separate charge of discrimination. Once an employee has made a complaint of discrimination, it is very important that the employer not alter any condition of his or her employment until the complaint has been resolved. Similarly, if a witness takes part in an investigation or hearing of another employee’s complaint, the witness could also bring charges of retaliation.
Bona Fide Occupational Qualification
The law does, however, allow discrimination on the basis of religion, gender, and national origin if a bona fide occupational qualification (BFOQ) reasonably necessary for normal business operations exists. For example, a Jewish synagogue may restrict hiring of rabbis to Jewish people only, and a Catholic church can restrict hiring priests to Catholic men only. Since BFOQ discrimination extends to national origin, a producer casting for a role that specifically calls for a Filipino actor can legally restrict hiring to Filipinos only.
Managers should be very careful in applying BFOQ discrimination. It is an exception that is very much based on individual cases and subject to strict interpretation. The BFOQ must be directly related to an essential job function to be “bona fide.” Customer preference is not a basis for BFOQ. For example, airlines cannot refuse to hire men even if surveys show customers prefer female flight attendants.
14.4 Enforcement of Title VII
Equal Employment Opportunity Commission
The Civil Rights Act of 1964 is a federal law, but it does not give victims of discrimination the immediate right to file a federal lawsuit. Instead, the Act created a federal agency, the Equal Employment Opportunity Commission (EEOC) to enforce civil rights in the workplace. The EEOC publishes guidelines to assist businesses in deciding what employment practices are lawful. The EEOC also investigates complaints filed by workers who believe they are victims of unlawful discrimination. If the EEOC believes that unlawful discrimination has taken place, the EEOC can file charges against the employer.
Employees must file a Title VII charge with the EEOC before going to court. If the EEOC investigates and decides not to pursue the case any further, the EEOC will issue a “right to sue” letter. With that letter, the employee can then file a case in federal court within 90 days of the date of the letter. Any EEOC complaint must be filed within 180 days of the alleged discriminatory act taking place. If employees wait beyond 180 days, their claims will be dismissed.
In 2009, the Lilly Ledbetter Fair Pay Act clarified that discriminatory pay decisions occur every time unequal compensation is paid and the statute of limitations begins again on the date of each unequal paycheck. Therefore, plaintiffs have 180 days from the time they receive a discriminatory paycheck to file a complaint with the EEOC.
The EEOC has the authority to award several remedies to victims of discrimination. These include the award of back pay for any lost wages, the issuance of an injunction to stop the employer from continuing any acts or policies of discrimination, ordering a terminated or demoted employee reinstated to his or her prior position, and the award of compensatory damages for out-of-pocket costs resulting from the discrimination as well as emotional harm. In cases of severe or reckless discrimination, punitive damages are also available.
EEOC Procedure
After receiving the charge, the EEOC will investigate the allegations. If there is sufficient proof of discrimination, the EEOC may (1) help the parties reach a settlement; (2) impose sanctions; or (3) prosecute the case in federal court. The EEOC’s investigative and enforcement powers are broad.
When filing a complaint, the plaintiff must show a prima facie case of discrimination. This means that “on first look,” the plaintiff has evidence that the defendant discriminated against him or her based on membership in a protected class. The plaintiff is not required to prove discrimination at this stage. Instead, the plaintiff must show only a presumption that discrimination occurred.
The defendant then files a response and may present evidence that its decision was based on a legitimate, non-discriminatory reason or business necessity. For example, an employee was fired for poor performance rather than membership in a protected class.
After the defendant presents its case, the plaintiff must show that the defendant’s reason is pretext. In other words, the reason the defendant gave was a “cover” for discrimination. In disparate impact cases, the plaintiff may show that less discriminatory rules would achieve the same result.
The case is investigated and decided by the EEOC hearing officer. The officer will issue either a finding on the charge or a notice of the right to sue, after which an employee has 180 days to file a discrimination complaint in federal court.
Figure 14.8 Burden of Proof in Equal Employment Opportunity Commission Charges
Affirmative Action
To correct past mistakes in treatment of women and minorities, many businesses go beyond being equal opportunity employers by adopting affirmative action programs. Businesses are not legally required to undertake affirmative action programs, but many do. Businesses may voluntarily undertake affirmative action programs, as long as those programs are meant to correct an imbalance in the workforce, are temporary, and do not unnecessarily infringe on the rights of non-beneficiaries.
Affirmative action plans can be tricky to administer because Caucasian Americans can also be the victims of race discrimination, which is often called reverse discrimination. The provisions of Title VII are meant to protect all individuals from race discrimination.
The EEOC will take into consideration if a defendant’s actions are part of an affirmative action program. However, businesses may still be liable for discrimination even if they adopt an affirmative action program. Therefore, businesses should be careful that they are not adopting a program that results in disparate impact claims from other protected groups.
14.5 The Age Discrimination in Employment Act of 1967
The Age Discrimination in Employment Act of 1967 (ADEA) makes it illegal to discriminate against workers over the age of forty. It does not protect younger workers so an employer may favor an older worker over a younger worker. The ADEA applies to any employer with over twenty workers, including state governments. The ADEA prohibits employers from treating any covered person unfavorably in any term or condition of employment, including the hiring decision. It is illegal, for example, to hire an inexperienced twenty-five-year-old for a job when a fifty-year-old is better qualified and willing to work under the same conditions. Mandatory retirement age is illegal under the ADEA, except for very high-level executives over the age of sixty-five who are entitled to a pension.
Employers may discriminate against older workers if there is a bona fide occupational qualification such as a production company casting for a young actor to play a young character, or airlines setting a mandatory retirement age for pilots.
Of course, older workers can still be dismissed for good cause, such as poor job performance or employee misconduct. Companies may also administer a layoff plan or early retirement plan that is evenly applied across all workers, and can offer early retirement incentives to induce workers to retire.
In 2005, the Supreme Court held that the disparate impact theory can apply to age discrimination cases. For example, an employer cannot require office workers to undertake strenuous physical tests if those tests are not related to the job being performed and would have a disparate impact on older workers.
14.6 The Americans with Disabilities Act of 1990
The Americans with Disabilities Act of 1990 (ADA) and the Americans with Disabilities Amendments Act of 2008 (ADAA) expand the promise of equal opportunity in the workplace to cover persons with disabilities. It is illegal for employers with fifteen or more employees to discriminate against “qualified individuals with disabilities.”
The ADA only applies to the qualified disabled. To be qualified, the individual must meet the legitimate skill, experience, education, or other requirements for the position he or she is seeking and be able to perform the “essential functions” of the job without reasonable accommodation. In other words, the first step an employer must take is to define what the essential functions of the job are, and then see if a disabled individual who has applied for the job meets the requirements for the job and can perform those essential functions. Obviously, someone who is legally blind will not be permitted to be a bus driver or airline pilot under this test.
On the other hand, the “essential functions” test means that employers must be very careful in denying employment to someone who is disabled. If the reason for denying employment is the disabled person’s inability to perform some incidental task (rather than an essential function), then that is illegal discrimination. The ADA also permits employers to exclude any disabled individual who poses a direct threat to the health or safety to the individual or of others, if the risk of substantial harm cannot be reduced below the level of “direct threat” through reasonable accommodation.
The ADA makes it illegal for an employer to require a job applicant take a medical exam before an employment offer is made. However, after a job offer has been made, applicants can be asked to take medical and drug exams. Tests for illegal use of drugs, any time during employment, are permitted under the ADA.
One of the hardest challenges is defining who is disabled. The ADA states that an individual is disabled if he or she has a “physical or mental impairment that substantially limits one or more major life activities,” has a record of such impairment, or is regarded as having such an impairment. Major life activities include seeing, hearing, speaking, walking, running, breathing, learning, and caring for oneself.
Consider a person being actively treated for cancer. During the treatment, many major life activities may be substantially limited, so the person is disabled. However, if a major life activity is not limited but the person loses his or her hair as a result of chemotherapy, he or she may be “regarded” as having an impairment, which makes him or her disabled under the ADA. An employer who purposefully refuses to hire a qualified job applicant with no hair because the employer believes the applicant has cancer (regardless of whether the cancer is active or in remission) is therefore violating the ADA. Finally, if the cancer patient recovers fully and has no physical sign of cancer, that patient is still considered protected by the ADA because he has a “record” of a qualifying disability.
Employers must provide reasonable accommodations to any disabled worker who asks for it. A reasonable accommodation is any change or adjustment to the work environment that would allow the disabled worker to perform the essential functions of the job or to allow the disabled worker to enjoy the benefits and privileges of employment equal to employees without disabilities. Reasonable accommodation might include allowing the worker to work part-time; reassigning the worker to a vacant position; purchasing special equipment or software; providing e-readers; or making an exception to an employment policy. Employers do not have to undertake reasonable accommodation if doing so would cause them undue hardship, meaning it would require significant difficulty or expense, or significantly alter the nature or operation of the business. Among factors to be considered in whether an accommodation would pose an undue hardship are the cost of the accommodation as well as the employer’s size and financial resources.
Figure 14.9 Americans with Disability Act Decision Tree
14.7 Genetic Information Nondiscrimination Act of 2008
In 2008, Congress passed the Genetic Information Nondiscrimination Act (GINA) to protect individuals from adverse decisions based on their genetics. Under GINA, employers may not require genetic testing, or use information about genetics (including family medical history) as a factor in hiring, promoting, demoting, or firing employees. This includes if an employee is a caretaker for someone with a genetic disorder. Health insurers cannot use genetic information when making coverage and premium decisions. Finally, an employer wellness program cannot require participants to answer questions about their family medical history.
14.8 Concluding Thoughts
Anti-discrimination laws are important for businesses to understand and follow. State and local laws may expand protections and identify more protected classes. Therefore, it is important for businesses to research all levels of anti-discrimination laws that apply to them to ensure they are not liable for discrimination against their employees, customers, and members of the public.
The 1964 Civil Rights Act is an important law that affects most employers in the United States. Originally created to ensure the integration of African Americans into mainstream society, the law prohibits discrimination on the basis of race, color, religion, gender, and national origin. Some forms of discrimination on the basis of religion, gender, or national origin are permitted if a bona fide occupational qualification exists. The Equal Employment Opportunity Commission (EEOC) investigates charges of illegal workplace discrimination. These charges must be filed by workers within 180 days of the alleged discriminatory act occuring.
The EEOC’s investigation and enforcement powers are broad. Both parties have an opportunity to present evidence and argue their case to the EEOC. Filing a charge with the EEOC is required before filing a lawsuit alleging violations of Title VII in federal court.
The Americans with Disabilities Act prohibits employment discrimination against the qualified disabled and prohibits pre-employment medical testing. To be considered disabled, an individual must demonstrate a mental or physical impairment that substantially limits a major life activity. Disabled persons are entitled to reasonable accommodation in the workplace, as long as reasonable accommodation does not place any undue hardship on the employer. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/14%3A_Anti-Discrimination_Law.txt |
Learning Objectives
• Know the basic principles of an agency relationship.
• Identify the different duties principals and agents owe each other.
• Understand the consequences of legal liability for principals regarding an agent’s actions.
15: Agency
Fundamentally, the principles of agency hold individuals and businesses liable for the acts of others. For example, if an employee uses a racial slur against a customer, the business is liable for that employee’s discriminatory act. Likewise, if an agent signs a contract in the name of a business, that business may be bound by the terms of the contract.
Agents cannot give themselves power without the express or implied authority of the principal. Once an agency relationship is formed, agents and principals owe each other certain duties. This ensures fair dealings between them and gives third parties some assurance regarding their rights.
Counselor’s Corner Agency is not a sexy area of the law. Most people don’t give much thought about it. But I often see cases in my courtroom where people and businesses are liable for the acts of their agents. It doesn’t matter if you didn’t know the person was legally your agent. You are still responsible for their actions under the law. While there is no way to prevent all mistakes and bad behavior of others, the best way you can insulate yourself from liability of an agent is to surround yourself with people who have integrity. If your grandmother wouldn’t approve of them, then you shouldn’t work with them. ~Christopher W., judge
15.02: The Agency Relationship
An agency relationship is created when one person or entity agrees to perform a task for, and under the direction of, another individual or entity. An agent is the person who is authorized to act for or in place of another. A principal is the person who authorizes another to act on his, her, or its behalf as an agent.
Agency is a fiduciary relationship created by express contract or implied actions, in which the agent has the authority to act on behalf of the principal and legally bind the principal to third parties.
A fiduciary relationship is a relationship in which one person is under a duty to act for the benefit of the other on matters within the scope of the relationship. Fiduciary relationships require trust, good faith, and acting in the best interest of the other. In fiduciary relationships, the law requires the fiduciary to act with the highest duty of care. This means that the fiduciary must put the interests of the other party before their own. Examples of fiduciary relationships include doctor-patient, attorney-client, accountant-client, trustee-beneficiary, and guardian-child. An agent is also a fiduciary of a principal.
Types of Principals
There are three types of principals, which are described from the perspective of a third party: disclosed, partially disclosed, and undisclosed.
A disclosed principal is a principal whose identity is revealed by the agent to a third party. These are the most common types of principals. For example, employees work for a disclosed principal when they are on the employer’s premise, wear a name badge or uniform identifying the employer, or answer the phone by identifying the employer’s name.
A partially disclosed principal is a principal whose existence, but not actual identity, is revealed by the agent to a third party. In other words, a third party knows that the agent represents a principal but does not know the identity of the principal. For example, a realtor in Aspen may represent celebrities and wealthy individuals who want to purchase property but do not want the paparazzi to publicize the information.
An undisclosed principal is a principal whose identity is kept secret by the agent. Often third parties do not realize that an agency relationship exists and believe that the agent is working on his or her own behalf. Undisclosed principals occur when the identity of the principal can lead to increased purchase prices, unwanted publicity, and security concerns.
Types of Agents
An agent is someone who is authorized to act on behalf of a principal. Because there is a variety of authority that a principal can grant an agent, there are many different types of agents. In general, agents are described as either general or special. General agents have the authority to transact all the principal’s business of a particular kind or in a particular place. General agents often include partners, managers, factors and brokers. Special agents, in contrast, only have the authority to conduct a particular transaction or to perform a specific act. Special agents often include realtors, athlete’s agents, and employment recruiters.
Some of the most common business agents include:
Agent Description
Broker Receives a commission to make contracts with third parties on behalf of a principal
Business agent Has general power involving the exercise of judgment and discretion, such as a manager or officer
Factor Receives and sells goods or property for a commission
Forwarding agent Receives and ships goods for a principal
Independent contractor Exercises independent judgment on the means used to accomplish the result demanded by principal
Local agent Acts as a representative to transact business within a specified area
Ordinary agent Acts under the direction and control of the principal, such as an employee
Process agent Authorized to accept legal service of process on behalf of the principal
Registered agent Authorized to accept legal service of process for a corporation in a particular jurisdiction
Types of Authority
Authority is the right or permission to act legally on another’s behalf. In general, authority can be either actual or apparent. Actual authority, sometimes called real authority, occurs when a principal intentionally confers authority on an agent. Actual authority can be either express or implied. Express authority is authority given by an express agreement, either orally or in writing. Implied authority is authority granted to the agent as a result of the principal’s conduct.
Figure 15.1 Types of Authority
Apparent authority is authority that a third party reasonably believes an agent has, based on the third party’s dealings with the principal. If a principal’s words or actions lead others to believe that he or she gave authority to someone else, then the principal is held accountable even if no authority was actually given to the agent. For example, if a principal fails to give notice that an agent is no longer working for the principal, the agent may still bind the principal through apparent authority when dealing with third parties.
To constitute apparent authority, three elements must be met:
1. The principal’s words or actions lead others to believe the agent has authority;
2. A third party reasonably relies on the principal’s words or actions; and
3. The third party is injured.
Sometimes an agent acts without authority. If a disclosed principal likes what an agent does, even if done without authority at the time, the principal can still benefit from the agent’s actions. Ratification occurs when a disclosed principal adopts or confirms a contract entered into on his or her behalf by an agent who did not have authority to act. Unlike apparent authority, the third party does not have to be injured. Rather, ratification allows principals to enter into contracts for their benefit. Ratification is an “all or nothing” doctrine that prevents principals from ratifying only part of the contract or renegotiating its terms. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/15%3A_Agency/15.01%3A_Introduction.txt |
Because they are in a fiduciary relationship, agents and principals owe each other specific duties. While the duties are similar in nature, there are differences based on their roles.
Duties of Agents
Figure 15.2 Duties of Agents
Agents are fiduciaries of principals and so they are required to act with the highest duty of care. In particular, agents owe principals the following duties:
Duty Description
Account Agent must keep proper records to account for all principal’s money and property given to agent
Care Agent must act reasonably, in good faith, and avoid negligence at all times
Inform Agent must inform principal of all material facts that affect principal’s interests
Loyalty Agent cannot engage in any dealings that compete or interfere with the principal’s business or interests
Obedience Agent must obey all principal’s instructions within scope of agency unless they are illegal or unethical
Protect confidential information Agent cannot use or disclose principal’s confidential information
If an agent breaches a duty owed to the principal, the principal has three available remedies:
1. The principal may recover damages the breach has caused;
2. The principal may receive any profit the agent received as a result of a breach of the duty of loyalty; and
3. The principal may rescind a transaction when the duty of loyalty is violated.
Duties of Principals
Principals also owe duties to agents as part of the fiduciary relationship. These duties are:
Duty Description
Compensation Principal must pay agent for work performed
Honesty Principals cannot deceive agents about the nature and scope of the work they are to perform
Indemnification Principal must hold agent harmless and free from legal liability for actions properly taken on principal’s behalf
Loyalty Principal cannot engage in any dealings that prevent agent from performing agency tasks
Reimbursement Principal must reimburse agent for money reasonably expended on behalf of principal
Figure 15.3 Duties of Principals
If a principal breaches a duty owed to the agent, the agent has two available remedies:
1. The agent may recover damages the breach has caused; and
2. The agent may terminate the agency relationship.
15.04: Liability to Third Parties
An agency relationship affects liability to third parties. The scope of liability depends on the type of principal involved, the type of authority involved, and the nature of the dispute.
Contractual Liability
A principal is always liable on a contract if the the agent had authority. However, the agent’s liability on a contract depends on how much the third party knows about the principal. Disclosure, when allowed by the principal, is the agent’s best protection against legal liability.
Figure 15.4 When Agents are Liable on Contracts
An agent is not liable for any contracts he or she makes with authority on behalf of a fully disclosed principal. Therefore, if a third party knows the existence and identity of the principal, then all legal liability lies with the principal. The only exception to this is when an agent exceeds his or her authority. In that case, the agent has not acted with authority and becomes personally responsible to the third party. If the agent did not have authority, but the principal later ratifies the contract, then the principal will be liable for the contract.
If a principal is partially disclosed, then the third party may recover from either the principal or agent. In this situation, the principal and agent are jointly and severally liable, and the third party may sue either or both of them to recover the full amount of damages owed. However, the third party cannot seek “double damages” and recover more than the total amount owed for the contractual breach.
In the event of an undisclosed principal, a third party may recover from either the agent or the principal. The fact that a principal’s existence or identity is hidden from third parties does not change the nature of the agent-principal relationship. Therefore, undisclosed principals may become liable for contracts entered into by agents acting with actual authority. An undisclosed principal has no liability to an agent or third party when the agent exceeds the actual authority granted by the principal. In addition, the type of contract must be the type that can be assigned to the undisclosed principal. If the contract is for personal services, then liability cannot be assigned to the principal in case of a breach.
Tort Liability
Agents, employees, and independent contractors are personally liable for their own torts. This concept is rooted in the notion that every individual who commits a tort is personally liable to the party who is damaged by the tortious act. The law holds wrongdoers personally accountable.
However, the reverse is not true. Agents, employees, and independent contractors are not liable for the torts of the principal or employer. If a principal or employer is engaged in tortious behavior, its liability cannot be passed down to its agents and employees.
Figure 15.5 When Principals Have Tort Liability for Employees and Independent Contractors
An employer is liable for the torts of an employee if the employee is acting within the scope of employment. This doctrine is called respondeat superior and imposes vicarious liability on employers as a matter of public policy. Even if the employer does not direct its employees to act negligently or intentionally, the employer is responsible because employers are usually in a better position to pay for damages than employees. There is also a strong public policy consideration to not allow employers to turn a blind eye to an employee’s bad behavior. By making an employer responsible for an employee’s actions, it incentivizes the employer to address situations promptly that could lead to potential liability.
Conversely, a principal is not usually liable for the torts of an independent contractor. Independent contractors have the power to control the details of the work they perform and generally are only responsible to a principal for the results of their work. Therefore, independent contractors are not directed and controlled by a principal as employees are by their employers. As a result, the doctrine of respondeat superior does not apply to independent contractors.
Two exceptions exist that may impose liability on a principal for the work of an independent contractor. The first exception is where the work is inherently dangerous. Public policy prevents principals from insulating themselves from the risks of liability by selecting an independent contractor rather than an employee to perform the dangerous work. The second exception is where the work is illegal. Public policy also prevents principals from hiring independent contractors to perform a task that is illegal.
15.05: Termination of Agency Relationship
Agents and principals may end their agency relationship in various ways. The most common way is through mutual agreement. As a matter of contract, principals and agents may decide to end their relationship. For example, an employee may decide to quit his or her job, or the agency agreement may only be for a set period of time or for a specific transaction.
In addition, there are some events that will terminate an agency relationship as a matter of law. Death of a principal or agent automatically terminates the agency agreement, even if the other party is unaware of the death. Once the time of death is established, any transactions afterward are deemed void.
Similar to death, mental incapacity of a principal or agent terminates an agency relationship. It is often hard to determine the precise time someone loses mental capacity. Therefore, courts often hold that an agent’s contract with a third party is binding on the principal unless the third party was aware of the principal’s incapacity.
Bankruptcy terminates an agency relationship when the bankruptcy affects the subject matter of the agency agreement. For example, if a principal declares bankruptcy and the real property that an agent is authorized to sell is part of the bankruptcy estate, then the bankruptcy will automatically terminate the agency relationship.
Finally, the destruction or illegality of the subject matter will terminate the agency relationship. For example, if Congress passes a law making it illegal for private parties to sell specific types of weapons, the agency relationship between a gun dealer and its factor for selling those weapons will automatically end.
15.06: Concluding Thoughts
Agency relationships are flexible and varied depending on the needs and interest of the principals and agents. Because the agency relationship is fiduciary in nature, agents and principals owe each other certain duties. Third parties may hold principals legally liable for the actions of their agents. Therefore, it is important for businesses to select their agents carefully to minimize their risk of liability. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/15%3A_Agency/15.03%3A_Duties_of_Agents_and_Principals.txt |
Learning Objectives
• Know the available entity choices when forming a business.
• Identify the factors that determine entity selection.
• Understand common business entities and their advantages and disadvantages.
16: Business Organizations
At its most fundamental level, a business exists to make a profit for its owners. Some businesses make things in factories (manufacturers), other businesses sell things that other businesses make (retailers), and still other businesses exist to help both the makers and sellers make and sell better (business consultants). Some businesses don’t make things at all, and instead profit by selling their services or by lending money.
With this diversity, it’s not surprising that there is no “one size fits all” approach to choosing a business organization. When choosing what form of entity is best, several factors are important to consider:
1. How much it costs to create the entity and how hard it is to create.
2. How easy it is for the business to continue if the founder dies or retires.
3. How difficult it is to raise money to grow or expand the business.
4. What type of managerial control they wish to keep on the business, and whether they are willing to cede control to outsiders.
5. If expanding ownership to members of the public is desired.
6. How to minimize the taxes paid on earnings and income.
7. How to protect personal assets from claims, a feature known as limited liability.
Depending on the type of business and its goals, different business entities may be appropriate.
Counselor’s Corner Selection of business entities is often the first step when going into business. Many entrepreneurs and small businesses do not spend enough time thinking about the legal and tax consequences of the entity they choose. Ironically, an important discussion to have at the beginning is an exit strategy. What happens if one of the business owners becomes ill, dies, or wants to leave the business? What if the economic situation changes and the business no longer is profitable? Discussing exit strategies up front helps people make the best decisions when crises happen. Don’t avoid hard conversations up front. It may be uncomfortable but will save a lot of problems down the road. ~Allison W., attorney
16.02: Sole Proprietorship
A sole proprietorship is an unincorporated business owned by one person or married couple. The legal name for a sole proprietorship is usually the owner’s name.
There are many advantages to doing business as a sole proprietor. First, it’s easy to create a sole proprietorship. In effect, no creation costs or time is required because there is nothing to create. The entrepreneur in charge of the business simply starts doing business, charging money, and providing goods or services.
Another key advantage to sole proprietorship is autonomy. The owner can decide how he or she wants to run the business. The owner can set her own hours, grow as quickly or slowly as she wants, and expand into new lines of businesses. That autonomy also comes with total ownership of the business’s finances. All the money that the owner takes in, even if it is in a separate bank account, belongs to her, and she can do with that money whatever she wants.
A sole proprietorship is a flow-through tax entity, which means the business does not pay tax on its profits and does not file a separate tax return. Instead, the owner pays personal income tax on all business profits.
These advantages must be weighed against some disadvantages. First, because a sole proprietorship can have only one owner, it is impossible to bring in others to the business. In addition, the business and the owner are identical so it is impossible to pass on the business.
Raising working capital can be a problem for sole proprietors, especially those early in their business ventures. Many entrepreneurial ventures are built on great ideas but need capital to flourish and develop. If the entrepreneur lacks individual wealth, then he or she must seek those funds from other sources. Outsiders can make a loan to the owner, or enter into a profit-sharing contract with her, but there is no way for him to own any part of the owner’s business. Traditionally, most sole proprietors seek funding from banks. Banks approach these loans just like any other personal loan to an individual, such as a car loan or mortgage. Down payment requirements may be high, and typically the banks require some form of personal collateral to guarantee the loan, even though the loan is to be used to grow the business.
Sole proprietors are personally liable for all the business’s debts and obligations. Unlimited liability puts all the personal assets of the sole proprietor at risk. Personal homes, automobiles, bank accounts and retirement accounts—all are within reach of creditors.
Advantages of Sole Proprietorship Disadvantages of Sole Proprietorship
• Easy to create
• No formal documents or governmental filings required to start business
• No formation start up costs
• Autonomy
• Total control over finances and management decisions
• Flow-through tax entity (owner pays personal income tax on all business profits)
• Cannot bring someone else into business
• Impossible to pass on the business
• Hard to raise capital
• Unlimited liability | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/16%3A_Business_Organizations/16.01%3A_Introduction.txt |
A partnership is an unincorporated association of two or more co-owners who operate a business for profit. Each owner is called a general partner.
General Partnerships
A general partnership is when all partners participate fully in running the business and share equally in profits and losses, even if the partners’ monetary contributions vary. No legal documents are required to file with the government to form a partnership. If two or more people do business together, sharing management of the business, profits and losses, they have a partnership.
If a partnership is formed formally, then the written agreement is called the articles of partnership. The articles can set forth anything the partners wish to include about how the partnership will be run. Normally, all general partners have an equal voice in management, but as a creation of contract, the partners can modify this if they wish.
A general partnership is taxed just like a sole proprietorship. A partnership is a flow-through tax entity, where the partnership’s income “flows through” the business to the partners, who then pay individual tax on the business income. The partnership may file an information return, reporting total income and losses for the partnership, and how those profits and losses are allocated among the general partners. However, an information return is usually not required.
General partnerships are also similar to sole proprietorships in unlimited liability. Every partner in the partnership is jointly and severally liable for the partnership’s debts and obligations. This is a very unattractive feature of general partnerships. One partner may be completely innocent of any wrongdoing and still be liable for another partner’s malpractice or bad acts.
General partnerships are dissolved as easily as they are formed. Since the central feature of a general partnership is an agreement to share profits and losses, once that agreement ends, the general partnership ends with it. In a general partnership with more than two persons, the remaining partners can reconstitute the partnership if they wish, without the old partner. A common issue that arises in this situation is how to value the withdrawing partner’s share of the business. Articles of partnership therefore typically include a buy/sell agreement, setting forth the agreement of the partners on how to account for a withdrawing partner’s share, which the remaining partners then agree to pay to the withdrawing partner.
Management Duties
Partners have a fiduciary duty to the partnership. This means that partners have a duty to act for the benefit of the partnership. In particular:
• Partners have an obligation of good faith and fair dealing with each other and the partnership.
• Partners are liable to the partnership for gross negligence or intentional misconduct. Partners are not liable for ordinary negligence.
• Partners cannot compete with the partnership.
• Partners cannot take opportunities away from the partnership unless the other partners consent.
• Partners cannot engage in conflicts of interest.
Limited Partnerships
In most states, owners can form a limited partnership. A limited partnership has both general partners and limited partners. As a limited partner, the most he or she can lose is the amount of his investment into the business, nothing more. Limited partnerships have to be formed in compliance with state law, and limited partners are generally prohibited from participating in day-to-day management of the business. This often occurs when someone invests money in the partnership but is not interested in running the business.
Advantages of Partnerships Disadvantages of Partnerships
• Easy to create
• No formal documents or governmental filings required to start business
• Flexibility in sharing management decisions
• Allows for investment by limited partners to raise capital
• Easy to dissolve
• Flow-through tax entity (owner pays personal income tax on all business profits)
• Unlimited liability
• May be hard to value individual partner’s share of business
• Dissolution occurs any time a new partner is added or old partner leaves | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/16%3A_Business_Organizations/16.03%3A_Partnerships.txt |
A franchise is when a business grants to another the sole right of engaging in a certain business or in a business using a particular trademark in a certain area. Franchises are not a separate form of business organization. Rather, they are a form of contract between businesses. Most franchises involve corporations or limited liability corporations, but they may include sole proprietorships and partnerships.
The advantage of a franchise is that under a franchise agreement, an entrepreneur can open and run a business under a proven business model. The local owner, the franchisee, uses the franchisor’s trademark, intellectual property, and business model under a license agreement. The franchisee offers goods or services to the public and keeps any income earned. In exchange for the right to sell goods or services developed by the franchisor, the franchisee pays a fee to the franchisor.
Franchises are common in some industries such as fast food restaurants, hotels, and tax preparation services. Franchise agreements are very detailed and often require the franchisee to use specific vendors, ingredients, store layouts, colors, etc.
Franchises are also very popular with US businesses interested in conducting business abroad. US businesses collect franchise fees from owners in other nations who are responsible for running the business abroad. This allows US companies to have a presence in nations that may restrict business ownership by foreigners because the businesses themselves are owned and operated by locals.
16.05: Joint Venture
A joint venture is when two or more individuals or businesses combine their efforts in a particular business enterprise and agree to share the profits and losses jointly or in proportion to their contributions. Unlike a partnership, which operates as a general business for as long as the partners desire, a joint venture is for a single transaction or a limited activity. The businesses remain separate entities and they do not share financial or confidential information unless they decide to. Joint ventures automatically terminate at the conclusion of an event or project.
Joint ventures are often formed to address a common need or to reach a mutual goal. For example, Google and National Aeronautics and Space Administration (NASA) developed Google Earth as a joint venture. To do so, they shared resources and information necessary to develop Google Earth but Google did not become part of the government, nor did NASA share any confidential information or intellectual property more than necessary.
Joint ventures are also common to share the costs of major research or infrastructure projects within an industry. This occurs frequently when industries are impacted by advances in technology. For example, BMW and Toyota created a joint venture to research hydrogen fuel cells, electric vehicles, and ultra-lightweight materials needed in next generation vehicles. By sharing the cost of research and development, the companies are able to be on the forefront of technological advancements in their industry.
Franchises Joint Ventures
• The right to use a trademark by paying a fee to the franchisor
• Contract isn’t separate from the business
• Franchise either offers a good or a service
• Mainly used in conducting business abroad
• Share a mutual goal/cost/losses
• Combines efforts in a single transaction or a limited activity
• Agreement becomes terminated at the end of the event or project
• Financial and confidential information is not shared | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/16%3A_Business_Organizations/16.04%3A_Franchises.txt |
Unlike a sole proprietorship or general partnership, a corporation is a legal entity separate and distinct from its owners. It can be created for a limited duration, or it can have a perpetual existence. Since it is a separate legal entity, a corporation has continuity regardless of its owners. Similarly, in a publicly traded company, the identity of shareholders can change, but the corporation continues its business operations without being affected.
Corporations must be formed in compliance with the law of the state law where they are incorporated. Most corporations incorporate where their principal place of business is located, but not all do. Many companies choose to incorporate in Delaware. Delaware chancery courts have developed a reputation for fairly and quickly applying a very well-developed body of corporate law in Delaware. The courts also operate without a jury, meaning that disputes heard in Delaware courts are usually predictable and transparent, with well-written opinions explaining how the judges decided the cases.
To start a corporation, the corporate founders must file articles of incorporation with the Secretary of State where they are incorporated. Articles of incorporation typically include:
• The name of the company;
• Whether the company is for-profit or nonprofit;
• The founders’ names;
• The company’s purpose;
• How many shares the corporation will issue initially; and
• The par value of any shares issued.
Unlike sole proprietorships, corporations can be quite complicated to manage and often require attorneys and accountants to maintain corporate books in good order. In addition to the foundation requirements, corporate law requires ongoing annual maintenance of corporations. In addition to filing fees due at the time of incorporation, there are typically annual license fees, franchise fees and taxes, and fees related to maintaining minute books, corporate seals, stock certificates and registries, as well as out-of-state registration. A domestic corporation is entitled to operate in its state of incorporation but must register as a foreign corporation to do business in other states.
Corporate Legal Structure
Owners of corporations are called shareholders. Corporations can have as few as one shareholder or as many as millions of shareholders, and those shareholders can hold as few as one share or as many as millions of shares. In a closely held corporation, the number of shareholders tends to be small, while in a publicly traded corporation, the body of shareholders tends to be large.
In a publicly traded corporation, the value of a share is determined by the laws of supply and demand, with various markets or exchanges providing trading space for buyers and sellers of certain shares to be traded. Shareholders own shares in the company but have no legal right to the company’s assets. As a separate legal entity, the corporation owns any property in its name.
Shareholders of a corporation enjoy limited liability. The most they can lose is the amount of their investment. Shareholders’ personal assets are not available to the corporation’s creditors.
Shareholders can be individuals or other business entities, such as partnerships or corporations. If one corporation owns all the stock of another corporation, the owner is said to be a parent company, while the company being owned is a wholly owned subsidiary. Often large corporations form subsidiaries for specific purposes so that the parent company has limited liability or advantageous tax treatment. For example, large companies may form subsidiaries to hold real property so that premises liability is limited to that real estate subsidiary only, shielding the parent company and its assets from lawsuits. Companies that deal in a lot of intellectual property may form subsidiaries to hold their intellectual property, which is then licensed back to the parent company so that the parent company can deduct royalty payments for those licenses from its taxes. This type of sophisticated liability and tax planning makes the corporate form very attractive for larger businesses in the United States.
An exception to the rule of limited liability arises in certain cases involving closely held corporations. Many sole proprietors incorporate their businesses to gain limited liability but fail to realize when they do so that they are creating a separate legal entity that must be respected as such. If sole proprietors fail to respect the legal corporation with an arm’s length transaction, then creditors can ask a court to pierce the corporate veil. If a court agrees, then limited liability disappears and those creditors can reach the shareholder’s personal assets.
Rights of Shareholders
Not all shareholders in a corporation are necessarily equal. US corporate law allows for the creation of different types, or classes, of shareholders. Shareholders in different classes may be given preferential treatment when it comes to corporate actions such as paying dividends or voting at shareholder meetings.
Shareholder rights are generally outlined in a company’s articles of incorporation or bylaws. Some of these rights may include the right to obtain a dividend, but only if the board of directors approves one. They also include the right to attend shareholder meetings, the right to examine the company’s financial records, and the right to a portion of liquidated company assets.
Under most state laws, shareholders are also given a unique right to sue a third party on behalf of the corporation. This is called a shareholder derivative lawsuit. In essence, a shareholder alleges that the people who are ordinarily charged with acting in the corporation’s best interests (the officers and directors) are failing to do so, and therefore the shareholder must step in to protect the corporation.
One of the most important functions for shareholders is to elect the board of directors of a corporation. Only shareholders elect a director. The board is responsible for making major decisions that affect a corporation, such as declaring and paying a corporate dividend to shareholders; authorizing major decisions; appointing and removing corporate officers; determining employee compensation, especially bonus and incentive plans; and issuing new shares and corporate bonds.
One critical function for boards of directors is to appoint corporate officers. These officers often hold titles such as chief executive officer, chief operating officer, chief marketing officer, and so on. Officers are involved in everyday decision making for the company and implement the board’s decisions. As officers of the company, they have legal authority to sign contracts on behalf of the corporation, binding the corporation to legal obligations. Officers are employees of the company and work full-time for the company, but can be removed by the board.
Corporate Taxation
Corporations are subject to double taxation. Because corporations are separate legal entities, they must pay federal, state, and local tax on net income. Then, if the board of directors declares a dividend, shareholders are taxed on the dividend that they receive in the form of a dividend tax.
One way for closely held corporations (such as small family-run businesses) to avoid double taxation is to form an S corporation. An S corporation (the name comes from the applicable subsection of the tax law) can choose to be taxed like a partnership or sole proprietorship. In other words, taxes are only collected when a dividend is declared and not on corporate net income. An S corporation is formed and treated just like any other corporation; the only difference is in tax treatment.
S corporations provide the limited liability feature of corporations but the single-level taxation benefits of sole proprietorships. There are some important restrictions on S corporations, however. They cannot have more than one hundred shareholders, all of whom must be US citizens or resident aliens and cannot include partnerships and corporations. S corporations can have only one class of stock and there are restrictions on how shares may be transferred. Finally, all shareholders must agree that the company should be an S corporation. These restrictions ensure that “S” tax treatment is reserved only for small businesses.
Advantages of Corporations Disadvantages of Corporations
• Separate legal entity from owners
• Corporation unaffected by change of ownership/shareholders
• Limited liability for shareholders
• Not subject to some laws
• Considered as an “individual” with Constitutional rights
• Formal documents required to filed in state of incorporation
• Can be complicated to manage
• High formation and maintenance costs
• Subject to double taxation
• Heavily regulated by government | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/16%3A_Business_Organizations/16.06%3A_Corporations.txt |
A limited liability company (LLC) is a “hybrid” form of business organization that offer the limited liability feature of corporations but the tax benefits of partnerships. Owners of LLCs are called members. Just like a sole proprietorship, it is possible to create an LLC with only one member. LLC members can be individuals or other LLCs, corporations, or partnerships. LLC members can participate in day-to-day management of the business.
Members are not personally liable for the debts of the business. Like shareholders of a corporation, members of an LLC risk only their financial investment in the company.
Taxation of LLCs is very flexible. Every year the LLC can choose how it will be taxed. It may want to be taxed as a corporation, for example, and pay corporate income tax on net income. Or it may choose instead to have income “flow through” the corporate form to the member-shareholders, who then pay personal income tax just as in a partnership. Sophisticated tax planning becomes possible with LLCs because tax treatment can vary by year.
Figure 16.1 LLC Taxation
LLCs are formed by filing the articles of organization with the state agency charged with chartering business entities, typically the Secretary of State. Starting an LLC is often easier than starting a corporation. Typical LLC statutes require only the name of the LLC and the contact information for the LLC’s legal agent. Unlike corporations, there is no requirement for an LLC to issue stock certificates, maintain annual filings, elect a board of directors, hold shareholder meetings, appoint officers, or engage in any regular maintenance of the entity. Most states require LLCs to have the letters “LLC” or words “Limited Liability Company” in the official business name.
Although the articles of organization are all that is necessary to start an LLC, it is advisable for the LLC members to enter into a written LLC operating agreement. The operating agreement typically sets forth how the business will be managed and operated. It may also contain a buy/sell agreement just like a partnership agreement. The operating agreement allows members to run their LLCs any way they wish.
Since LLCs are a separate legal entity from their members, members must take care to interact with LLCs at arm’s length, because the risk of piercing the veil exists with LLCs as much as it does with corporations. Fundraising for an LLC can be as difficult as it is for a sole proprietorship, especially in the early stages of an LLC’s business operations. Most lenders require LLC members to personally guarantee any loans the LLC may take out. Finally, LLCs are not the right form for taking a company public and selling stock. Fortunately, it is not difficult to convert an LLC into a corporation, so many start-up business begin as LLCs and eventually convert into corporations prior to their initial public offering (IPO).
Advantages of LLCs Disadvantages of LLCs
• Limited liability for owners
• Flow-through tax entity so not subject to double taxation
• Easier to form and operate than corporation or S corporation
• Owners can deduct losses for personal taxes
• Subject to state laws so lacks consistency in enforcement
• Laws not as developed as corporate law & partnership law
Limited Liability Partnerships
A related entity to the LLC is the limited liability partnership, or LLP. Be careful not to confuse limited liability partnerships with limited partnerships. LLPs are just like LLCs but are designed for professionals who do business as partners. They allow the partnership to pass through income for tax purposes, but retain limited liability for all partners. LLPs are especially popular with doctors, architects, accountants, and lawyers. Most of the major accounting firms have now converted their corporate forms into LLPs.
Professional Corporations
Professional Corporations (PCs) are mostly a legacy form of organization. In other words, before LLCs and LLPs were an option, PCs were the only option available to professionals who wanted limited liability. Some states still require doctors, lawyers, and accountants to organize as a PC.
If a member of a PC commits malpractice, the PC’s assets are at risk along with the personal assets of the member who committed malpractice. However, the personal assets of the non-involved members are not at risk. PCs do not shield individuals from their own malpractice but they offer limited liability to innocent members.
PCs are a separate taxable entity but they are not flow-through entities like partnerships. As a result, taxation of PCs is complicated and a major drawback of this form of business entity.
Type of Business Organization Ease of Formation Funding Personal Liability for Owners Taxes Ease of Transferring Ownership Perpetual Existence Dissolution
Sole Proprietorship Very easy Same as owner Yes Flow-through Must sell entire business No When & how owner decides
General Partnership Easy Partners contribute capital Yes Flow-through Hard No Upon death, bankruptcy, agreement, or termination of partnership
Limited Partnership Easy Partners contribute capital General partner is personally liable; limited liability for limited partners Flow-through Hard No Upon death, bankruptcy, agreement, or termination of partnership
Corporations Difficult Sell stock to raise capital No Subject to double taxation Easy Yes By resolution of board of directors, bankruptcy, or court order
S Corporations Difficult Sell stock to raise capital No Taxed only on dividends Transfer restrictions Yes By resolution of board of directors, bankruptcy, or court order
Limited Liability Companies (LLCs) Medium Members make capital contributions No Flow-through Depends on operating agreement Varies by state; yes in most states Upon death, bankruptcy, agreement, or court order
Limited Liability Partnerships (LLPs) Difficult Members make capital contributions Non-acting partners have limited liability; state law varies regarding liability of acting partners vs. partnership Flow-through Depends on the partnership agreement Depends on partnership agreement Upon death, bankruptcy, agreement, or termination of partnership
Professional Corporations Difficult Members make capital contributions No Complex tax issues Transfer restricted to members of the same profession Yes, as long as it has shareholders Upon death, bankruptcy, agreement, or court order
16.08: Concluding Thoughts
Depending on a business’s type and goals, different business entities may fit the needs of owners better than others. It is important when starting a business to decide how to minimize tax and liability exposure and to maximize profits. Because there is no perfect “fit” for every business need, understanding the advantages and disadvantages of the various business entities is important. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/16%3A_Business_Organizations/16.07%3A_Limited_Liability_Entities.txt |
17.1 Introduction
LEARNING OBJECTIVES
1. Learn when a partnership exists.
2. Understand the rights and duties of partners.
3. Comprehend how a partnership is terminated and the priority of distributing assets.
Partnerships are the most common business form in the United States. Partnerships may be express or implied, and they are the default business organization when two or more people work together who are not legally married. People do not need to call themselves partners for a partnership to exist, so it is important for business professionals to understand what constitutes a partnership so they do not inadvertently form a business entity that they do not intend. And, if they do intend to form a partnership, partners should understand their rights and duties towards each other.
17.2 Types of Partnerships
A partnership is a voluntary association of two or more people who jointly own and carry on a business for profit. Under the Uniform Partnership Act, a partnership is presumed to exist if the parties agree to share proportionally the business’s profits or losses.
There are only two required elements to form a partnership:
1. A common interest to conduct business together; and
2. An understanding to share profits and losses.
A general partnership is a partnership in which all partners participate fully in running the business and share equally in profits and losses, even if the partners’ monetary contributions vary.
A limited partnership is composed of one or more people who control the business and are personally liable for the partnership’s debts. These partners are called general partners and they have the power to make all types of business decisions and manage all aspects of the partnership. A limited partnership also has one or more people who contribute capital and share profits but who cannot manage the business and are liable only for the amount of their contribution. These partners are called limited partners. The main purpose of a limited partnership is to allow people to invest in a business without having to manage the business, and without risking more than the invested sum.
Partnerships may also have silent and secret partners. A silent partner is a partner who shares in the profits, has no active voice in management of the business, and whose existence is not publicly disclosed. A secret partner is a partner whose connection to the business is concealed from the public but may participate in the management of the business. The difference between a silent and secret partner relates to whether the partner may make management decisions.
A partnership by estoppel is an equitable doctrine in which a partnership is implied when one or more people represent themselves as partners to a third party who relies on that representation. A person who is deemed a partner by estoppel becomes liable for any credit extended to the partnership by the third party.
Counselor’s Corner When a business is seeking to innovate their operations, become more efficient, introduce new products or seek competitive advantages, corporate or business attorneys are most effective if they are business partners from the outset. Consulting with legal counsel early and often allows the business to avoid legal pitfalls without wasting valuable time and other resources by making legal counsel a true business partner. So often in business, the legal consulting occurs at the end of the process but by forming the consulting relationship early and often, it avoids being blindsided by possible legal restrictions or impediments and more importantly allows the business to adjust and adapt to any legal implications during the process. ~Rick T., attorney
17.3 Partnership Agreements
A written partnership agreement is not required to form a partnership, but it is a best business practice. Given the variety of different types of partnerships, it is understandable that no formal requirements for a partnership agreement exist. However, the following provisions are ones that should be considered when writing a partnership agreement.
• Name of partnership. Partnerships may choose almost any name they would like. However, partnerships may not use the word “company” or any other word that would imply the business is a corporation. If partners choose a name that does not include their names, the fictitious name statement requires that they must give public notice as to the identities of the partners.
• Purpose and duration. Is the partnership for a limited time or for a specific purpose? Is it a joint venture between businesses that grants partners only limited authority and property rights? Is it a general partnership with the flexibility to grow the business as the market allows?
• Capital contributions. Partners may contribute cash, intellectual property rights, real and personal property, and goodwill to the partnership. Capital contributions do not include the partners’ business experience. An individual may also become a partner without making a capital contribution as long as the other partners agree to it.
• Methods of sharing profits and losses. Without this provision, the default rule is that each partner shares equally in the profits and losses of the partnership. These provisions often include any credit for capital contributions partners may receive in the event of dissolution.
• Effects of advances. If the partnership is short of cash and a partner agrees to advance money to the partnership, that cash advance could be considered either a personal loan or a capital contribution to the partnership. Determining in advance how that money will be spent, repaid, and/or credited within the partnership helps facilitate these types of transactions.
• Compensation. If general partners receive any salary or additional compensation for their management of the business, the terms of compensation should be clearly defined. In addition, the procedure for setting the amount and type of compensation should also be addressed.
• Fiscal year and accounting methods. How a partnership will handle accounting and tax liabilities are important to clearly define, especially because partnerships are flow-through tax entities.
• Property. Partnerships often use personal property of partners as well as property of the business. The default rule is that all property brought into the partnership or acquired by it becomes partnership property. If a partner does not want to lose property rights to the partnership or its creditors, he or she should specify that it remains personal property.
• Dispute resolution. If partners are unable to agree on how to manage the business, how will the deadlock be resolved? These provisions are especially helpful when there are an even number of partners to avoid dissolution when deadlock occurs.
• Modification. How may the partners modify the partnership agreement? Is unanimous consent required to add new partners or add new terms to the contract?
• Rights and obligations at dissolution. Partners should think about what will happen if a partner chooses to leave the partnership or dies. Can the remaining partner(s) buy out that partner’s share of the business? If so, under what terms or process?
It is important to remember that partnership agreements exist between partners in a business, not between the partners and third parties. Partnership agreements are contracts between individuals who want to work together. Therefore, provisions that help facilitate that business relationship within the particular industry may be appropriate.
17.4 Rights and Duties of Partners
Rights of Partners
Figure 17.1 Rights of Partners
All general partners have an equal right to manage the partnership’s business. This does not mean that partners cannot divide up responsibility for the day-to-day management of the business. Rather, partners have the right to enter into contracts on behalf of the partnership, hire employees, and engage in business transactions.
Partners also have a right to compensation for services on behalf of the partnership if they have an agreement for compensation beyond profit sharing. Compensation provisions are particularly common in limited partnerships where some partners are active in the management of business and others are not.
Partners also have the right to receive interest on cash advances made to the partnership. Similar to a loan, an advance is not automatically considered a capital contribution unless determined to be so under the partnership agreement.
Every partner is entitled to full and complete access to inspect the business records of the partnership. Each partner has the right to receive notices and information from all other partners regarding the business. Therefore, partners must notify other partners about material information related to the business and business interests.
Similarly, partners are entitled to an accounting when another partner has withheld profits from the partnership, when there are legal proceedings against the partnership, or upon dissolution.
Partners also have the right to indemnification from the partnership for actions of other partners. For example, if the partnership is sued because a partner commits a tort, the other partners may lose their monetary investment in the partnership but their personal assets are not at risk.
Partners are co-owners of partnership property. Unless altered by a partnership agreement, partners have an equal right to possess partnership property for business purposes.
Duties of Partners
Figure 17.2 Duties of Partners
A partnership is a fiduciary relationship. Therefore, partners owe each other duties as a result of their relationship of trust and confidence.
Partners owe each other a duty of care. In a partnership, this generally means refraining from intentional and reckless misconduct. A partner is not liable to the other partners for simple negligence. Thus, the duty of care for partnerships is not particularly burdensome.
Partners also owe each other the duty of loyalty, which requires the partner to put the interests of the partnership before his or her own personal interests. Self-dealing and taking business opportunities away from the partnership are examples of breaches of the duty of loyalty.
From the duty of loyalty rise the remaining duties that partners owe each other: the duty of service, obedience, accounting, and to inform other partners of material information. When loyal to the partnership, a partner will work in service of the partnership, follow reasonable directions of other partners, provide an accounting of business assets, and inform the other partners of material information that affects the business.
17.5 Termination of a Partnership
The legal end of a partnership is called dissolution. Dissolution may occur when partners mutually agree to stop working together, a partner dies or withdraws from the partnership, or a new partner is added. A new partnership is formed when there is a change in partners, whether an existing partner leaves or a new partner is added. Often, these types of changes do not impact the day-to-day operations of the business significantly. However, a new partnership agreement, and sometimes a new partnership name, is necessary.
If the partnership ceases to operate, then winding up occurs. Winding up is the process in which a partnership is liquidated. Partnership assets are reduced to cash, creditors are paid off, and any remaining profit and assets are distributed to the partners. Partial winding up occurs when the partnership has insufficient cash to operate its business and needs to sell its assets to pay off debts. Complete winding up occurs when the partnership is no longer viable or the partners decide not to work together any more. Termination is when the process of winding up is finished and the partnership no longer exists.
Figure 17.3 Dissolution of Partnership
Many factors can determine whether there is partial or complete winding up. For example, bankruptcy of a partner or the partnership, change in laws that make the subject matter of the business illegal, the death or incapacity of a partner, change in economic circumstances, or litigation.
During winding up, there is a priority of distributing the partnership assets. In general, all creditors other than partners are entitled to be paid before the partners divide up the partnership’s assets.
The priority of distributing the partnership assets is:
1. Third party creditors;
2. Partnership advances;
3. Partnership capital; then
4. Remaining profits to partners.
If the partnership does not have enough assets to cover its debts, then the priority of paying creditors is governed by the state law where the partnership exists. State laws vary regarding the priority of distributing assets, but most states follow a process called marshaling of assets. Marshaling of assets is an equitable doctrine for a fair distribution of a debtor’s assets among multiple creditors.
17.6 Concluding Thoughts
Partnerships are the most common business form in the United States, in large part because of their flexibility and ease of creation. However, if individuals want to create a partnership, a best practice would be to create a partnership agreement that identifies the rights and obligations of the partners. Partnerships are fiduciary relationships in which the law creates certain rights and obligations even if there is not a partnership agreement. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/17%3A_Partnerships.txt |
18.1 Introduction
LEARNING OBJECTIVES
1. Understand how corporations are structured and managed.
2. Learn about shareholder rights and the powers and liabilities of corporate officers and directors.
3. Learn the legal theories under which limited liability is taken away from corporations.
4. Comprehend how corporations merge, consolidate, and dissolve.
Corporations are incredibly important to the stability and growth of the US economy. Without corporations, industries such as pharmaceuticals and technology would not be able to raise the capital needed to fund their research and development of new drugs and products. As discussed in Chapter 16, corporations are incorporated under state law and are subject to double taxation. Corporations are separate legal entities from the shareholders who own them.
Counselor’s Corner“Corporations are [often] people too!” Although the word “corporation” is not found in the Constitution, US corporations are increasingly considered US persons for legal purposes. The Supreme Court has ruled that corporations are entitled to equal protection, to make political contributions, and to refuse certain employee health plans on religious grounds. Congress now generally defines “person” as including “corporations,” which allows them to enter contracts, own property, sue and be sued, and pay taxes. The president has issued Executive Orders giving corporations certain privacy protections regarding the government’s authority to collect and use information about them. Corporations do not, however, have all the legal protections that people have, such as the right to avoid self-incrimination. Nevertheless, generally thinking of US corporations as US persons will often help you better understand their legal rights, responsibilities, and protections, and make you a more educated business person, lawyer, or citizen. ~Tom M., attorney
18.2 Corporate Structure
Under most state laws, corporations are required to have at least one director. A director is a person appointed or elected to sit on a board that manages the business of a corporation and supervises its officers. Directors are elected by shareholders and collectively are called the Board of Directors. Directors elect officers, who are responsible for the daily operations of the corporation. Officers often have titles such as president, chief operating officer, chief financial officer, or controller.
Figure 18.1 Corporate Legal Structure
18.3 Shareholder Rights
As owners of the corporation, shareholders have specific rights to help them assess their investment decisions. Shareholders are not entitled to manage the day-to-day operations of the business, but they enjoy the following rights.
Figure 18.2 Corporate Shareholder Rights
Inspection
Shareholders have the right to inspect the certified financial records of a corporation. This right also extends to other information related to exercising their voting privilege and making investment decisions.
The right, however, is limited to good-faith inspections for proper purposes at an appropriate time and place. A proper purpose is one that seeks to protect the interests of both the corporation and the shareholder seeking the information. In other words, the inspection cannot be against the best interest of the corporation.
Courts have held that proper purposes include:
• Reasons for lack of dividend payments or low dividend amounts;
• Suspicion of mismanagement of assets or dividends; and
• Holding management accountable.
Corporations have a legitimate interest in keeping their financial and managerial documents private. Therefore, inspection of documents usually occurs at the corporation’s headquarters during regular business hours. Documents made available for inspection do not have to be allowed off premise if the corporation does not want them to be removed.
Shareholder Meetings
Shareholders have the right to notice and to attend shareholder meetings. Shareholder meetings must occur at least annually, and special meetings may be called to discuss important issues such as mergers, consolidations, change in bylaws, and sale of significant assets. Failure to give proper notice invalidates the action taken at the meeting.
A quorum of shareholders must be present at the meeting to conduct business. A quorum is the minimum number of shareholders (usually a majority) who must be present to take a vote. The corporation’s bylaws define what constitutes a quorum, if not set by state law.
If a shareholder is not able to be physically present during a meeting, he or she may vote by proxy. A proxy is a person authorized to vote on another’s stock shares.
Vote
Depending on the type of share owned, shareholders may have the right to vote. In general, shareholders of common stock are entitled to a vote for each share of stock owned. Owners of preferred stock often do not have a voting right in exchange for a higher dividend amount or preference in receiving dividends.
Common issues that shareholders vote on include:
• Election of directors;
• Mergers, consolidations, and dissolutions;
• Change of bylaws;
• Change in major corporate policies; and
• Sale of major assets.
Preemptive Rights
The Preemptive right is a shareholder’s privilege to buy newly issued stock in the corporation before the shares are offered to the public. Shareholders are allowed to buy shares in an amount proportionate to their current holdings to prevent dilution of the existing ownership interests.
Preemptive rights usually must be exercised within thirty to sixty days of being offered. This allows the corporation to complete the sale to shareholders before offering any remaining shares to the public.
Derivative Suit
A derivative suit is a lawsuit brought by a shareholder on the corporation’s behalf against a third party because of the corporation’s failure to take action on its own. Derivative actions are usually brought by shareholders against officers or directors for not acting in the best interest of the corporation.
To be eligible to bring a derivative action, a shareholder must own shares in the corporation at the time of the alleged injury. An individual or business cannot buy shares in a corporation to file a derivative suit for actions that occurred before becoming a shareholder.
Before bringing a derivative suit, shareholders must show that they attempted to get the officers and directors to act on behalf of the corporation first. Only after the officers and directors refuse to act may a derivative suit be filed.
Dissatisfaction with the corporation’s management is insufficient to justify a derivative suit. Derivative suits have been successful when misconduct or fraud of a director or officer is involved. If successful, any damages are awarded to the corporation, not the shareholders who brought the lawsuit.
Dividends
A dividend is a portion of a corporation’s profits distributed to its shareholders on a pro rata basis. Dividends are usually paid in the form of cash or additional shares in the corporation.
Although shareholders have a right to a dividend when declared, the board of directors has the discretion to decide whether to declare a dividend. The board may decide to reinvest profits into the corporation, pay for a capital expense, purchase additional assets, or to expand the business. As long as the board of directors acts reasonably and in good faith, its decision regarding whether to declare a dividend is usually upheld by the courts.
18.4 Corporate Officer and Directors
Although shareholders own the corporation, the officers and directors are empowered to manage the day-to-day business of the corporation. The officers and directors owe a fiduciary duty to both the corporation and its shareholders. This means that the officers and directors must act in the best interest of the corporation and shareholders.
Duty of Loyalty
As part of their fiduciary duty, officers and directors have a duty of loyalty to the corporation and its shareholders. The duty of loyalty requires them to act:
• In good faith;
• For a lawful purpose;
• Without a conflict of interest; and
• To advance the best interests of the corporation.
Duty of loyalty issues frequently arise in the context of a director entering into a contract with the corporation or loaning it money. Other situations may involve a director taking a business opportunity away from the corporation for his or her own personal gain. The corporate opportunity doctrine prevents officers and directors from taking personal advantage of a business opportunity that properly belongs to the corporation.
Duty of Care
The duty of care requires officers and directors to act with the care that an ordinary prudent person would take in a similar situation. In other words, they have a duty not to be negligent.
The extent of this duty depends on the nature of the corporation and the type of role the director or officer fills. For example, the duty of care imposed on the board of directors of a federally-insured bank will be higher than the duty imposed on a small nonprofit organization.
In general, though, directors should understand the nature and scope of the corporation’s business and industry, as well as have any particular skills necessary to be successful in their role. Officers and directors also should stay informed about the corporation’s activities and hire experts when they lack the expertise necessary to make the best decisions for the corporation. The duty of care requires officers and directors to make informed decisions.
Compensation
Officers and directors are usually entitled to compensation for their work on behalf of the corporation. Some states restrict whether directors may receive compensation and, if so, how much. The issue of executive compensation has been a hot button issue in recent decades.
Business Judgment Rule
The business judgment rule is the presumption that corporate directors act in good faith, are well-informed, and honestly believe their actions are in the corporation’s best interest. The rule shields directors and officers from liability for unsuccessful or unprofitable decisions, as long as they were made in good faith, with due care, and within their authority.
It is important to understand that courts do not focus on the result of the business decision. Instead, courts look at the process that the decision makers went through. If the process is careless or not in the best interest of the corporation and shareholders, the business judgment rule will not protect them.
The business judgment rule does not protect officers and directors from decisions made in their own self-interest or self-dealing. In those situations, the action must be approved by disinterested members of the board of directors or shareholders. If the decision is subject to a derivative suit, the court may determine that the decision was fair to the corporation. If the decision is approved by the court or disinterested board members or shareholders, then the decision may be valid.
The business judgment rule does not protect officers and directors from decisions made in bad faith, as a result of fraud, through gross negligence, or as an abuse of discretion. In those situations, the officers and directors may be personally liable for their actions.
Figure 18.3 Business Judgment Rule Flowchart
18.5 Legal Theories
One of the main benefits of corporations is limiting shareholders’ liability to the amount of their investment in the corporation. In general, a shareholder may lose his or her investment in the corporation if it is not a successful business or if it is sued. Because corporations are a separate legal entity than their shareholders, shareholders are generally shielded from corporate liability. However, three exceptions to this rule allow shareholders to be held liable for the corporation’s actions.
Piercing the Corporate Veil
Piercing the Corporate Veil is a legal theory under which shareholders or the parent company are held liable for the corporation’s actions or debts. Under this theory, plaintiffs ask the court to look beyond the corporate structure and allow them to sue the shareholders or parent company as if no corporation existed. In essence, the court strips the “veil” of limited liability that incorporation provides and hold a corporation’s shareholders or directors personally liable.
This theory applies most often in closely held corporations. While legal requirements vary by state, courts are usually reluctant to pierce the corporate veil. However, courts will do so in cases involving serious misconduct, fraud, commingling of personal and corporate funds, and deliberate undercapitalization during incorporation.
Alter Ego Theory
The Alter Ego Theory is the doctrine that shareholders will be treated as the owners of a corporation’s property or as the real parties in interest when necessary to prevent fraud or to do justice. In other words, the court finds a corporation lacks a separate identity from an individual or corporate shareholder.
This theory applies most often when a corporation is a wholly-owned subsidiary of another company. Courts allow the alter ego theory when evidence exists that the parent company is controlling the actions of the subsidiary, and the corporate form is disregarded by the shareholders themselves. The rationale is that shareholders cannot benefit from limited liability when there is such unity of ownership and interest that a separate entity does not actually exist. To allow shareholders to “have it both ways” would result in injustice to the corporation’s debtors and those hurt by its actions.
Promotion of Justice Theory
The Promotion of Justice Theory is used when the corporate form is used to defraud shareholders or to avoid compliance with the law. Courts use this theory to prevent shareholders from using a corporation to achieve what they could not do directly themselves. For example, if a state limits the number of liquor licenses an individual may obtain at one time, a person cannot form multiple corporations to obtain more licenses.
18.6 Mergers, Consolidations, and Dissolutions
Once incorporated, corporations may last forever. However, they also may be merged or consolidated into other business entities or dissolved.
Often businesses will buy the assets of another business. When this happens, the seller remains in existence and retains its liabilities. The buyer does not become legally responsible for the seller’s actions through a mere purchase of assets.
Mergers and consolidations, however, involve the termination of the seller.
Merger
A merger occurs when one corporation absorbs another. The acquiring corporation continues to exist but the target corporation ceases to exist. The acquiring corporation acquires all the assets and liabilities of the target corporation.
Corporate mergers must conform to state laws and usually must be approved by the majority of shareholders of both corporations. Many states require approval by two-thirds of the shareholders. If approved, articles of merger must be filed in the state(s) where the corporations exist.
Figure 18.4 Merger
Consolidation
Consolidation occurs when two or more corporations are dissolved and a new corporation is created. The new corporation owns all the assets and liabilities of the former corporations.
Like mergers, consolidations must be approved by the majority or two-thirds of shareholders of all corporations involved. If approved, articles of consolidation must be filed in the state(s) where the corporations existed.
Mergers and consolidations are often scrutinized under antitrust laws to ensure that the resulting corporation is not a monopoly in the relevant market. Antitrust laws are discussed in Chapter 19.
Figure 18.5 Consolidation
Voluntary Dissolution
A corporation that has obtained its charter but has not begun its business may be dissolved voluntarily by its incorporators. They simply need to file articles of dissolution in the state of incorporation.
If a corporation has been in business, voluntary dissolution is possible when either (1) all shareholders give written consent or (2) the board of directors vote for dissolution and two-thirds of the shareholders approve.
To dissolve a corporation voluntarily, the corporation must file a statement of intent to dissolve. At that point, the corporation must cease all business operations except those necessary to wind up its business affairs. The corporation must give notice to all known creditors of its dissolution. If the corporation fails to give notice, then the directors become personally responsible for any debt and legal liability. The corporation is required to pay off all debts before distributing any remaining assets to shareholders.
Until the state issues the articles of dissolution, the statement of intent may be revoked if shareholders change their mind.
Involuntary Dissolution
States have the power to create corporations through granting corporate charters. Similarly, states have the right to revoke corporate charters. Actions brought by the state to cancel a corporate charter are called quo warranto proceedings.
Corporate charters may be canceled when a corporation:
• Did not file its annual report;
• Failed to pay its taxes and licensing fees;
• Obtained its charter through fraud;
• Abused or misused its authority;
• Failed to appoint or maintain a registered agent; or
• Ceased to do business for a certain period of time.
Shareholders may also request dissolution when:
• The shareholders are deadlocked and cannot elect a board of directors;
• When there is illegal, fraudulent or oppressive conduct by the directors or officers;
• When majority shareholders breach their fiduciary duty to the minority shareholders;
• Corporate assets are being wasted or looted; or
• The corporation is unable to carry out its purpose.
Finally, dissolution may occur as a result of bankruptcy or when the corporation is unable to cover its debts to creditors.
18.7 Concluding Thoughts
Corporations are owned by shareholders but are run by directors and officers. As a legal entity separate from its shareholders, corporations provide limited liability to shareholders who invest in them. However, personal liability may be imposed when fraud or other serious misconduct occurs. As long as their decisions are made in good faith, with due care, and within their authority, officers and directors are protected by the business judgment rule. Finally, corporations have a perpetual existence unless they are dissolved through their own action, by the state, or initiated by shareholders or creditors. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/18%3A_Corporations.txt |
19.1 Introduction
LEARNING OBJECTIVES
1. Understand the important federal antitrust laws, along with their exemptions.
2. Learn the factors used to determine whether a monopoly exists.
3. Comprehend the common types of unreasonable restraints on trade.
Antitrust laws are designed to protect trade and commerce from unreasonable restraints, monopolies, price fixing, and price discrimination. Antitrust laws regulate the market just enough to foster economic growth and competition while preventing stagnation and unethical practices by monopolies that prevent the free market from operating as it should.
The main federal antitrust laws are the Sherman Act, the Clayton Act, and the Federal Trade Commission Act. The legislative declarations of these Acts make it clear that Congress wants to promote fair competition within the market economy.
Counselor’s Corner It is difficult at first blush to determine if a business’s strong market presence is the result of a superior product or service that the public demands or unfair business practices. In the technology industry, the big players have invested so much into research and development to bring cutting edge products to market. But if their products are not user friendly and do not meet customer needs, they will not get a return on their investment. As a result, we see an uptick in antitrust complaints from competitors to bring down businesses when they can’t do so on the open market. Antitrust laws are not a sword of competitors to be used for unjust means. Thus, antitrust allegations require examining the entire relevant market, including the complaining party. ~Robert S., judge
19.2 Historical Development
The United States economy was founded on the capitalist principle of free enterprise. Free enterprise is a private and consensual system of production and distribution, usually conducted for profit in a competitive environment, that is relatively free of governmental interference. The theory is that, given the freedom, businesses will operate efficiently and be responsive to consumer needs and demands.
The weakness of the free enterprise system is that it assumes that businesses will be ethical and compete with each other fairly. During the Industrial Revolution, powerful businessmen took advantage of the free enterprise system to increase their wealth at the expense of their workers, competitors, and consumers.
These Industrialists bought shares in competing companies then transferred the shares to a trust. The trust then set prices for goods within the industry, determined which companies could operate in a given geographic area, and micromanaged the business operations of companies within an industry. As a result, companies that were not part of the trust went bankrupt, new competitors were prevented from entering the market, and consumer prices rose beyond market requirements.
States tried to stop the abuses of the Industrialists through the trusts. State attempts failed because the US economy was growing beyond state industries to national ones. As a result, national legislation was needed to restore balance to the market. The resulting legislation is called “antitrust law” because its purpose was to break up the power of the Industrialists’ trusts.
In 1890, Congress passed the Sherman Antitrust Act under its power to regulate interstate commerce. The Sherman Antitrust Act (also known as the Sherman Act) prohibits direct or indirect interference with the freely competitive interstate production and distribution of goods. The Act addresses two main concerns:
1. Unreasonable restraints on trade between two or more parties; and
2. Monopolies.
In 1914, Congress passed the Clayton Act. The Clayton Act amended the Sherman Act and expanded antitrust regulations to prohibit:
1. Price discrimination;
2. Tying arrangements;
3. Exclusive-dealing contracts; and
4. Mergers resulting in monopolies or substantially lessening competition.
Congress also passed the Federal Trade Commission Act in 1914. The Federal Trade Commission Act established the Federal Trade Commission (FTC) to protect consumers against deceptive practices and enforce antitrust laws. The Act prohibits false, deceptive, and unfair advertising and trade practices. Some of these practices are discussed in more detail in Chapter 20.
Figure 19.1 The Federal Trade Commission Act
The last major antitrust law is the Robinson-Patman Act, which was passed by Congress in 1936. The Robinson-Patman Act amended the Clayton Act and prohibits price discrimination that hinders competition or that tends to create a monopoly.
19.3 Monopoly
A monopoly is the control or advantage obtained by one supplier or producer over the commercial market within a given region. Not all monopolies are illegal. In fact, some industries are exempted from antitrust laws:
• Highly regulated industries;
• Utilities;
• Railroads;
• Airlines;
• Insurance companies;
• Securities; and
• Banks
• Labor unions;
• Agricultural and fishing cooperatives (farmers not distributors);
• Exporters;
• Lobbyists;
• States (unclear if includes US territories); and
• Professional baseball.
To be an illegal monopoly, a business must have (1) monopoly power (2) in the relevant market and (3) the intent to acquire and use such power.
Monopoly Power
Monopoly power is the power of a business to fix prices unilaterally or to exclude competition. The size of a business’s market share is a primary factor of whether monopoly power exists.
Courts have found monopoly power when a business controls seventy percent or more of a market.
If a business controls 51-69 percent of a market, then it is possible that monopoly power exists. Courts examine other factors such as number of competitors, market concentration, degree of difficulty for new businesses to enter the industry, and the nature of the industry. If the entry costs and barriers are high and there are few other competitors, a business may have monopoly power when it controls slightly more than half the market.
If a business controls fifty percent or less of a market, then no monopoly power exists.
Relevant Market
To determine whether a business has monopoly power, it must be determined whether it has monopoly power within the relevant market. However, defining the relevant market can be challenging. The relevant market includes both the product or service market and the geographic area.
Product or Service Market
The first element in determining the relevant market is to determine what goods or services are interchangeable in consumers’ minds. This is sometimes called substitutability or functional interchangeability. Defining the exact product or service market is usually heavily litigated because it may result in market concentration or dilution, and ultimately whether a business has enough market share to be deemed a monopoly.
For example, Ford shares the passenger truck market with manufacturers such as Chevrolet, GMC, Dodge, Toyota, Nissan, and Honda. However, Ford shares the commercial truck market with manufacturers such as Peterbilt, Volvo, Daimler, and Volkswagen. If sued for violation of antitrust law, Ford would want a broad definition of the product market, such as “trucks,” to include a greater number of competitors and lessen its own market share. Plaintiffs would want to define the product narrowly, such as “three-quarter ton passenger trucks,” to lessen the number of competitors and heighten Ford’s market share.
As large companies expand their products and services across industries, this inquiry becomes more complex and expensive to litigate.
Geographic Area
Determining a business’s market power also requires determining the geographic area in which the business operates. As globalization and e-commerce increase the geographic reach of businesses, this inquiry is also becoming more difficult.
For example, should the market for Ford passenger trucks be determined by city, state, nation, continent, hemisphere, or globally? Ford trucks may have higher sales in Detroit, Michigan than in Tokyo, Japan. Determining the geographic area of the relevant market may include areas of higher or lesser concentrations of sales. Therefore, parties also heavily litigate what is the appropriate geographic area for the relevant market.
Intent
The third factor is the business’s intent to acquire and use its monopoly power.
Not all monopolies are the result of a business’s predatory actions. Some “boom and bust” industries, such as mining and oil and gas, are difficult to maintain long-term success. If an industry goes through a difficult time and competitors go out of business, the remaining company may end up as a monopoly without engaging in anticompetitive behavior.
To determine intent, courts look at the conduct of the business. Purchasing smaller competitors to increase its market share and engaging in predatory pricing is often evidence of a company’s intent to become a monopoly.
Specifically, an intent to monopolize requires:
1. Predatory or anticompetitive conduct;
2. Specific intent to control prices or destroy competition; and
3. A dangerous probability of success.
A business’s intent is evaluated in the context of the current industry and economic conditions. For example, are there significant changes to the law that affect the profitability of the industry or an economic downturn that impacts competition? Just because a company is large enough to successfully survive a challenging time, it may not have the necessary intent to become an illegal monopoly.
19.4 Unreasonable Restraints on Trade
Antitrust laws prohibit unreasonable restraints on trade. A restraint on trade is an agreement between two or more businesses intended to eliminate competition, create a monopoly, artificially raise prices, or adversely affect the free market. A restraint on trade that produces a significant anticompetitive effect and, therefore, violates antitrust laws is an unreasonable restraint on trade.
Concerted Action
Concerted action is an action that has been planned, arranged, and agreed on by parties acting together to further some scheme or cause. Concerted action can be either horizontal or vertical. Horizontal agreements occur between direct competitors. For example, cell phone providers decide to lock customers into two-year contracts. Customers are required to agree to terms that benefit the companies, regardless of which provider they choose.
Figure 19.2 Horizontal Restraints on Trade
Horizontal agreements are almost always struck down as per se violations of antitrust laws. Because competitors appear to make decisions based on their own self-interest rather than letting the market forces decide price and conditions, courts conclude that such agreements are not in the interest of consumers and the free market.
Vertical agreements occur between businesses at different places along the distribution chain of a given product. For example, a manufacturer suggests a sale price to a wholesaler of its product (i.e. “manufacturer’s suggested retail price”).
Figure 19.3 Vertical Restraints on Trade
Vertical agreements are usually subject to a “rule of reason” test to determine if they are illegal. The rule of reason test is a case-by-case analysis of the agreement, industry, effects, and intent of the businesses. Although it is possible to show that a vertical agreement is legal, it usually costs businesses a lot to litigate these types of cases.
Price Fixing
Price fixing is the artificial setting or maintaining of prices at a certain level, contrary to the workings of the free market. Horizontal price fixing is price fixing among competitors at the same level, such as retailers throughout an industry. Vertical price fixing is price fixing among businesses in the same chain of distribution, such as manufacturers and retailers attempting to control a product’s resale price.
One form of price fixing is predatory pricing. Predatory pricing occurs when a company lowers its prices below cost to drive competitors out of business. Once a predator rids the market of competition, it raises prices to make up lost profits. The goal of predatory pricing is to win control of a market or to maintain it.
Predatory pricing has three elements:
1. The alleged predator is selling products below cost;
2. The alleged predator intends that its competition goes out of business; and
3. If the competitors go out of business, the alleged predator will be able to earn sufficient profits to recover its prior losses.
Predatory pricing cases are often hard to win because it is difficult to prove the alleged predator’s intent.
Division of the Market
Division of the market occurs when businesses agree to exclusively sell products or services in specific geographic territories. A horizontal division of the market is when competitors enter into an agreement to not compete for customers by dividing a geographic area into separate sales territories. A vertical division of the market is when a manufacturer and its wholesalers agree to exclusive distributorships in a given territory.
Exclusive distributorships are usually legal unless the manufacturer has dominant power in the overall market. For example, Wendy’s grants exclusive distributorships to its franchisees to avoid oversaturation in a given geographic area. As long as Wendy’s is not the only fast food restaurant within a particular market, the exclusive distributorships will be upheld. This is because Wendy’s has a legitimate business interest in not diluting the value of its franchises, which does not restrict consumers’ choice of fast food restaurants in the overall market.
Group boycotts
A boycott is an action designed to socially or economically isolate an adversary. A group boycott is an agreement between two competitors who refuse to do business with a third party unless it refrains from doing business with an actual or potential competitor of the boycotters. Group boycotts may be either horizontal or vertical.
Figure 19.4 Horizontal Group Boycott
Exclusionary Contracts
Exclusionary contracts require businesses to buy or lease products on the condition that they do not use the goods of a competitor of the seller. The most common types of exclusionary contracts are tying arrangements and exclusive dealing arrangements.
A tying arrangement occurs when a buyer is not permitted to purchase one item without purchasing another. These are often called “bundling packages.” These arrangements benefit a seller because it allows the seller to wed a popular item with one that is less desirable and would not get as many sales independently.
Under the rule of reason test, a tying arrangement is illegal when:
1. The agreement involves two distinct products not closely related to each other;
2. Commerce is impacted significantly; and
3. The seller has sufficient economic power in the tying product to enforce the tie-in.
An exclusive dealing arrangement exists when a buyer agrees to purchase all of its requirements from a single seller or a seller agrees to sell all of its output to a single buyer. Exclusive dealing arrangements are illegal when they substantially lessen competition or tend to create a monopoly.
Mergers and Acquisitions
Regardless of a business’s intention when merging or acquiring another business, a merger or acquisition is prohibited when it may substantially lessen competition or may create a monopoly. When analyzing a potential merger, the court considers:
1. The relevant market;
2. The pre-merger profile of the business; and
3. The post-merger profile of the business.
As discussed above, the relevant market is determined by examining the relevant product or service market, as well as the geographic area of the business’s operations.
The pre-merger profile is determined by analyzing the type of merger, the size of the companies involved, and the concentration of the industry. Mergers may be horizontal, vertical, or conglomerate. Horizontal mergers are between competitors. Vertical mergers are between businesses within a supply chain. And conglomerate mergers are between companies in different industries. An example of a conglomerate merger is Amazon’s acquisition of Whole Foods in 2107.
The post-merger profile uses the same factors as the pre-merger profile but looks at the anticipated business after the merger.
19.5 Price Discrimination
Price discrimination is the practice of offering identical or similar goods to different buyers at different prices when the costs of producing the goods are the same. Price discrimination may violate antitrust laws if it reduces competition.
Price discrimination may be either direct or indirect. Direct price discrimination occurs when a seller charges different prices to different buyers. Indirect price discrimination occurs when a seller offers special concessions (such as favorable credit terms) to some, but not all, buyers.
The Robinson-Patman Act defines discrimination in terms of first, second and third lines. First line price discrimination is when the seller directly offers different prices to different buyers. For example, coffee sold to individual customers is priced differently. First line price discrimination is legal when the lower price is offered to customers who buy large quantities, use coupons, or are part of a loyalty program. It is also legal if the price difference is the result of manufacturing, sales or delivery costs. For example, coffee prices may be lower for Hawaiian coffee in Hawaii because there are less transportation costs involved than shipping coffee to the Continental United States.
Figure 19.5 First Line Discrimination
Second line price discrimination occurs when a manufacturer demands lower prices from suppliers. For example, large retailers often demand discount prices from manufacturers because they buy goods in large quantities. Second line price discrimination is legal as long as the negotiations for the lower price are done fairly and there is not a substantial anticompetitive impact in the market. When second line price discrimination results in larger businesses freezing out smaller competitors, it violates antitrust laws.
Figure 19.6 Second Line Price Discrimination
Third line price discrimination occurs when a customer of a customer of the seller is benefited by the seller’s actions. For example, a clothing manufacturer gives a price discount to a clothing wholesaler, who then passes the savings on to the retailer, who then reduces prices for consumers. The consumers ultimately benefit from the price discount given to the wholesaler by the manufacturer.
Figure 19.7 Third Line Price Discrimination
Price discrimination, at any line, is legal when a seller lowers prices in good faith to meet an equally low price offered by a competitor. If lower prices are a result of good faith, courts determine that the prices reflect market forces at work. In other words, the businesses are honestly competing for consumers. However, if the lowered prices are not done in good faith but are an attempt to undercut competition, then the business commits predatory pricing.
19.6 Enforcement
Antitrust laws impose both civil and criminal penalties. A private business that has been injured by anticompetitive practices may sue for damages. To encourage private enforcement, the Sherman and Clayton Acts award successful litigants treble (i.e. triple) damages and attorneys’ fees. To be successful, a plaintiff must show that an anticompetitive act directly resulted in a tangible injury.
However, most antitrust actions involve governmental enforcement. This makes sense because the government has the power to investigate and subpoena that private businesses do not. It also saves businesses a lot of money for the government to enforce the laws rather than through private litigation.
Both the Department of Justice and the Federal Trade Commission enforce antitrust laws. Both agencies may pursue civil and criminal remedies for violations of the law.
Civil remedies include:
• Injunctions (court orders prohibiting the business from committing further violations);
• Consent decrees (court-approved agreements in which a party does not admit wrongdoing but agrees to change its behavior); and
• Divesture orders (court orders requiring a company to sell its interest in an acquired company).
The Department of Justice may also pursue criminal charges for violations of antitrust laws. If convicted of a felony, individuals may be fined up to \$1 million per violation and may be sentenced up to ten years in prison. A business may be fined as much as \$100 million per violation.
19.7 Concluding Thoughts
The underlying tension of antitrust laws is the appropriate amount of regulation in a free enterprise system. By definition, a free enterprise market-oriented system should be free from governmental regulation. However, it is clear that some regulation and oversight is necessary to protect individuals and businesses from unethical and anticompetitive business practices. Even absent unethical practices, some businesses may be so successful that over time they gain enough market share to freeze out competition, and have less incentive to deliver quality products and services. As a result, the market may become stagnant, which is not in the best interest of the national economy or consumers. Antitrust laws attempt to protect consumers and the economy while allowing free enterprise to operate. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/19%3A_Antitrust_Law.txt |
20.1 Introduction
LEARNING OBJECTIVES
1. Learn the primary consumer laws that protect purchasers and debtors.
2. Understand the enforcement role of the Consumer Financial Protection Bureau.
Consumer law is the area of law dealing with consumer transactions, including an individual’s ability to obtain credit, goods, real property, or services for personal, family, or household purposes. Business to business transactions are usually governed by contract law and are not considered part of consumer law.
Consumer protection laws are laws designed to protect consumers against unfair trade and credit practices involving consumer goods, as well as to protect consumers against faulty and dangerous goods. The focus of these laws is to ensure that businesses do not take advantage of individual consumers.
Counselor’s Corner Approximately 80 percent of Americans are in debt. Consequently, consumer protection laws, especially those that protect debtors, are incredibly important to the majority of Americans, even if they don’t realize it. Debt collection agencies can be aggressive and unethical. Know your rights so that you are not bullied or taken advantage of. ~Maria M., attorney
20.2 Protecting the Purchaser
Consumer protection laws that protect purchasers of goods and services generally fall into four categories:
• Labeling and packaging;
• Sales;
• Deceptive advertising; and
• Hazardous materials.
Labeling and Packaging
How goods are labeled and packaged influences whether consumers will buy them. As a result, regulations require that labels must be truthful and allow consumers to understand what the product is, what it contains, and any potential hazards.
Labeling and packaging regulations fall into four categories:
Type Example
Product comparison Nutrition labels on food and beverages
Preventing injury Warning not to use lawn mower to trim hedges
Preventing access Childproof caps on medications; tobacco secured in retail stores
Informing of potential hazards Potential side effects of hazardous items and drugs
Sales
The general principle in sales regulations is that advertising must be honest. Consumers should be able to make informed decisions based on what products and services really are and not based on false claims or empty promises. These regulations apply to all sales materials regardless of medium: print, electronic, social media, or radio.
One important regulation involves door-to-door sales. Consumers who buy goods or services from door-to-door salespeople have three days to cancel purchases without penalty. This is called a cooling off period and is intended to protect consumers from high pressure sales tactics. The exception to the cooling off period is when services are immediately rendered. For example, someone who aerates a lawn or removes snow as soon as a consumer consents to pay for the service is entitled to payment without being subject to a cooling off period.
Another important regulation involves delivery of goods ordered online, through catalogs, or by door-to-door sales. Goods must be shipped within the promised time period or notice must be given to the consumer. If the goods are not shipped and proper notice is not given, then the consumer has the right to cancel the order for a full refund. Similarly, if a consumer receives goods that he or she did not order through the mail, the consumer can treat it as a gift and does not have to pay for it.
Sellers are allowed to promote their goods and services and make them appealing to consumers. Puffery is a broad promotional statement made by a business about goods or services that is not intended to be taken literally. In other words, puffery is an exaggerated opinion, such as “the best,” “most popular,” and “nobody can beat it!” As long as puffery remains an opinion and does not contain false factual statements, puffery is legal. However, if puffery contains false statements, then the statements are deceptive advertising and illegal.
Deceptive Advertising
Deceptive advertising is a material misrepresentation or omission likely to mislead a potential customer and would mislead a reasonable customer. In other words, deceptive advertising is a lie.
For example, if a car manufacturer advertises a vehicle as “the best in its class” or “the most popular” sedan, such statements are legal puffery. If the manufacturer advertises that the vehicle gets 35 miles per gallon when it only gets 30 miles per gallon, then that statement is deceptive advertising.
Another form of deceptive advertising is called bait and switch or bait advertising. Bait and switch is a sales practice where a seller advertises a low-priced product to lure consumers into a store only to induce them to buy a higher-priced product. Often the advertised product is not actually available as advertised or the seller refuses to sell it on the advertised terms. The low-priced product is the “bait” that brings consumers in but then the seller “switches” the higher-priced product as the subject of the transaction. Bait and switch advertising can also apply to sales of services.
Hazardous Materials
In the context of consumer protection law, hazardous materials are products deemed dangerous to the consuming public. Hazardous materials include drugs that may be consumed safely in small amounts under supervision of a medical provider, as well as toxic chemicals that are banned for certain public uses such as lead and asbestos.
Hazardous materials regulations are extensive to ensure that products reaching consumers are safe for their intended use and other reasonable, foreseeable uses. These regulations also control product recalls.
Regulations vary depending on the business’s industry. To help consumers understand their rights and report harmful products, the Consumer Product Safety Commission established the www.SaferProducts.gov website.
20.3 Protecting the Debtor
A debtor is someone who owes an obligation to another individual or business, especially the obligation to pay money. Consumers become debtors when they owe a business money for the purchase price of goods and services. If consumers pay the purchase price at the time of the transaction or shortly afterward, then the transaction is completed. If, however, the consumer does not immediately pay but receives the goods or services, then the consumer becomes a debtor under consumer protection laws.
Consumer protection laws that protect debtors generally fall into five categories:
• Obtaining credit;
• Reporting credit information;
• Electronic fund transfers;
• Identity theft; and
• Debt collection.
Obtaining Credit
The process of obtaining credit is regulated by two federal laws. The Truth in Lending Act regulates what information must be provided by creditors who wish to extend credit to consumers. The Equal Credit Opportunity Act prohibit creditors from discriminating against consumers based on their membership in certain protected classes.
Truth in Lending Act
Congress passed the Truth in Lending Act (TILA) in 1968 to help consumers understand and compare various credit options available to them. TILA only applies to consumer credit transactions and leasing. The law does not apply to commercial credit transactions.
TILA applies to all real estate transactions and consumer credit transactions of \$25,000 or less. The law also applies to credit transactions involving finance charges or when the loan repayment involves four or more installments.
TILA also regulates credit cards. The law prohibits credit card companies from issuing credit cards unless they were requested by the consumer. Any changes to interest rates or policies to existing credit card accounts must be provided in writing to consumers, who must be allowed to cancel their credit cards without penalty. Consumers are required to pay any outstanding balance accrued to that point, but they cannot be forced to accept altered terms.
TILA requires certain disclosures be made to applicants for credit. These disclosures include:
• Minimum rate of repayment;
• Billing period;
• Interest rate in the form of the annual percentage rate;
• Type of interest (simple or compound);
• Service charges and fees; and
• Prepayment penalties.
All disclosures must be in ordinary language that makes sense to the ordinary customer. Disclosures must also be clear and conspicuous, meaning that the terms cannot be buried in a contract to hide them from consumers.
Equal Credit Opportunity Act
Congress passed the Equal Credit Opportunity Act (ECOA) in 1975 to protect consumers from discrimination when applying for credit. ECOA prohibits creditors from discriminating against creditors based on their:
• Race;
• Color;
• National origin;
• Religion;
• Gender;
• Age;
• Marital status; and
• Welfare status.
The purpose of ECOA is to require creditors to consider only those characteristics of an applicant related to creditworthiness rather than social status or stereotypes. Therefore, creditors may consider an applicant’s marital or welfare status only to the extent that it relates to the applicant’s creditworthiness. For example, an applicant’s marital assets and debts are relevant factors when determining how much credit, if any, should be extended to the applicant. However, denying or granting credit solely on the basis of marital and welfare status is illegal.
ECOA also requires creditors to provide specific reasons for denying credit to applicants. This allows applicants to determine whether the denial was for discriminatory reasons or as pretext to hide the discriminatory reason, in violation of the law.
Reporting Credit Information
Congress passed the Fair Credit Reporting Act (FCRA) in 1970 to regulate the gathering, storage, and reporting of credit-related information. FCRA applies to individual consumer information only. FCRA does not apply to business entities’ credit reports.
A credit bureau is an organization that maintains and distributes information regarding a person’s credit worthiness to potential creditors, insurance companies, and employers. The three main credit bureaus in the United States are Equifax, Experian, and Transunion.
Before releasing consumer information, a credit bureau must confirm the identity of the party making the request and verify the reason for its use. The credit bureau then provides information about a consumer’s credit in the form of a credit report.
In general, consumers do not have to consent to the release of their information. FCRA requires notice to consumers in three specific circumstances:
• A credit report is provided to an employer and includes negative information that could prevent the consumer from being hired;
• When the consumer is denied credit, insurance, or employment based on information contained in the report;
• An investigative report is requested about the consumer’s character, personal attributes, and living arrangements.
Credit bureaus must delete general information that is more than seven years old, and bankruptcies that are more than ten years old. If debts were incurred over seven years ago, or bankruptcies filed more than ten years ago, but are still “open” because the debt has not been paid off, then that information may be reported.
FCRA gives consumers some specific rights regarding their consumer reports. First, consumers are entitled to one free report per year from each of the credit bureaus. Consumers may pay for additional copies of their credit reports.
Second, consumers are entitled to dispute information included in a credit report. If the credit bureau determines that the report contained an error, the erroneous information must be removed. If the credit bureau confirms the information or cannot determine that it was erroneous, then the consumer has the right to add an objection to the information in the report.
Finally, consumers are entitled to place a credit freeze on their credit reports. A credit freeze is when the consumer restricts or prohibits creditors from requesting credit reports about them. In essence, a credit freeze prevents third parties from requesting a consumer’s credit report without the consumer’s permission. If the consumer wants to apply for credit or a new job, then the consumer may lift the credit freeze for a limited period of time or give authority to specific entities to request a credit report.
Electronic Fund Transfers
The Electronic Fund Transfer Act (EFTA) was passed by Congress in 1978 to protect consumers from unauthorized electronic fund transfers from their accounts. EFTA applies to electronic direct deposits and withdrawals, automatic teller machines (ATMs), and point-of-sale transactions with merchants.
EFTA requires banks to investigate errors and reported fraud promptly and to correct any errors within one business day. A consumer’s liability for unauthorized transfers is limited to \$50 or the amount of the transfer (whichever is less) for transfers made before the consumer notified the bank of the unauthorized use. After the consumer notifies the bank, the consumer is not liable for any additional unauthorized transfers. However, if the consumer fails to notify the bank within two business days of the unauthorized transfer, then the consumer’s liability rises to \$500.
A preauthorized transfer is an electronic fund transfer authorized in advance to recur at regular intervals. For example, a consumer authorizes her monthly mortgage payment to be automatically withdrawn from her banking account on the first of every month. Preauthorized transfers require banks to:
• Receive written instructions from the consumer about the timing, amount, and duration of the transfers; and
• Allow the consumer to stop payment up to three business days before the scheduled transfer date.
Identity Theft
Identity theft is an increasing concern for businesses and consumers. The Federal Trade Commission estimates that at least ten million consumers are victims of identity theft each year.
While consumers cannot completely prevent identity theft, there are some steps that they can take to minimize their risk. First, consumers should monitor their bank accounts and charges on their credit and debit cards. If they notify their banks of unauthorized transactions as soon as possible, then they will minimize their personal liability. Second, consumers should request their credit report at least annually. Parents are entitled to request credit reports for their minor children. Third, consumers can place a credit freeze on their credit report to prevent third parties from accessing their financial and personal information and from obtaining credit under their name.
If a consumer is a victim of identity theft, he or she can post a fraud alert with the credit bureaus to be included in his or her credit report. A fraud alert requires businesses to verify the identity of an applicant for credit before extending any credit to him or her.
Debt Collection
Businesses that are owed money from debtors may seek a court judgment to collect the debt. However, the judicial process is often expensive and time consuming. As a result, many businesses prefer to collect debts outside of the court system.
To prevent abusive practices by debt collectors, Congress passed the Fair Debt Collection Practices Act (FDCPA) in 1978. Under FDCPA, a debt collector must, within five days of contacting a debtor, send a written notice containing:
• The amount of the debt;
• The name of the creditor to whom the debt is owed; and
• A statement that if the debtor disputes the debt in writing, all collection efforts must stop until the creditor receives evidence of the debt.
FDCPA also prohibits certain debt collection practices. Debt collectors cannot:
• Contact a debtor who has notified the collector in writing that he or she wants no further contact;
• Contact a debtor who is represented by an attorney;
• Call a debtor before 8:00 a.m. or after 9:00 p.m.;
• Threaten a debtor or use obscene or abusive language;
• Contact a debtor at work if the employer prohibits such contact;
• Imply or say that they are attorneys or government officials when they are not;
• Use a false name;
• Make any false, deceptive, or misleading statements;
• Contact family and acquaintances of the debtor more than once or for any reason other than to locate the debtor;
• Tell family and acquaintances of the debtor that he or she is in debt;
• Publish the debtor’s name and address on a “bad debt” list on the internet or in the newspaper; or
• Collect charges in addition to the debt unless permitted by state law or contract signed by the debtor.
Filing a collection action in court does not violate any of these rules.
20.4 Enforcement
Congress empowered both the Federal Trade Commission and the Consumer Financial Protection Bureau to enforce the primary federal consumer protection laws. However, numerous federal and state laws contain provisions to protect consumers. As a result, there are many federal and state agencies that have regulations related to consumer protection.
The Consumer Financial Protection Bureau (CFPB) was created by Congress in 2010 to be a single point of contact for consumers who seek financial consumer protection. The CFPB is intended to consolidate enforcement efforts and to make them more consistent than when they were shared among agencies. The CFPB is authorized to enforce the federal consumer protection laws discussed in this chapter, as well as others.
20.5 Concluding Thoughts
Consumer protection laws are intended to protect consumers from unethical and unfair business practices. These laws are broad in range, from advertising and marketing to recalling delivered products that are hazardous. With the continued evolution of electronic transactions and banking, consumer law will continue to evolve to address areas of concern as they develop. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/20%3A_Consumer_Law.txt |
Learning Objectives
• Identify some of the most important privacy laws impacting businesses today.
• Understand the Constitutional basis for privacy rights.
• Explore the legal issues involved with modern technology and information security.
21: Workplace Privacy and Information Security
Privacy is a fundamental right of individuals that is often compromised by government and businesses. Sometimes individuals and businesses voluntarily give up their privacy rights, without considering the consequences of doing so. Workplace privacy and information security is a fast growing area of the law that has important implications across industries.
Counselor’s Corner Privacy and cybersecurity are two of the most dynamic areas of the law. As our society becomes more and more dependent on technology, and as the Internet of Things continues to expand, we are seeing privacy issues explode in personal and professional contexts. Businesses would do well to consult with cybersecurity and privacy experts to ensure that they are complying with the law and protecting their networks and confidential information as much as possible. Bringing in experts after you have a security breach or lawsuit filed is way too late. Be proactive. It just may save your business. ~Katie D., attorney
21.02: Right to Privacy
Privacy is the right of a person or person’s property to be free from unwarranted public scrutiny or exposure. In other words, it is the right to personal autonomy and to express oneself selectively. Privacy includes both bodily integrity and the protection of confidential information, including medical and financial records.
Implied Constitutional Right
Privacy is an implied Constitutional right, meaning it is a right based on the “zones of privacy” created by the US Constitution. However, the word “privacy” is not in the Constitution itself.
The right to privacy was first mentioned in a Harvard Law Review article in 1890 by Samuel Warren and Louis Brandeis, who later served on the US Supreme Court from 1916 until 1939. Warren and Brandeis argued the right to privacy is an important civil liberty which should not be violated by sensational journalists and developments in technology. The technology in the late 1890s they were the most concerned with was photography and telephones. In particular, they were concerned about people losing their right to privacy when others take photographs of them or listen to their conversations.
Privacy was discussed in the legal community for 75 years before the US Supreme Court expressly held individuals have a Constitutional right to privacy in the 1965 Griswold v. Connecticut decision.
Privacy cases involve different circumstances, such as the right to choose whether to marry and to whom, the right to choose whether to have children, and the right to protect confidential information such as medical and financial records.
The Framers of the Constitution did not include the word “privacy” in the Constitution but it is a fundamental right underlying the core tenets of the document. The Bill of Rights begins by recognizing fundamental rights that are essential to an individual’s identity: speech, religion, press, assembly, and petition for redress from the government. From there, the Bill of Rights expands protection of individuals to include their homes and possessions. For example, the Fourth Amendment prohibits unreasonable searches and seizures by the government. As reflected in the Bill of Rights, privacy is an essential right the Constitution intends to protect.
When analyzing privacy cases, courts ask whether an individual has a reasonable expectation of privacy. To establish a “reasonable expectation of privacy,” a person must meet two requirements:
1. The individual has an actual, subjective expectation of privacy. In other words, did that particular person think he or she was doing something in private that others could not observe?
2. Society accepts the individual’s expectation of privacy as reasonable. In other words, as a community do we expect those circumstances to be private?
This legal test has both a subjective and objective standard. If an individual does not expect their actions to be private, then no right to privacy exists under the circumstances. Similarly, if society as a whole does not expect to have privacy under the circumstances, it does not matter what the individual may personally believe, no right of privacy exists.
For example, if a person calls her doctor to discuss medical test results, then she has a subjective expectation of privacy. If she calls her doctor from her home, then she has an objective expectation of privacy because society recognizes the right of people to have private conversations in their own homes. However, if she has the conversation on her cell phone while riding the bus, then she does not have a right to privacy because it is not objectively reasonable to expect privacy on public transportation.
Privacy cases also focus on whether a person has given either express or implied consent to disclose or use personal information. Express consent is often given in the form of contracts, including end user agreements. Implied consent is usually based on the person’s actions, such as a history of business transactions. In essence, implied consent means that a business has reason to believe that a person would give consent if the business asked for it. For example, customers who sign up for a loyalty program may give implied consent to receive marketing emails from that particular business.
While consent and the expectation of privacy are interrelated concepts, they are legally different concepts.
Statutes
Congress and state legislatures have also passed various laws to protect the privacy of individuals and their property. Some of the most important federal laws related to workplace privacy are discussed below.
There is a growing trend among states to require internet service providers to obtain consent from consumers before sharing any of their personal information, including websites visited and consumer habits.
Businesses engaged in e-commerce with residents of California must post their privacy policy conspicuously on their websites and abide by their policies. California law also requires disclosure of consumer software tracking policies.
International Law
The right to privacy is contained in Article 12 of the Universal Declaration of Human Rights, which was adopted in 1948 in response to the horrors of World War II. The Universal Declaration of Human Rights states:
No one shall be subjected to arbitrary interference with his privacy, family, home or correspondence, nor to attacks upon his honor and reputation.
The Universal Declaration of Human Rights has been adopted by the majority of nations, including the United States.
Many other bilateral treaties and conventions recognize the right to privacy in various circumstances. Currently, about 150 nations recognize privacy as part of their international legal obligations. However, enforcement of the right to privacy is inconsistent across nations.
It is important for US businesses operating in Europe or conducting business transactions with Europeans to understand that the European Union (EU) has a comprehensive set of laws to protect the privacy of European individuals and businesses. The EU General Data Protection Regulation (GDPR) applies to all businesses, even located outside of Europe, that collect, store, or process data about any European. Under GDPR, individuals have the right to know how their personal data is being collected and used, to remove information from the internet, and to stop companies from processing their data. GDPR has significant penalties. For example, businesses mishandling customer information may be fined up to four percent of their annual worldwide revenue.
Under GDPR, businesses must comply with six data processing principles. Personal information must be:
1. Processed lawfully, fairly and transparently;
2. Collected only for specific legitimate purposes;
3. Adequate, relevant and limited to what is necessary;
4. Accurate and, where necessary, kept up to date;
5. Stored only as long as is necessary; and
6. Processed in a manner that ensures appropriate security. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/21%3A_Workplace_Privacy_and_Information_Security/21.01%3A_Introduction.txt |
Employees generally do not have a reasonable expectation of privacy in the workplace, especially when using company equipment or when the employer has a policy stating employees may be monitored. However, some areas such as employee restrooms and locker rooms may not be monitored. Courts have held employees do not give up all expectations of privacy by the nature of their employment. Therefore, employers should ensure that they limit monitoring activities to reasonable places where the employer has a legitimate business interest for doing so.
Hiring Process
Employers often run background checks on prospective employees as part of their hiring process. Depending on what type of background check is done and the information used, a range of privacy issues are involved. Some states regulate the type of documents that a prospective employer may consider when making hiring decisions. Businesses need to ensure they comply with all state laws where they hire employees.
The use of artificial intelligence (AI) is a growing trend in recruiting and hiring. AI is often used to review resumes, applications, and publicly available social media. AI-powered video-interview platforms apply algorithms to video-recorded interviews to facilitate an employer’s assessment of applicants.
Illinois was the first state to pass an AI Interview Act, which requires prospective employers to notify applicants of their use of AI and to obtain their consent before using AI tools on their application materials. Although limited to its state, the Illinois law has been cited by many legal experts as a template for other federal and state laws.
Based on the Illinois law, employers who use AI during their hiring process should adopt the following best practices:
• Give notice to applicants of the use of AI-powered video-interview platforms;
• Explain what the AI is and how it works in ordinary language to applicants;
• Obtain consent of applicants to use and record their video interviews;
• Offer an alternative interview method for interviews; and
• Have a procedure in place for the destruction of recordings.
Drug and Alcohol Testing
Employers with drug and alcohol testing policies are highly regulated by the states where they operate. State requirements vary about required notice of testing, the nature and location of testing, and when testing may occur. All states protect employee privacy regarding who receives the test result and how those results are to be collected, stored, and destroyed. Employers who engage in drug and alcohol testing need to be informed about the legal consequences of enforcing their policies.
Employees frequently challenge drug and alcohol testing as a violation of their right to privacy. Employers generally win these lawsuits when:
• The employer complies with all state requirements for drug and alcohol testing;
• Conducts the test with the employee’s consent;
• Conducts the test in a manner that was not offensive; and
• The test results do not reveal information unrelated to the purpose of the test.
Employers must be careful to limit disclosure of test results to only those with a need to know. Businesses may lawfully conduct a drug or alcohol test but still be liable for privacy violations based on how they handled the results.
Health Insurance Portability and Accountability Act
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) seeks to protect confidential health information and mandates standards for handling such information.
HIPAA has a Privacy Rule regulating the use and disclosure of individually identifiable health information. The Privacy Rule protects Protected Health Information (PHI) , which includes all information related to the past, present or future health status of an identified individual, of treatment received, or of payment for treatment. PHI also includes billing records, information about premium payments, and enrollment information. As a result, PHI includes medical information required by employers to carry out their obligations under the Americans with Disabilities Act, the Family Medical Leave Act, workers’ compensation, drug testing, and employer-sponsored health care plans.
HIPAA also has a Security Rule to ensure the confidentiality, integrity and availability of electronic PHI. Under the Security Rule,
• Confidentiality means PHI is not made available or disclosed to unauthorized individuals or processes;
• Integrity means PHI is not altered or destroyed in an unauthorized manner; and
• Availability means PHI is accessible and usable upon demand by an authorized individual.
The Security Rule also requires businesses to protect electronic PHI against reasonably anticipated threats and reasonably anticipated violations of the Privacy Rule.
Figure 21.1 HIPAA Security Rule
HIPAA requires businesses to designate a single person who is ultimately responsible for the security of electronic PHI. This person is also responsible for ensuring the business engages in the mandatory security management process under HIPAA. This process starts with a risk analysis of the potential vulnerabilities in the business’s system and management of PHI. The security management process is extensively regulated.
Importantly, HIPAA applies to “covered entities” rather than specific types of information. Personal fitness trackers such as Fitbit, gather what is essentially healthcare data of its consumers. However, Fitbit data can be sold as consumer information because Fitbit is not a covered entity under HIPAA with regard to its consumers. However, if Fitbit gathers PHI of its employees who request medical leaves of absence, then Fitbit is a covered entity as an employer.
Electronic Monitoring
Federal law and most state laws allow employers to monitor their employees’ electronic communications occurring over the employer’s hardware, software, and servers. If the employer provides the computer system, the employer has the right to monitor electronic communications on the system, even if those communications are not work related.
Employers may also monitor communications when employees consent to the monitoring. Therefore, many employers require employees to sign a waiver consenting to private communications sent via the employer’s equipment to be monitored. This helps defend against invasion of privacy claims better than having a policy in the employee handbook alone.
Businesses may also monitor conversations with customers in the ordinary course of business as long as they give notice. As a result, many customer service lines use a recorded message that “this call may be monitored for training purposes” before customers are connected to a customer service agent.
The most important federal law regarding monitoring of electronic communications is the Electronic Communications Privacy Act (ECPA), which was passed by Congress in 1986. ECPA has two parts. The first part is known as the Wiretap Act and the second as the Stored Communications Act. ECPA prohibits the acquisition of the the content of a wire, oral or electronic communication using an electronic, mechanical or other device. ECPA also prohibits the use or disclosure of an unlawfully intercepted communication.
ECPA exposes businesses to multiple levels of liability within a business. For example, personnel in the IT department may be liable for unlawfully intercepting an employee’s email, and human resource personnel who use and disclose the email may be liable as well. Each unlawfully intercepted communication may give rise to liability. Therefore, a handful of communications may result in multiple individuals throughout a business repeatedly violating ECPA.
Workplace Recordings
Although recordings may be useful to capture the content of a conversation, recordings pose legal and business risks to employers. Both employers and employees may violate federal and state wiretapping laws by recording conversations without consent of the other parties. Even with consent, businesses that engage in recording employees and customers damage employee morale and risk losing customers.
Twelve states prohibit recording a conversation unless all parties consent. The majority of states allow customers and employees to hold a business liable for wiretapping violations under the respondeat superior doctrine. As a result, businesses may be liable for their employees’ unlawful recordings if done in the course and scope of employment or done to help the business.
State and federal wiretapping laws carry both civil and criminal penalties. Many state laws provide for treble damages or a statutory damage amount. Federal wiretapping laws impose fines up to one hundred dollars per day or ten thousand dollars, whichever is greater.
Another potential problem for businesses is putting confidential business information at risk. For example, employees may capture trade secrets, proprietary information, or business strategies that the business wants to protect. Recorded information can be compromised or shared against the business’s interests.
Social Media
An employer’s right to monitor electronic communications generally does not include social media. As a result, employers are not entitled to monitor social media accounts through coercion or deceit. For example, an employer cannot require employees to provide passwords to their social media accounts. Employers also cannot log onto the social media accounts of others (including employees) and pose as them to see private accounts.
However, if social media accounts are public, then employers are entitled to review them to the same extent as other members of the public.
Videotaping and Surveillance Cameras
ECPA only protects electronic communications. As a result, ECPA does not apply to video or camera surveillance without an audio component. To avoid violating ECPA, businesses should ensure their security and surveillance cameras do not capture human voices.
Security cameras cannot be used in areas in which employees and customers have a reasonable expectation of privacy. For example, retailers cannot use cameras in changing rooms, restrooms, and locker rooms. Businesses need to place cameras so that private activity cannot, and is not, monitored and recorded.
Businesses engaged in surveillance must use the most limited means available to conduct the surveillance. Companies should have a legitimate business reason to use security cameras, and they need to ensure the surveillance is targeted and limited in duration and scope.
Retailers who use cameras to prevent theft at entryways and cash registers should place cameras in positions that are open and obvious to act as notice to customers. Signs giving express notice are also a best practice to avoid legal liability.
Biometrics and Wearable Technology
Biometrics is the automated identification of people using their physical characteristics. While many metrics can be used, fingerprints and facial recognition are the most common. It is helpful to think of biometrics as measurements of some aspect of a person.
There is a growing trend among businesses to move from traditional time clocks to biometric time clocks that scan fingerprints, retinas, or irises to verify an employee’s identity and clock the employee in and out of work. Biometric time clocks prevent time clock fraud, increase timekeeping efficiency, and increase accuracy of wages.
The type of biometric technology used impacts the privacy rights involved. Technology storing biometric data directly impacts privacy rights more than technology creating a “template” through an algorithm to create a representation of a fingerprint. Whether the technology captures and uses existing personal information or creates a replica has legal consequences.
There have been a series of class action lawsuits against employers that have not notified employees when their biometric identifiers and data were being shared with third party timekeeping vendors. Consent is only a defense for employers if they give notice and obtain consent for all uses of the information.
Another technology trend is the use of wearable technology. Wearable technology is a category of electronic devices that can be worn as accessories, embedded in clothing, implanted in the user’s body, or even tattooed on skin. The devices are intended to be hands-free, are powered by microprocessors and connect with the Internet. Wearable technology includes smartwatches, fitness trackers, and medical devices. It is helpful to think of wearable technology as something that an employee has.
Wearable technology is often used to track employee locations and grant access to areas. Concerned about private companies coercing employees to be microchipped, states are passing laws prohibiting employers to require, coerce, or compel an individual to receive a microchip implant or use wearable technology as a condition of employment. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/21%3A_Workplace_Privacy_and_Information_Security/21.03%3A_Workplace_Privacy.txt |
Information security is one of the fastest growing areas of the law affecting businesses today. Any business that collects, uses, and stores personal information about employees and customers is subject to these laws. Businesses are also increasingly targeted by hackers who seek to steal private information on a large scale.
Security Analysis
A simple but widely-used security model is the CIA Principle or CIA Security Rule, which stands for Confidentiality, Integrity and Availability. The principle is applicable across points of contact from access to a user’s internet history to security of encrypted data across the Internet.
Figure 21.2 CIA Principle
Confidentiality is the ability to hide information from those without authorization to view it. While perhaps the most obvious principle, it is usually the one that is attacked most often. Cryptography and Encryption are methods used to protect confidentiality of data transferred across the Internet.
Integrity is the ability to ensure that data is an accurate and unchanged representation of the original information. One common security attack is to intercept some important data and make changes to it before sending it on to the intended receiver.
Availability is the ability to make information readily accessible to authorized users at all times. Some security attacks attempt to deny access to appropriate users, either to inconvenience them or to achieve another goal such as redirecting business to a competitor.
As discussed in Section 21.3 above, HIPAA’s Security Rule requires covered entities to implement the CIA principle to protect PHI.
Data Breaches
According to the Pew Research Center, almost eighty-five percent of individuals in the US shop online. And most retailers collect customer’s personal and financial data. If a customer uses a form of payment other than cash, then the customer’s personal and financial information will be shared with the business.
Rather than pickpocket an individual consumer, thieves today are targeting businesses to collect personal and financial information of entire consumer sets. Data breaches affect all industries, such as retail, credit bureaus, hospitals, and government agencies. In the first half of 2019, there were over 4.1 billion compromised documents reported as part of only 3,800 disclosed data breaches.
Cybersecurity experts advise that cyber criminals run automated online scripts looking for unsecured databases. While some larger businesses are particularly targeted, cyber criminals are the most successful when targeting small to medium-sized businesses that are unaware of the threat or do not want to spend adequate resources on cybersecurity.
Businesses should be aware, though, that approximately sixty percent of data breaches are the result of human error rather than outdated or insufficient technology. Therefore, by adequately training employees, many data breaches may be avoided. For example, breaches often result from sending emails to the wrong person, responding to phishing attacks, sharing passwords, and leaving computer screens open.
Another big risk is when people use the same password for multiple accounts, such as email accounts, bank accounts, and social media. If the password is obtained by cyber criminals and added to the database of passwords, all the accounts will be at risk.
Big Data
In addition to financial data, businesses collect personal information about consumers and their habits. This is called big data. Consumer information is very valuable because businesses can search the data to identify spending habits to target marketing to likely customers. This reduces costs and increases profit for businesses, especially as e-commerce increases the number of competitors across industries.
Another benefit to mining the data available about consumers is businesses can make more profitable decisions. For example, health insurance companies are heavily invested in big data because they want information about the lifestyle habits of the people they insure and potentially insure. If they know someone is a smoker, eats a lot of sugary foods, or has a sedentary lifestyle, then they can adjust premiums accordingly to minimize their risk. Insurance companies look for trends not just for individuals but also regions, types of occupations (including those with the highest risk of addiction or obesity), and socio-economic status.
Big data is also connected to the Internet of Things. The Internet of Things (IoT) is a system of interrelated computing devices, mechanical and digital machines, objects, animals or people that are provided with unique identifiers and the ability to transfer data over a network without requiring human-to-human or human-to-computer interaction. In other words, the IoT includes everyday devices connected to the internet, including medical devices, appliances, vehicles, and buildings.
As more businesses seek big data about consumers and sell IoT items to consumers, privacy rights are impacted. Data collection in public spaces, such as billboards tracking who stops to read them, may be lawful. However, the location and manner of data collection involves different expectations of privacy. For example, businesses argue that by purchasing and installing “smart home” appliances and products, consumers have consented to surveillance and data collection. Consumer advocacy groups argue that purchasing goods for a particular use does not give consent to businesses to invade consumer privacy in their homes. These issues will be heavily litigated in the years to come.
Transborder Data Transfers
As discussed previously, the EU has a comprehensive set of privacy laws and regulations. The EU has strict limits on the export of all human resources data and consumer information to the US, even when the data export occurs within the same business. To help US businesses comply with the EU laws, the US Department of Commerce negotiated a “safe harbor” of data protection practices that the EU approved. If a US business can certify its compliance with the Safe Harbor Principles, then the EU will approve data transfers to that business.
Security Incident Preparation and Response
Businesses are not able to prevent all data security breaches. However, businesses need to take steps to protect against known and reasonably anticipated threats to confidential information. For businesses without sufficient in-house cybersecurity staff or expertise, Managed Security Service Providers (MSSPs) offer a wide range of security services, including setting up security infrastructure and incident response.
Although federal and state laws vary regarding legal requirements, a business should have a written cybersecurity program that conforms to their industry’s recognized cybersecurity framework.
In general, a cybersecurity program should:
• Protect the security and confidentiality of all electronically stored records containing an employee or customer’s social security number, driver’s license number, state identification card number, credit and debit card information, dates of birth, passwords, and personal information;
• Protect against any anticipated threats or hazards to the security or integrity of the confidential information;
• Provide for reliable and accurate backups of data; and
• Protect against unauthorized access to and acquisition of information likely to result in an employee or customer being exposed to a material risk of identity theft or fraud.
Many laws, including HIPAA, have cybersecurity regulations with which businesses must comply. Certain industries have also issued their own security standards. For example, the Payment Card Industry (PCI) Security Standards Council has issued standards for the safety of credit and debit cardholder data across the globe.
Businesses wanting information about implementing cybersecurity programs that are appropriate for their industry should consider the National Institute of Standards and Technology’s (NIST) Framework for Improving Critical Infrastructure Cybersecurity. The mission of NIST is to help organizations understand and improve their management of cybersecurity risks. It is an excellent place to start when analyzing cybersecurity issues.
21.05: Concluding Thoughts
The internet and technology are changing the world at an incredibly fast pace. With those changes come the challenges to individuals and businesses to maintain privacy and protect personal information. Privacy is an implied Constitutional right deeply impacted by the use of technology. Regardless of type of industry, businesses need to have adequate cybersecurity policies and practices in place to protect confidential business, employee, and customers information. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/21%3A_Workplace_Privacy_and_Information_Security/21.04%3A_Information_Security_Issues.txt |
Learning Objectives
• Distinguish between personal property and real property.
• Understand classifications of property.
• Examine methods of acquisition of real and personal property.
• Examine the landlord-tenant relationship.
• Understand how property is transferred through wills and trusts.
• Explore common land use regulations and environmental laws that businesses face.
22: Property
Property refers to tangible and intangible items that can be owned. Ownership is a concept that means the right to exclude others. Legal systems create a peaceful means to acquire, retain, and divest property, and to settle property disputes. Businesses need to understand the legal system regarding both personal and real property because they often own or lease both. In addition, the government regulates how real property can be used as well as any environmental impact a business has.
Counselor’s Corner Property is regulated by state laws. Because of the variation of laws from state to state, it is imperative that businesses understand all legal requirements where they have property interests. Property can be a great seducer–it seems like owning or possessing property is an asset. However, the liability that comes with it may not be in the business’s best interest. Take the time to assess the financial and legal risks and rewards before acquiring property interests to ensure that you are not overextending yourself. ~Elizabeth H., judge
22.02: Personal Property
Property can be classified as real or personal. Real property is land, and certain things that are attached to it or associated with it. Real property is raw land, such as a forest or a field, as well as buildings, like a house or an office. Additionally, things associated with land, like mineral rights, are also real property. People often talk about real property by using the term real estate, which includes both real property and its related ownership interest.
Figure 22.1 Types of Real Estate Legal Issues
Personal property is property that is not real property. Tangible property is something that can be touched. Moveable, tangible personal property is called chattel. Many businesses exist to sell personal property. For example, the primary purpose of retailers is to sell personal property. Some property can also be described as fungible property. Property that can easily be substituted with identical property is said to be fungible. Types of fungible goods include juices, oil, metals such as steel or aluminum, and physical monetary currency.
Intangible property does not physically exist, but it is still subject to ownership principles, including acquisition, transfer, and sale. For instance, the right to payment under a contract, the right to exclude others from a patented product, and the right to prohibit others from using copyrighted materials are all examples of intangible property.
Personal property can become attached to the land as a fixture. A fixture is something that used to be personal property, but it has become attached to the land so that it is legally a part of the land. Fixtures are treated like real property so when real property is transferred, fixtures are transferred as a part of the real property. A ceiling fan for sale at a store is personal property. However, once the fan is installed in a house, it becomes a fixture and is part of the real property.
Some things that are attached to the land are not fixtures but are part of the real property itself. Imagine a farm with planted corn. The corn crop is an example of real property that can become personal property. While the corn is growing and still attached to the land, the corn is real property. Once it is picked from the stalk, the ear of corn becomes personal property.
Property also can be classified by ownership. Personal and real property can be private or public. Private property is owned by someone or some entity that is not the government, such as individuals, corporations, and partnerships. Private property can include real property like land or buildings, and personal property, such as vehicles, furniture, and computers. Property that is owned by the government is public property. Rocky Mountain National Park is an example of public property that is real property. Public property can also include personal property, such as vehicles and computers owned by state or local governments.
Methods of Acquisition of Personal Property
Personal property may be acquired in several different ways. For example, ownership by production occurs when one produces something. However, if an employee produces a good as part of his or her job, then the employer will own the property, not the employee. Ownership by purchase is the most common method of acquiring property. For example, if a customer buys a good, then the customer owns it through purchase from the manufacturer.
Property may also be gifted. A gift is a voluntary transfer of property. Generally, the donor of the gift must intend to gift the property, the donor must deliver the gift, and the gift must be accepted by the intended recipient. A conditional gift is a gift that requires a condition to be met before the gift will transfer, such as a wedding or graduation.
Property that someone finds can be classified in several ways. If property is abandoned, a person who finds it may claim ownership. However, the original owners of abandoned property must intend to relinquish ownership in it. For example, if someone takes a chair to the landfill, he or she has abandoned the chair. Someone may come along and take legal possession of it. However, if the property is simply lost or mislaid, then the finder must relinquish it once the rightful owner demands its return. Another classification of personal property applicable to found property is treasure trove. A treasure trove is money or precious metals, like gold, which is hidden in the ground or other private place by an unknown owner. Whoever finds a treasure trove becomes the owner unless the true owner (i.e. the person who hid it) comes forward.
Type of Property Description Rights of Finder Rights of Owner
Abandoned Owner intentionally parted with property with intent to relinquish ownership rights Finder acquires rights to the property None
Lost Owner unintentionally parted with possession of the property Finder has rights to the property against everyone except the owner Owner has right to have property returned because owner never lost ownership interest
Mislaid Owner intentionally placed property in a specific place but has forgotten where Finder has no rights and cannot keep property Owner has right to have property returned because owner never lost ownership interest
Treasure Trove Owner intentionally hid property Finder acquires rights to the property unless the owner comes forward Owner must come forward to maintain right to property; if not, finder becomes new owner
Bailment
Sometimes it is necessary to intentionally leave personal property with someone else. A bailor is someone in the rightful possession of personal property who gives the property to someone else to hold, who is called a bailee. A bailment is the arrangement in which the personal property is exchanged. The bailee agrees to accept the property and has the duty to return it. For example, a customer gives clothes to a dry cleaner. The dry cleaner is a bailee and has a duty to return the clothes (personal property) upon demand by the customer, who is the bailor.
Bailments may be voluntary or involuntary. A voluntary bailment is created when intention exists to create the bailment, as described in the dry cleaner example above. An involuntary bailment is created when someone finds lost or mislaid property. The finder may not destroy the property, though the duties that he or she owes regarding the property may vary from state to state.
Bailment is common in business, including placing packages with common carriers for delivery, warehousing goods with a third party, or taking clients’ or customers’ automobiles in a valet service.
The duty of care that the bailee owes to a bailor depends on the nature and value of the property involved, as well as who benefits from the bailment. In general, a higher standard of care is required for more valuable property. Damages in a bailment case are based on the retail replacement value of the property. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/22%3A_Property/22.01%3A_Introduction.txt |
Real property is land, and certain things that are attached to or associated with it. Real property includes undeveloped land, like a field, and it includes buildings, such as houses, and office buildings. Real property also includes things associated with the land, like subsurface rights (rights to minerals and things found beneath the surface).
Methods of Acquisition
Real property may be acquired by purchase, inheritance, gift, or through adverse possession. Ownership rights are transferred by title. Ownership of real property means that the owner has the right to possess the property, as well as the right to exclude others, within the boundaries of the law. If someone substantially interferes with the use and enjoyment of real property, the owner may bring a nuisance claim. Similarly, the owner may bring a trespass claim against those who enter the land without consent or permission.
Purchase
Land owners may convey or sell part or all of their land interests. Different types of deeds convey different types of interests. A quitclaim deed, for instance, conveys whatever interests in title that the grantor has in the property to the party to whom the quitclaim is given. That means if the grantor has no interests in the real property, a conveyance by quitclaim will not grant any interests in the property. By comparison, a warranty deed conveys title and the seller gives a warranty against defects in title as well as encumbrances. Buyers typically demand a warranty deed when they purchase property because the seller assumes the risk of the title not being clear.
After title is transferred by the deed, the deed is recorded in the county where the property is located. Recording a deed is important because it places others on notice about who owns the property. States have different rules about who is considered the legitimate owner when a conflict in ownership claim exists. A bona fide purchaser is a purchaser who takes title in good faith, with no knowledge of competing claims to title. Many states recognize a bona fide purchaser’s rights to ownership over those who did not properly record a deed.
Inheritance
Another common way in which real property may be obtained is through inheritance. Real property may be bequeathed through a will or may be transferred by state law when someone dies without a will. Generally speaking, people have the right to dispose of their property as they wish when they die, providing that their will or other transfer instrument meets their state’s requirements for validity. If someone dies without living relatives, the government becomes the owner of the property.
Gift
Real property may also be acquired through a gift. A gift is valid when:
1. The person giving property intends to make the gift;
2. The person delivers the deed to the recipient; and
3. The recipient accepts the gift.
If one of these elements is not met, then title will not be conveyed.
Figure 22.2 Comparison of Contract and Gift
Adverse Possession
A less common way to acquire real property is through the doctrine of adverse possession. Adverse possession is when someone who is not the owner of real property has claimed the real property for his own. This is referred to as “squatter’s rights.” If land sits idle at the owner’s hands but someone else puts it to use, then the law may favor the user’s claim to the land over that of the actual owner. Adverse possession claims often occur around property lines, where one party has routinely used another’s property because a fence has been misplaced.
Figure 22.3 Adverse Possession Cartoon
Interests and Scope
Owning real property carries many responsibilities, as well as the potential for great profit and great liability. It is important to learn how to protect against potential liability of property ownership. For instance, if a toxic waste site is discovered on real property, the owner may be liable for its cleanup, even if he or she did not realize that such a site was there when purchasing the land. Each buyer of real property has a duty to exercise due diligence when purchasing land. A purchaser should never agree to buy land “sight unseen” or without a professional inspector.
It is important to know the duties of landowners, how to limit liability associated with the ownership of land, and when severance of liability occurs.
Duties of Landowners
Landowners owe different duties to different types of people who enter their land. These responsibilities vary, depending on whether the person is a trespasser, a licensee, or an invitee.
A trespasser is a person who intentionally enters the land of another without permission. A landowner has a duty to not intentionally injure a trespasser. For instance, booby traps and pitfalls are illegal. Trespassers injured from such traps have valid claims against the landowner. However, if trespassers are injured from unknown or unforeseeable dangers, the owner is not usually liable.
A licensee is someone who has permission to be on the land. Landowners have a higher duty of care to such a person. Licensees include delivery people, meter readers, and utility workers. A landowner must not intentionally injure a licensee and must warn the licensee of known defects. For example, if a landowner knows that the steps to his or her porch are icy, he or she has a duty to warn a licensee that those steps are icy. Failure to do so may result in liability for the landowner.
An invitee is someone who has entered real property by invitation. Businesses and public places that want members of the community to visit have issued invitations to the public. Landowners must inspect their property for defects, correct those defects when found, and warn invitees about such defects. For example, a grocery store must clean up spills as quickly as possible and put up a “caution” sign in that area.
Ownership Interests in Real Property
Different types of interests may be owned in real property. For example, real property may be owned without restriction, subject only to local, state, and federal laws. Sometimes ownership interests may be narrower, subject to conditions, the violation of which can lead to loss of those ownership interests.
The most complete ownership interest recognized by law is called fee simple absolute. This ownership allows the owner complete control over the land and lasts until the owner dies or conveys the property to someone else. Generally, if someone wants to buy real property, he or she is looking to buy property in fee simple absolute.
Compare that with a defeasible fee. A fee simple defeasible is subject to a condition of ownership or to some future event. For instance, if an owner donates land to a city “so long as it is used as a public greenway,” then the land would be owned in defeasible fee by the city as long as it maintains it as a public greenway. Once the condition is violated, the land would revert back to either the original owner or whoever owned the reversion interest, which is a future interest in real property.
Another ownership interest is a life estate. This interest is measured by the life of the owner. For example, a person could grant ownership rights in real property to a parent for the length of his or her life, but then the property would be returned upon the parent’s death. A common investment, known as a reverse mortgage, employs the concept of life estate. A reverse mortgage is an arrangement where the purchaser of real property agrees to allow the seller of the property to retain possession of the property for a specified period of time (such as the remainder of his or her life) in exchange for the ability to purchase the property at today’s price. These arrangements essentially gamble on life expectancies of the sellers of real property by granting life estates to them in the property.
Property can be owned by more than one owner. Several types of co-ownership interests are recognized in law. These ownership interests are important for matters of possession, right to transfer, right to profits from the land, and liability. For example, tenancy in common describes an ownership interest in which all owners have an equal right to possess the whole property. Compare this to joint tenancy, in which the surviving owner has the right of survivorship. If one of the owners dies, his or her property interests automatically transfers to the remaining owner(s).
These different interests are created by specific wording in the instrument of conveyance. An owner in tenancy in common may sell or transfer his or her rights without seeking permission from the other owners. This is because owners in a tenancy in common have the unilateral right to transfer their interests in property. Conversely, to transfer one’s interests in a joint tenancy, the consent and approval of the other owners is required.
Scope of Interests in Real Property
Scope of ownership determines what can (or cannot) be done with the land. The surface of the land and the buildings that are attached to the land are what most people think of about ownership of real property. However, land interests also include subsurface or mineral rights, and right to light or to a view. Moreover, water rights are granted differently, depending on whether the property is in the western or the eastern United States. Additionally, easements (the right to cross or otherwise use someone’s land for a specified purpose) and covenants (guides or restraints on how one may build on their land) grant certain rights to non-possessors of land.
Subsurface Rights
Subsurface or mineral rights are rights to the substances beneath the actual surface of the land. Purchasing mineral rights allows the owner to extract and sell whatever exists under the surface of the land, such as oil, natural gas, and gold.
Water Rights
Water rights are determined in two different ways in the United States. Generally speaking, states east of the Mississippi River follow a riparian water rights doctrine, which means that those who live next to the water have a right to use the water. The water is shared among the riparian owners. However, most western states use the prior appropriation doctrine, which grants rights to those who used those rights “first in time.” Under this concept, the use must be beneficial, but the owner of the right need not be an adjacent landowner. This policy has resulted in claims by “downstream” users having priority over landowners where water runs through the land. For example, casinos in Las Vegas, Nevada may have priority of water rights over ranchers in Colorado where a tributary runs through the ranch. Prior appropriation is a “use it or lose it” doctrine.
Easements and Covenants
Easements and covenants are nonpossessory interests in real property. An easement can be express or implied and it gives people the right to use another’s land for a particular purpose. For example, a common easement is for utility companies to enter private property to maintain poles and power lines. Other examples include sidewalks and a landlocked property having an easement across another piece of property for the purpose of a driveway or walkway.
A covenant is a voluntary restriction on the use of land. Common covenants are homeowners associations’ rules, which restrict the rights of the owners to use their land in certain ways, often for aesthetic purposes. For instance, such covenants might require houses subject to the covenant to be painted only in certain approved colors, or they might contain prohibitions against building swimming pools.
Some covenants and easements “run with the land,” which means that the restrictions will apply to subsequent owners of the property. Whether a covenant or easement runs with the land depends on the type of interest granted.
Landlord-Tenant Relationships
A leasehold interest also may be created in real property. A tenant has the right to exclusive possession of the real property and the duty to follow the rules of occupancy set out by the landlord. The landlord has the right to be paid rent and the duty to ensure that the premises are habitable. If one party does not perform under the lease as required, the other party may seek a legal remedy for breach of contract. Most state laws also impose duties on landlords to maintain safe and habitable conditions on the property. Tenants also have a duty to use the premises properly and not to damage the property beyond normal wear and tear.
Different types of tenancies may be created:
Type of Tenancy Description
Tenancy for years
• Lease lasts for a specified period of time;
• Called tenancy for years regardless of how long the tenancy is for;
• Once the time expires, so does the tenancy
Periodic tenancy
• Lease states when rent is due but does not have a set duration;
• E.g. a month-to-month lease
Tenancy at will
• Lease may be terminated at any time by landlord or tenant;
• Tenancy often created through actions of parties rather than written lease
Tenancy at Sufferance
• Tenant remains on the property after the right of possession has ended and without the landlord’s consent;
• Law views tenant as trespasser who is responsible for paying rent during holdover period;
• Most states require landlord to evict tenant through formal eviction or unlawful detainer proceedings
Tenancies may be created for residential or commercial purposes. Commercial leases typically last for longer periods of time than residential leases. Many of the same responsibilities and duties exist with commercial leases, but there are some important differences. For example, a commercial tenant may demand that the landlord refuse to rent to a competitor of the tenant within the same building.
Lease interests are assignable unless those rights are expressly restricted by agreement. This means that the rights conveyed by the lease may be transferred to another party by assignment, unless expressly prohibited by the lease. Common restrictions on assignment in residential leases is a no-subletting clause. Just as the owner of real property may sell any or all of his or her interests, any ownership interest in real property may also be leased. For example, someone who owns the subsurface rights of land may lease the right to drill for oil or gas to another. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/22%3A_Property/22.03%3A_Real_Property.txt |
Both real and personal property may be transferred to another owner through wills and trusts. Although most people think of wills and trusts as a tool for conveying property owned by individuals, businesses property often needs to be transferred when the business owner dies. This is especially true for sole proprietorships and partnerships.
A will is a document by which an individual directs his or her estate to be distributed upon death. Wills must be in writing and signed by the individual(s) making them. Although state laws regarding wills vary slightly, most states require:
Requirement Description
Legal age
• The individual must be 18 (16 in Louisiana, 14 in Georgia, under 18 in the military)
Testamentary intent
• Must make clear that document is a will through words such as “last will and testament”
Testamentary capacity
• The individual must be “of sound mind” and understand that he or she is creating a will, what property is being transferred & to whom it is being given
Signature
• The individual must sign the document
Witnesses
• There must be 2 adult witnesses to the individual signing the will;
• Most states do not require the will to be notarized but this step is recognized as a best legal practice
A trust is a property interest held by one person or entity at the request of another for the benefit of a third party. For a trust to be valid, it must involve specific property, reflect the person’s or entity’s intent, and be created for a lawful purpose. Trusts are very popular for leaving property to benefit children who are under 18 years old, elderly, and people with disabilities.
When planning how to distribute property upon death, it is important to understand the difference between probate and non-probate assets. Probate is the process through which a court determines how to distribute property after someone dies. Some assets are distributed to heirs by the court (probate assets) and some assets bypass the court process and go directly to beneficiaries (non-probate assets). Probate assets generally are subject to inheritance taxes and distribution can be delayed until the court orders the distribution of the assets. Because of these drawbacks, many individuals prefer non-probate assets.
Probate Assets Non-Probate Assets
• Real property titled solely in the decedent’s name or held in tenancy in common
• Personal property, such as jewelry, furniture & vehicles
• Bank accounts solely in the decedent’s name
• Interest in a partnership, corporation or limited liability company
• Life insurance policies or brokerage accounts identifying the decedent or his or her estate as a beneficiary
• Real property held in joint tenancy or tenancy by the entirety
• Bank or brokerage accounts held in joint tenancy or with payable on death (POD) or transfer on death (TOD) beneficiaries
• Real property, personal property, and money held in a trust
• Life insurance or brokerage accounts identifying someone other than the decedent as a beneficiary
• Retirement accounts
Death of a property owner impacts the ability to transfer property. The ownership interest dictates how the property may be transferred.
Type of Ownership Death of Owner Transfer Where Available
Tenancy in Common Owner’s interest passes to heirs Owner may transfer interest without agreement of co-owners All states
Joint Tenancy Owner’s interest passes to the remaining joint tenants as non-probate asset Owner may not transfer interest without agreement of co-owners All states
Tenancy by Entirety Owner’s interest passes to the surviving spouse Owner may not transfer interest without agreement of spouse Approximately half of the states
Community Property Half of owner’s interest passes to the surviving spouse & other half passes to other heirs Owner may not transfer interest without agreement of spouse Only 9 states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas & Washington
If someone dies without a will or trust, the probate court will determine:
1. The nature and value of the decedent’s estate;
2. The nature and value of any outstanding debts and tax obligations;
3. Whether the decedent has any heirs;
4. The identity of the heirs and their relationship to the decedent; and
5. What, if anything, the heirs are entitled to receive from the decedent’s estate.
The essential role of the probate court is to ensure that the deceased person’s creditors are paid and that any remaining assets are distributed to the proper beneficiaries. However, this process takes time and costs money from the deceased person’s estate. And there is no guarantee that the deceased person intended his or her property to be distributed based on the state’s rules on who qualifies as an heir and what they are entitled to receive. Business assets owned by the deceased person may complicate the probate process even more.
22.05: Land Use Regulation
A nuisance is a condition or situation, such as a loud noise or foul odor, that interferes with the use or enjoyment of property. Courts balance the utility of the act that is causing the problem against the harm done to neighboring property owners. For example, restrictions exist on when manufacturing plants may operate to not interfere with sleeping patterns of neighbors.
Nuisance can be both intentional and unintentional, as well as public or private. A public nuisance is an unreasonable interference with a right common to the general public, such as a condition dangerous to the public’s health or a restriction on the public’s access to public property. Many jurisdictions also include conduct that is offensive to the community’s moral standard to regulate the placement of adult industries in residential neighborhoods. Public nuisance claims often include manufacturing noises, smoke and smells. A private nuisance is a condition that interferes with a person’s enjoyment of their property that does not involve a trespass. For example, cigarette smoke entering a neighbor’s house from a smoker on an adjacent property is a private nuisance.
Figure 22.4 Public Nuisance Street Sign
Figure 22.5 Private Nuisance Example
Most states have passed laws that allow local governments to regulate zoning. Zoning ordinances are laws passed by counties, cities, and municipalities that regulate land development. These ordinances determine whether commercial or residential buildings can be built in an area, how tall buildings may be, and how much green space must be maintained. They also apply to existing buildings and regulate whether a building may be converted from residential property to commercial, as well as what type of commercial property it may be. For example, many zoning ordinances regulate the types of businesses that may be located next to schools and hospitals.
Eminent domain is the power of the government to take private property for public use. A governmental entity may need to build or expand highways, public transport systems, or public housing. To address the public’s need, the government can take private property and use it for the good of the community. All levels of government–federal, state, and local–have the power of eminent domain. The Fifth Amendment of the US Constitution requires that any owners of private property taken for public use must be given “just compensation.” Just compensation means fair market value for the land. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/22%3A_Property/22.04%3A_Wills_and_Trusts.txt |
Federal and state governments have passed environmental laws to limit pollution and protect the health and welfare of the public. Although most people are supportive of these laws in theory, the practical implementation of them has been controversial. Underlying the political debate is the question, how should the law balance the costs and benefits of environmental decisions?
Clean Air Act
In 1963, Congress passed the Clean Air Act to regulate air pollution. Under the Clean Air Act, the Environmental Protection Agency (EPA) has the authority to regulate both the total amount of existing air pollution and its ongoing production. The Clean Air Act was passed to address concerns of global warming and acid rain.
Figure 22.6 EPA Seal
The Clean Air Act requires the EPA to set national air quality standards that protect public health and provide an adequate margin of safety without regard to cost and to implement them if appropriate and necessary. This “without regard to cost” directive has been heavily litigated. In 2015, the US Supreme Court ruled that the EPA must consider costs as part of its analysis of whether the standards are “appropriate” and necessary. In other words, a regulation is not “appropriate” if it does more harm than good.
The Clean Air Act is a federal law that is implemented through the states. After the EPA sets air quality standards, states must enforce them. States may implement more stringent air quality standards than the EPA requires, but they cannot do less. Therefore, businesses must comply with both state and federal agencies to ensure their compliance with the Clean Air Act.
A controversial aspect of the Clean Air Act is that it allows for trading of credits. For example, a manufacturer who removes more carbon monoxide than necessary from its emissions is given a “credit” from the EPA. These credits can then be sold to another manufacturer that does not remove enough to be compliant with the law. The rationale is that credits make it profitable for manufacturers to invest in technology that pollutes less than is legally required. By giving a market incentive to industries to protect the environment, there will be less need for governmental enforcement.
The Clean Air Act imposes daily fines for emission violations, as well as punitive damages and criminal liability for corporate officers who knowingly and willfully violate the law. As a result, the Clean Air Act is a law that manufacturers must take seriously.
Figure 22.7 Common Air Pollutants
Clean Water Act
Congress passed the Clean Water Act in 1972 to regulate water quality of navigable waters. Similar to the Clean Air Act, the EPA sets standards that are enforced by the states. The intent of the Clean Water Act is to keep water clean for recreational use and to protect fish and wildlife. It requires a discharge permit to release waste into navigable water.
Figure 22.8 Photo of discharge of industrial waste into river
The EPA sets limits, by industry, on the amount of each type of pollution that can be discharged in a given area, as well as the type of technology that can be used to treat water. As a result, the two biggest issues when enforcing the Clean Water Act are (1) is the waterway navigable? and (2) what is the best available technology that each industry can use to reduce pollution. Both issues are heavily litigated.
The Clean Water Act also requires the EPA to set national standards for water quality in general. It is worth noting that water quality standards vary depending on the use of the water. Water quality for drinking is the highest, with wildlife and recreation higher than irrigation and industry. As a result, even businesses that are not discharging waste into navigable waterways are subject to EPA standards of water quality on their premises. For example, a retailer must comply with water quality requirements in its drinking fountains and bathrooms.
Like the Clean Air Act, the Clean Water Act imposes daily fines for emission violations, as well as punitive damages and criminal liability for corporate officers who knowingly and willfully violate the law.
Waste Disposal
Waste disposal, especially of chemicals, has been an area of increased regulation over the past decades. The disposal of ordinary garbage is primarily regulated by the states. However, the federal government sets minimum standards for landfills and regulates how states manage garbage. Most of these regulations are “invisible” to businesses and individuals.
Figure 22.9 Improper Toxic Waste Disposal
Toxic waste, on the other hand, directly impacts manufacturers. In 1976 Congress passed several laws to address the problem of industrial waste and toxic waste. Toxic waste is hazardous or poisonous substances that cause an increase in the death rate or serious irreversible illnesses. Toxic waste includes arsenic, asbestos, clinical waste (i.e. syringes), cyanide, lead, and mercury. Many of these chemicals are found in batteries, electronics, and household cleaners. Manufacturers have a “cradle to grave” responsibility for all hazardous and toxic waste. This means that hazardous waste must be (1) tracked from creation to final disposal and (2) disposed of at a certified facility.
To clean up hazardous waste that was illegally dumped in the past, Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), which is popularly known as “Superfund.” The philosophy of Superfund is that the polluter pays. Therefore, former and current owners of a site on which hazardous waste is found or who transported waste to the site are strictly liable for remediation of the land. The law has an exception for innocent landowners who unknowingly purchased the land. However, that exception is narrowly applied.
Environmental Impact Statements
The National Environmental Policy Act (NEPA) requires all federal agencies to prepare an environmental impact statement (EIS) for every major federal action that significantly affects the quality of the human environment. An EIS is required not only for actions by the federal government, but also activities regulated or approved by the government. Therefore, private businesses that need federal approval to open or expand their operations are subject to this requirement. For example, an EIS was needed before expanding the Snowmass ski area in Aspen because the US Forest Service was required to approve the expansion.
An EIS must include:
• A description of the environmental impact of the proposed action;
• An estimate of the energy requirements for the project;
• A description of potential adverse effects on the urban quality, including historic and cultural resources;
• Identification of the short-term and long-term impact on the environment;
• A description of any irreversible impact on the environment;
• A plan of how to mitigate any adverse environmental impact; and
• A discussion of possible alternatives.
The process of preparing an EIS can be long and expensive. After an EIS is written, the federal agency must allow for public comments and hold a hearing. Therefore, a private business may have its EIS scrutinized and commented on by interest groups and competitors before receiving federal approval. There is also a risk to the business that the government agency denies the business’s request based on public comments and concerns.
22.07: Concluding Thoughts
Property is classified as real property or personal property, tangible or intangible, and private or public. Personal property can be transformed into real property when it is affixed to the land. Real property can be transformed into personal property when it is severed from the land. Personal property can be acquired for ownership through production, purchase, or gift or, in certain circumstances, by finding it. Bailments are legal arrangements in which the rightful possessor of personal property leaves the property with someone else who agrees to hold it and return it on demand.
When thinking about acquiring property, it is important to understand the rights and duties associated with acquiring it, the protections afforded to the owner, and how to transfer it to another party at the time of sale, lease, or licensing the right to use it. Real property includes land and the buildings attached to it, as well as the minerals below it. Personal property is everything else. Because property ownership includes exposure to liability, businesses need to take steps to protect people on their real property from hazards. Businesses are also subject to land use regulations and environmental laws for the use of their real property.
Real and personal property may be transferred to another owner through wills and trusts upon the death of the original owner. Businesses property often needs to be transferred when the business owner dies, and not having a will or trust in place to convey the property can complicate the probate process. Non-probate assets are popular to avoid inheritance taxes and delays in distributing assets.
Environmental laws have a big impact on businesses, especially manufacturers. The Clean Air Act and the Clean Water Act are federal laws that are implemented through the states, so businesses must work with both state and federal governments to ensure they are legally compliant. Businesses that want to open or expand their operations are required to prepare an environmental impact statement if they need federal approval. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/22%3A_Property/22.06%3A_Environmental_Law.txt |
Learning Objectives
• Understand what intellectual property is.
• Define the four types of intellectual property.
• Explore the Constitutional roots for providing legal protection to intellectual property.
23: Intellectual Property
Regardless of size and industry, a business’s Intellectual Property (IP) is often more valuable than its physical assets. In fact, Fortune 500 companies have 45-75% of their assets tied to IP. Companies invest tremendous resources in developing innovative new products and services. Intellectual property law prevents competitors from immediately profiting from another’s invention and provides incentives for continued innovation.
Counselor’s Corner Intellectual property is one of a business’s most important assets. But it can also be hard to define and, thus, hard to protect. A good IP attorney will understand the nuances of your invention and help you identify ways to get the most protection for your intellectual property. You may find that working with her contributes to your inventive process! ~ Jenny C., attorney
23.02: Intellectual Property
Intellectual Property is a form of intangible property representing the commercially valuable product of the human mind. IP can be in either an abstract or concrete form. For example, a composer may have IP interests to both the abstract sound of the music he or she composed, as well as the concrete sheet music that instructs musicians how to play the musical composition.
Protection of IP rights generally fall into one of four categories: patents, trade secrets, copyrights, and trademarks.
Patent Trade Secret Copyright Trademark
Protects Inventions & methods Valuable secrets that give a business a competitive advantage Tangible expression of an idea; but not the idea itself Words & symbols used to identify products or services
Elements Novel & non-obvious Distinctiveness Original expression Reasonable measures in place to protect secrecy
Filing Requirements Application must be approved by USPTO Information must be kept secret but no formal process is necessary Protection is automatic once creative expression takes tangible form; does not have to be filed with the CO but receives greater protection if it is Mark is used in commerce; does not have to be filed with USPTO but receives greater protection if it is
Duration 20 years (14 years for a design patent) Forever, as long as information is kept secret 70 years after death of author, 95 years from publication, or 120 years from creation (whichever is shorter) 10 years but can be renewed an unlimited number of times as long as mark is still being used
Type of Law Federal only State (Economic Espionage Act may provide some federal protection depending on facts of case) Federal only Federal and state
Type of Enforcement Action Infringement Misappropriation Infringement Infringement & dilution
Criminal Liability No Yes Yes Yes
Expensive Yes No No Maybe (depends on policing costs)
Search Required for Existing IP Holders Yes No No Yes
Different types of IP may attach to aspects of the same product or service. For example, Coca-Cola has trademarks for its name and logo, a patent for the shape of its original glass bottle, a copyright for its commercial jingle, and a trade secret for its cola recipe.
Figure 23.1 Examples of Coca-Cola trademarks
23.03: Constitutional Roots
The US Patent and Trademark Office (USPTO) was established to protect patents as enumerated in Article I, Section 8 of the Constitution. That clause, known as the Copyright Clause, says that Congress may “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.” The USPTO website has a searchable database for trademarks and patents.
The Copyright Clause directs the federal government to protect certain products of the mind, just as much as it protects personal land or money. The Copyright Clause essentially allows the government to create a special kind of monopoly around IP. For example, a pharmaceutical company invents a drug and applies for a patent. If the patent is granted, then the company can charge as much as it needs to recover its research and development costs because competitors are shut out of that drug market by virtue of the patent. Violations of patent law carry severe penalties.
How can Congress outlaw most monopolies when the Constitution grants monopolies for IP? The answer lies in the genius of the Copyright Clause itself. As in all monopolies, there are two sides: the producer and the consumer. The producer wants the monopoly to last as long as possible, while the consumer wants the monopoly to end as quickly as possible. The Copyright Clause strikes a compromise between the producer and the consumer in two ways.
First, the Clause states that Congress can grant the monopoly only to “promote the progress of Science and Useful Arts,” which is a very specific purpose. Note that making an inventor rich is not the purpose. Rather, the purpose is progress. Granting temporary monopolies encourages progress by providing a financial incentive to producers. Singers, songwriters, inventors, drug companies, and manufacturers invent and create in the hope of making money. If they were not protected, they would either not invent at all or would simply do it for themselves, without sharing the fruits of their labor with the rest of society.
Second, the Clause states whatever monopoly Congress grants has to be for a “limited time.” Congress makes the decision on how long a monopoly can last based on how best to promote progress. When the monopoly ends, science is advanced again because others can freely copy and improve upon the producer’s products. Society benefits greatly from the expiration of IP monopolies. Important drugs such as aspirin and penicillin, for example, can now be purchased for pennies and are accessible to the entire human population. Similarly, literary works, such as Shakespeare’s Hamlet or Beethoven’s Fifth Symphony, can be performed and enjoyed by anyone at any time without seeking permission or paying royalties because copyrights last for only seventy years after the death of the author or creator. These inventions and works are now in the public domain to be enjoyed by all. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/23%3A_Intellectual_Property/23.01%3A_Introduction.txt |
A patent is the exclusive right to make, use or sell an invention for a specified period of time (usually seventeen years), granted by the federal government to the inventor. A patent holder owns a patent. Patents may be legally sold to others. Therefore, an inventor may sell a patent to others, which ends his or her property interest in the invention.
Many inventors and designers work for employers in creative and inventive capacities. If an employee invents something as part of his or her employment, then the employer is the patent holder. This arrangement allows innovative ideas to be adequately funded and to prevent employees working against the best interests of their employers. However, if an employee invents something outside of work on his or her own time, and the invention is not related to his or her employment, then the employee is the patent holder.
To apply for a patent, an inventor must meet two requirements: the invention must be (1) novel and (2) non-obvious. To be novel, the invention must not have been previously invented and must not come from a trivial improvement to an existing invention. In other words, it must not have been previously known or used. To be non-obvious, the invention must not be obvious to a reasonable person in an appropriate field with ordinary skill. In other words, patents reward creativity that results in something new and is not considered common knowledge by someone in the industry.
Patent Requirement Description
Novel New; cannot be something that was already invented or in use
Non-obvious Not common knowledge to a reasonable person with ordinary skills in the industry
Not all things can be patented. An idea alone (without a definite description) cannot be patented. Similarly, the laws of nature (such as gravity) and things that occur naturally (such as DNA) cannot be patented. This is because some items found in nature are not the result of the human mind or creativity. If not the product of human invention, then a patent cannot apply. This distinction can be narrow in some industries. For example, DNA cannot be patented but the scientific process of synthetically reproducing DNA can be patented. Likewise, oil cannot be patented but the process for extracting it from the ground can be.
Types of Patents
Three types of patents exist. The most common type of patent is the utility patent. Utility patents are granted for a useful innovative machine, process, manufacture, composition of matter (such as a new chemical) or an improvement to an existing item or process. These patents usually are granted for twenty years.
A design patent may be granted for new, original, and ornamental designs for an article of manufacture. This type of patent protects a product’s appearance or nonfunctional aspects. These patents last for only fourteen years.
A plant patent covers inventions or discoveries of asexually reproduced plants (e.g., plants produced through methods such as grafting, root cuttings, and budding). In other words, the plant is able to multiply without using seeds. For example, one company patented a unique rose whose color combination did not exist in nature.
Type of Patent Description
Utility
• Protects the way an invention is used and operates
• Useful innovative machine (e.g. table saw), process (e.g. software program), manufacture (e.g. thumb drive that fits into USB port), composition of matter (e.g. new chemical) or an improvement to an existing item or process
• Must be useful and functional
• Inventor does not have to show invention has monetary value
• Lasts 20 years (unless patent granted before June 8, 1995)
Design
• Protects appearance of product (e.g. Jeep’s grill design)
• Lasts 14 years
Plant
• Protects any distinct and new variety of plant
• Plant cannot have been sold or released in US for more than 1 year
• Involves many controversial patents involving genetically modified plants used for food
• Lasts 20 years
Patent Enforcement
The USPTO grants property rights to patent holders within the United States. Patent law is complicated, and attorneys who wish to practice patent law must have an engineering or science background and pass a separate patent bar exam. When an application is filed, the USPTO assigns a patent examiner to decide whether the patent application should be approved. While the application is pending, the applicant is permitted to use the term “patent pending” in marketing the product to warn others that a patent claim has been filed. Even after a patent has been issued by the USPTO, however, the patent is only presumed to be valid. If someone challenges a patent in a lawsuit, final validity rests with the US federal courts.
In the last decade there has been more than a 400 percent increase in the number of patents filed, resulting in a multiyear delay in processing applications. An increase in the number of business method patents contributed to this dramatic increase in patent applications. A business method patent seeks to monopolize a new way of conducting a business process. For example, “Patent Filing for One-Click Web Ordering” describes a method of e-commerce by which a customer can order an item and pay for it immediately with just one click of a button. This one-click patent was granted to Amazon.com. Amazon licensed the patent to Apple so that it could feature one-click on its website. This in turn allowed Amazon to recover some of its development costs from Apple, which also wanted to use the technology.
IP protection sometimes involves controversial issues. For example, pharmaceutical companies rely on patent law to protect their massive investment in research and development of new drugs. For the few drugs that eventually get governmental approval and commercial success, manufacturers seek to extract the highest possible price during the period of patent monopoly. For example, antiretroviral drugs has greatly extended the lives of HIV/AIDS patients, but the drugs cost between \$10,000 and \$12,000 per year in the United States. In many developing nations, individuals cannot afford US prices. Therefore, some governments have declared national health emergencies, a procedure under international treaties called compulsory licensing, that forces drug companies to license the formula to generic drugmakers. As a result, Cipla, a generic drug manufacturer in India, manufactures the same antiretrovirals for about \$350 a year.
Outside the United States, a patent granted by the USPTO does not automatically protect the inventor’s interest in that property. Instead, IP is protected by a series of international conventions. Because international law is only binding on nations who agree to be bound by it, IP is not protected internationally in nations that have not signed the conventions.
Patent Infringement
If someone uses a patented invention without permission from the patent holder, then the user violates the patent holder’s rights. Patent infringement is the act of making, using, selling, or offering to sell a patented invention without the permission of the patent holder. Patent infringement can be either direct or indirect. Direct infringement occurs when someone copies and uses an invention, or uses an invention with a slight variation or addition. Indirect infringement occurs when someone “designs around” a patent by creating a product that is substantially the same and performs a similar function.
If patent holders successfully sue for patent infringement, they may be entitled to an injunction forcing their competitors to stop using the invention, treble damages, costs, and attorney’s fees. The most common defense to patent infringement claims is to challenge the validity of the patent. Given the scientific and technical nature of patent cases, litigating these cases is expensive.
As a result of the cost of litigation, patent trolls exist in certain industries such as technology and pharmaceuticals. Patent trolls are individuals or companies who obtain the rights to one or more patents to profit by means of licensing or litigation, rather than by producing their own goods or services. The main source of revenue for patent trolls comes from suing companies for infringement and hoping the companies settle. For a relatively minor cost of applying for a patent and attorneys’ fees, patent trolls look for a big payout. For example, NTP, a patent troll, sued the maker of BlackBerry, claiming patent infringement for the technology used to deliver the BlackBerry’s push email feature. Faced with a potential shutdown of service, BlackBerry settled the case for more than six hundred million dollars.
Over the past decade, there have been some legal developments to help protect companies from patent trolls. For example, the US Supreme Court unanimously ruled that patent infringement cases must be filed in the federal court where the defending company is based rather than a court of the plaintiff’s choice. This reduces the exposure and cost to the company of defending against cases filed across the nation, and for the patent trolls to “forum shop” for districts they believe will be more beneficial to their claims.
More companies are choosing to fight patent trolls in court rather than payout. For example, Apple has been defending itself in court against patent troll VirnetX over patents that VirnetX obtained in FaceTime and iMessage delivery systems. Although Apple has a large enough budget to engage in protracted litigation, not every company does. Therefore, patent trolls often target start-up companies hoping that the economic threat of a lawsuit encourages quick settlements.
23.05: Trade Secrets
A Trade secret is a formula, process, device, or other business information that is kept confidential to maintain an advantage over competitors. The scope of trade secret protection goes well beyond patent law. Unlike patent law, protection under trade secret law is not tied to the information’s novelty. Instead, the essence of a trade secret is its relative secrecy.
Elements of a Trade Secret Information that:
1. Is not generally known or ascertainable;
2. Provides a competitive advantage;
3. Has been developed at the owner’s expense & is used continuously in the owner’s business; and
4. The owner intends to keep it confidential.
A trade secret is, in short, secret information. This information may include a process, formula, pattern, program, device, method, technique, or compilation. For many companies, lists of suppliers, costs, margins, and customers are all trade secrets. Soft drink recipes, the Big Mac’s special sauce, and even the combination of wood that is used in the burning process to make Budweiser beer are all trade secrets. Additionally, Google’s algorithm for conducting web searches is a trade secret.
Trade secrets are unlike patents in that with a patent, the inventor must specifically disclose in the application the details of the invention. Thus, the inventor has not protected the secret of the invention. However, in exchange for this disclosure, a patent owner has a legal monopoly over the property for a specified period of time. Even if others discover how the invention works (which often is not difficult because patent applications are public record), they are prohibited from making, using, or selling it without the patent holder’s permission. After the patent expires, the patent holder no longer has a property right to exclude others.
Trade secrets can last forever if the owner of the secret keeps it a secret. If someone uses lawful means to uncover the secret, then the secret is no longer protected. Therefore, some companies would rather not make their confidential information public knowledge through a patent application in return for a temporary monopoly. Instead, they choose to protect the confidentiality of the information or product internally with the hope of a longer period of protection. For example, Google protects its search algorithm as a trade secret to maintain a competitive advantage in the market for as long as possible.
A claim for misappropriation may be brought when a trade secret has been wrongfully obtained, such as through corporate espionage or bribery. Generally, misappropriation occurs if the secret was acquired by improper means, or if the secret was disclosed or used without permission from the secret’s owner. Damages may include actual loss and unjust enrichment not captured by actual loss. Additionally, in cases of willful or malicious misappropriation, double damages may be awarded, as well as attorney’s fees. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/23%3A_Intellectual_Property/23.04%3A_Patents.txt |
A trademark is any word, name, logo, motto, device, sound, color, or graphic symbol used by a manufacturer or seller to distinguish its products. The main purpose of a trademark is to guarantee a product’s genuineness. In effect, the trademark is the commercial substitute for one’s signature. To receive federal protection, a trademark must be (1) distinctive rather than merely descriptive, (2) affixed to a product that is actually sold in the marketplace, and (3) registered with the USPTO.
Symbol Associated with Trademarks Meaning
® The mark is officially registered with the USPTO
The mark is not registered with the USPTO & is used with goods
SM The mark is not registered with the USPTO & is used with services
The Lanham Act protects trademarks. Unlike copyrights and patents, trademarks can last forever and are not subject to the Constitution’s limited time restriction. Since the objective of trademark law is to prevent consumer confusion, the public good is best served by allowing companies to maintain their trademarks as long as consumers associate a trademark with a specific origin. The moment they no longer make that association, however, the trademark ceases to exist.
When it comes to trademarks, distinctiveness is good. Therefore, an invented word is the easiest type of trademark. In 1997, Larry Page and Sergey Brin were brainstorming names for their new Internet search engine, and invented the word “Google,” which is a play on “googol” that means 1 followed by 100 zeroes. They felt the name reflected their goal to organize the staggering amount of information available on the Internet. Common words can also become trademarks as long as consumers identify them with a particular source. For example, Amazon is the name of the world’s longest river, but it is also the name of an online retailer. Since consumers now identify Amazon.com as an online retailer, the name can be trademarked.
People’s names may also be trademarked as long as they have a business presence. Over time, if consumers begin to identify a person’s name with their business, then the name has acquired secondary meaning and can be trademarked. Thus, Sam Adams is a trademark for a beer, Ben & Jerry’s is a trademark for ice cream, and Ford is a trademark for motor vehicles.
Figure 23.1 Photo of Samuel Adams Beer Bottle
Figure 23.2 Photo of Ben & Jerry’s Justice ReMix’d Ice Cream
In addition to names and logos, slogans may also be trademarked. For example, “Built Ford Tough” and the “Quicker Picker Upper” are both trademarked slogans. Trademarks can also apply to a combination of distinctive words, logos, and slogans. McDonald’s has a trademark for its name, a trademark for its “golden arches,” and a trademark for its slogan “i’m lovin’ it.” McDonald’s could also trademark the combination of how those three items are displayed together in its advertising materials.
Trademarks are usually granted for a specific category of goods. The same name can sometimes be used for multiple categories of goods. The name Delta is a trademark for both an airline and a brand of faucets. Since there is little chance that consumers will confuse an airline with a faucet brand, trademark law allows these dual registrations.
On the other hand, some brands are so strong that they may stop registration even for a completely different category of goods. McDonald’s is a good example of this. The McDonald’s trademark is one of the strongest in the world and is instantly recognizable. In 1988, hotel chain Quality Inns launched a new line of budget motels called “McSleep.” McDonald’s sued, claiming trademark infringement. McDonald’s claimed that consumers might be confused and believe that McDonald’s owned the hotel chain. A federal judge agreed and ordered Quality Inns to change the name of the chain, which it did, to Sleep Inns.
Trademarks go beyond a company’s name or its logo. A color can be trademarked if it is strong enough to create consumer identification. Pink, for example, is trademarked when used for building insulation by Owens Corning. All other insulation manufacturers must use different colors. Sounds can be trademarked too, such as MGM Studios’ lion’s roar. Distinctive colors, materials, textures, and signage of a Starbucks or T.G.I. Friday’s are considered trade dress and cannot be copied. A unique bottle shape also can be trade dress. Trade dress is the overall appearance and image in the marketplace of a product or commercial enterprise, including any packaging, labeling, design and decor. Interestingly, courts have been reluctant to grant certain smells trademark protection, even though it can be argued that certain fragrances such as Old Spice or CK One are distinctive.
Companies providing services may receive trademark protection called a service mark. Instagram, for example, is a service mark.
A trademark can also be used to demonstrate certification meeting certain standards, such as the Good Housekeeping Seal of Approval. The International Organization for Standardization (ISO) and its various standards for quality management (ISO 9000) or environmental quality (ISO 14000). The Forest Stewardship Council (FSC) allows its logo to be used on paper products that come from sustainable forests, while certain foods can be labeled “Organic” or “Fair Trade” if they meet certain standards as established by governmental or nongovernmental organizations. Each of these marks is an example of a certification mark.
Finally, a mark can represent membership in an organization, such as the National Football League, Girl Scouts of America, Chartered Financial Analyst, or Realtor. Each of these is known as a collective mark. The rules that apply to trademarks apply equally to service marks, collective marks, and certification marks.
The Lanham Act excludes a few categories from trademark registration, mainly for public policy purposes. Obviously, trademarks will not be granted if they are similar or identical to a trademark already granted. When starting a new company, businesses need to make sure that their business name is not already trademarked by someone else. Trademarks also cannot contain the US flag, any government symbol (such as the White House or Capitol buildings), or anything immoral. Trademarks cannot be merely descriptive. Therefore, every restaurant is allowed to offer a “Kid’s Meal,” but only McDonald’s can offer a “Happy Meal.”
A trademark is valid as long as consumers believe that the mark is associated with a specific producer or origin. If the mark refers to a class of goods instead, then the trademark no longer exists. This process is called genericide. Many words today once started as trademarks: furnace, aspirin, escalator, thermos, asphalt, zipper, lite beer, Q-tip, and yo-yo are all examples of trademarks that are now generic and have therefore lost legal protection. To prevent genericide from occurring, trademark owners must actively police their use. If trademarks become generic, the owners will lose control of the marks and the public (and competitors) will be free to use those words just as they use “aspirin” and “yo-yo” today.
Trademark infringement occurs when someone uses someone else’s mark, either completely or to a substantial degree, when marketing goods or services without the permission of the mark’s owner. When Apple first released the iPhone, it found out that “iPhone” was already a registered trademark belonging to Cisco for a phone used for calling over the Internet. To avoid trademark infringement liability, Apple purchased the trademark from Cisco.
The elements of trademark infringement are:
• Distinctiveness (strength) of plaintiff’s mark;
• Similarity of the two marks;
• Similarity of goods or services associated with marks;
• Similarity of the parties’ facilities/operations;
• Similarity of the parties’ advertising;
• Defendant’s intent; and
• Proof of actual confusion.
Even if a trademark owner does not believe a similar use of its mark would lead to any consumer confusion, it can protect its trademark through a concept called dilution. Trademark dilution occurs when a trademark’s strength or effectiveness is impaired by the use of the mark by an unrelated product, often blurring the trademark’s distinctive character or tarnishing it with an unsavory association. For example, when an adult novelty store in Kentucky opened as “Victor’s Secret,” Victoria’s Secret filed a dilution suit in response. Under dilution concepts, the trademark owner only needs to show a likelihood that its mark will be diluted or tarnished in some way.
Companies or persons accused of trademark infringement can rely on several defenses:
• Marks are sufficiently different;
• Fair use;
• Parody;
• Comedy and satire; and
• Consumer advocacy.
The most obvious is arguing that no infringement has occurred because the two marks are sufficiently different enough that consumers will not be misled. For example, in 2002 Jeep sued General Motors for infringing on what Jeep called its trademark grill. GM’s Hummer division released the H2 that year, with a similar seven-bar grill. A district court held that there was no trademark infringement because the grills were too dissimilar to cause consumer confusion.
Figure 23.3 Photos of Hummer H2 and Jeep Grills
Another defense is fair use. The Lanham Act prohibits the use of someone else’s trademark when selling goods. However, when a company mentions a competitor’s product to draw a comparison, this is called comparative advertising and is fair use of the competitor’s trademark. Honda, therefore, is free to claim that the “Honda Accord is better than the Toyota Camry” in its advertising even though Toyota and Camry are both trademarks.
The First Amendment also recognizes the use of parody, comedy, or satire as fair use. Comedy skits on television that make fun of, or use, company logos are an example of this fair use. The First Amendment is also a defense for websites run by consumer activists who seek to criticize or parody companies, such as “www.fordreallysucks.com” or “www.peopleofwalmart.com.” | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/23%3A_Intellectual_Property/23.06%3A_Trademarks.txt |
The final form of intellectual property protection is copyright. A copyright is a property interest in an original work of authorship (such as literary, musical, artistic, photographic, or film work) fixed in any durable medium of expression. The owner of a copyright has the exclusive right to reproduce, adapt, distribute, perform, and display the work. The durable medium requirement exists because otherwise it would be impossible to prove who is the original author of a work. Ideas, by themselves, cannot be copyrighted.
Like patents and trademarks, federal law protects copyrights. Copyright is designed to protect creativity. It is one of the two types of IP specifically mentioned in the Copyright Clause of the US Constitution. Copyright extends to any form of creative expression, including digital forms.
Because computer software is a compilation of binary code expressed in 1 and 0, software can be copyrighted. Similarly, if a group of students were given a camera and asked to photograph the same subject, each student would frame the subject differently, which is an expression of their creativity.
A copyrighted work is automatically protected upon its creation. Unlike patents and trademarks, which must go through an expensive and rigorous application process, authors do not need to send their work to the government for approval. In 1989, the United States signed the Berne Convention, which is an international copyright treaty. This treaty eliminated the need to write “Copyright” or place a © symbol on the work itself to receive legal protection. Copyrights may be registered with the US Copyright Office, if the author chooses.
Copyright protection lasts for seventy years after the death of the author. If there is more than one author, the copyright expires seventy years after the death of the last surviving author. If a company, such as a publisher, owns a copyrighted work, the copyright expires ninety-five years from the date of publication, or one hundred twenty years from the date of creation, whichever comes first. After the copyright expires, the work falls into the public domain. The works of Shakespeare and Beethoven are in the public domain, and may be freely recorded or modified without permission.
The copyright owner may allow the public to view or use a copyrighted work for free or for a fee. This use is contained in a copyright license. A license is essentially permission from the copyright holder to use the copyrighted material, within the terms of the license. When purchasing a book, MP3 or DVD, for example, the copyright license allows the purchaser to read the book, listen to the music, and view the movie in private. The license does not allow the purchaser to show the movie to a broad audience, to modify the music, or to photocopy the book to give away or sell. These rights of reproduction, exhibition, and sale are not part of a license. The purchaser does have the right of first sale. This means that the owner of the physical work can do with it as he or she pleases, including resell the original work.
There are common licenses that authors can easily refer to if they wish to distribute their work easily. The General Public License (GPL) for software and Creative Commons (CC) license for text and media are well-known examples.
Licenses in the digital arena can be very restrictive. Copyright holders may use schemes such as Digital Rights Management (DRM) to limit ownership rights in digital media. DRM limits the number of copies and devices a digital file can be transferred to, and in some cases even permits the copyright holder to delete the purchased work.
Copyright infringement occurs when someone uses a copyrighted work without permission or violates the terms of a license. Copyright infringement is common when someone takes someone else’s work and simply repackages it as their own. For example, J. K. Rowling’s Harry Potter series created an international following, and many fans gather online to discuss her books. One website, called the Harry Potter Lexicon, served as an encyclopedia to the Harry Potter world, with reference notes on characters, places, spells, and other details. When the site announced plans to publish the contents of the Lexicon in a book format, J. K. Rowling successfully sued, claiming copyright infringement.
Copyright infringement also may be indirect, such as helping others violate a copyright. Websites such as Napster and Grokster, which existed solely for the purpose of facilitating illegal downloading of music, were copyright infringers even though the websites themselves did not directly violate any copyrights. The music recording industry pursues these cases aggressively.
Copyright law makes a distinction between “fair” and “infringing” use. Fair use includes copying a work for purposes of commentary, criticism, news reporting, teaching, or research. Just because a work is used in a news article or in a classroom, however, does not make its use fair.
Factors to determine Fair Use of Copyrighted Materials:
1. The purpose and character of the use
• Is it for educational purposes or to make a profit?
2. The nature of the copyrighted work
• Is the work part of the “core” of the intended protection that copyright provides?
3. The amount and substance of the portion used
• Is the amount used a small portion or the entire work?
4. The effect of the use on the potential market for the copyrighted work
• Does the use of the copyrighted work unfairly impact the owner’s business?
In an attempt to tackle the problem of copyright infringement on the Internet, Congress passed the Digital Millennium Copyright Act (DCMA) in 1998. One portion of the law helps Internet service providers by expressly stating that those providers cannot be sued for copyright infringement if others use their networks for infringing uses. Another portion of the law helps websites by stating that if a user uploads infringing material and the website complies with a copyright holder’s request to remove the material, the website is not liable for infringement. For example, if an individual uploads a portion of a copyrighted song, movie, or television show to YouTube, YouTube may remove the clip at the request of the copyright holder. Finally, the DMCA makes it illegal to attempt to disable a copy protection device, such as DVD and Blu-ray Discs. Anyone who writes software that disables a copy protection device violates the DMCA.
23.08: Concluding Thoughts
The framers of the Constitution recognized the value of intellectual property by including the Copyright Clause into Article I, Section 8. As IP law evolved, laws that govern trade secrets, patents, trademarks, and copyright have emerged. These legal protections provide a foundation for businesses, entrepreneurs, and artists to create useful and innovative works. Without the financial incentives provided by IP law, innovation would grind to a halt.
The Constitution states the primary purpose of providing temporary IP monopolies is to advance science and the useful arts. This advance can take place when IP owners create IP, but it can also take place when the IP falls into the public domain at the end of its limited time. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/23%3A_Intellectual_Property/23.07%3A_Copyright.txt |
Learning Objectives
• Examine the three primary chapters of the federal bankruptcy code affecting businesses.
• Compare and contrast the different types of bankruptcies.
• Explore the priority of payment of debts in a bankruptcy estate.
24: Bankruptcy
Bankruptcy occurs when an individual or business is financially unable to pay off debts and meet financial obligations. Bankruptcy is a proceeding under federal law in which an individual or business is relieved of most debts and undergoes a court-supervised reorganization or liquidation for the benefit of the creditors. Bankruptcies may be either voluntary or involuntary. A voluntary bankruptcy is a proceeding initiated by the debtor. An involuntary bankruptcy is a proceeding initiated by creditors to force the debtor to be legally declared bankrupt so the creditors may recover their assets.
The purpose of bankruptcy is to preserve as much of the debtor’s property as possible and to divide it as fairly as possible between the debtor and creditors. Bankruptcy encourages businesses to take risks and engage in entrepreneurial activities. It ultimately allows debtors in difficult financial situations to have a fresh start financially. However, critics allege that it allows some businesses to avoid the consequences of their mistakes and mismanagement. The United States has the highest bankruptcy rate in the world, with individuals filing for bankruptcies more frequently than businesses.
Counselor’s Corner Bankruptcy is a vehicle for individuals and businesses to get out of crushing debt. But it comes at a cost: bankruptcy upends a person’s life and may end a business. Before filing for bankruptcy, people and businesses should see if they can negotiate a settlement to some of their debt. Often creditors will accept partial payment that is guaranteed over a claim for a larger debt that they will never receive. Cash in hand has value to unsecured creditors. So pick up the phone and put your negotiation skills to work. It just may save your business and prevent needing to file for bankruptcy. ~M. Mo, attorney
24.02: Types of Bankruptcy
There are three main types of bankruptcy under the federal bankruptcy laws that impact businesses the most. They are identified by the chapter number in the bankruptcy code. Regardless of the type of bankruptcy, there are some important terms under bankruptcy law. A debtor is the individual or business entity who owes money to others. Debtors either file a bankruptcy petition (in a voluntary bankruptcy) or a petition is filed against them (in an involuntary bankruptcy). A claim is the right of payment from the debtor. A creditor is an individual, business or governmental entity to whom money is owed by the debtor. Therefore, a creditor has a claim against the debtor.
Figure 24.1 Types of Bankruptcy
Chapter 7 of the bankruptcy code involves the liquidation of an individual’s or business’s assets to satisfy creditor claims. The debtor loses most, if not all, of current assets but keeps all future earnings free of claims by current creditors. Chapter 7 bankruptcy results in the end of the current business entity.
Chapters 11 and 13, on the other hand, aim to reorganize and rehabilitate the debtor. Chapter 11 may apply to either an individual or business entity, while Chapter 13 only applies to individuals. Under Chapter 11, businesses continue to operate and their creditors are entitled to a portion of both current and future assets and earnings.
Chapter 7 Chapter 11 Chapter 13
Objective Liquidation Reorganization Reorganization
Type of Debtor Individual & business Individual & business Individual
Voluntariness Voluntary or involuntary Voluntary or involuntary Voluntary
Who Distributes Assets Trustee Debtor Trustee
Who Selects Trustee Creditors or US Trustee Program —– US Trustee Program
Who Proposes Plan —– Debtor & creditors Debtor
Creditor Approval Needed? No Creditors can vote but court retains power to approve plan without creditor approval No
Future Income Debtor keeps all future income Debtor must pay debts under court approved plan Debtor must pay debts under court approved plan
To prevent individuals and businesses from using bankruptcy as a tool to avoid all negative financial situations, the law requires waiting periods between bankruptcy filings. In other words, a debtor must wait a certain amount of time before being able to file for bankruptcy again.
First Bankruptcy Case To File under Chapter 7, must wait: To File under Chapter 13, must wait:
Chapter 7 8 years 4 years
Chapter 11 8 years 4 years
Chapter 13 6 years 2 years
Chapter 7 Liquidation
Under Chapter 7 of the bankruptcy code, most or all of a debtor’s assets are liquidated and used to satisfy creditor claims. Liquidation is the process of converting assets into cash to settle debts. Under Chapter 7, liquidation includes winding up the affairs of a business entity because it will no longer exist after the bankruptcy is complete. As a result, discharge of debts under Chapter 7 applies to all debts incurred before bankruptcy was filed.
Before filing for Chapter 7 bankruptcy, individual debtors must meet two requirements:
1. The individual must receive credit counseling from an approved agency within 180 days before filing for bankruptcy; and
2. The individual must financially qualify under the Department of Justice’s means test.
The means test for individuals is complex and dependent on the median income in the state where the individual debtor resides.
Chapter 7 has some advantages for debtors. The first is that it immediately protects them from collection efforts and wage garnishments from creditors. The exception to this is child support. Regardless of the status of other creditors, the law prioritizes the right of children to receive financial support from their parents. A second advantage is that most income received after the bankruptcy filing date is not part of the bankruptcy estate. The main exception to this rule is that inheritance is added to the bankruptcy estate and may be used to satisfy creditors. A third advantage is that no minimum amount of debt is required and bankruptcy may be filed if the debtor owns assets but faces cash flow problems. The final advantage is that it is a relatively quick proceeding, with most bankruptcies discharged within three to six months.
Chapter 7 has some disadvantages to debtors, too. The first is that the debtor is not in charge of distributing the bankruptcy estate. Instead, a trustee is appointed by the United States Trustee Program, which is a part of the Department of Justice responsible for overseeing the administration of bankruptcy cases. Trustees in Chapter 7 cases usually sell all non-exempt property, including homes and vehicles. Therefore, individual debtors risk losing a significant amount of their personal property without being able to retain any control of the process. A second disadvantage is that co-signors of any affected loans may be responsible for the full amount of the debt under the loan. Sometimes trustees will prioritize payment of debts without co-signors, which may result in co-signors filing for bankruptcy as well.
Chapter 11 Reorganization
The goal of reorganization under Chapter 11 is to restructure the debtor’s finances and pay creditors’ claims over an extended period of time. Ultimately, the goal of Chapter 11 is to help debtors remain in business.
One advantage of Chapter 11 bankruptcies is that a trustee is not always required. If the debtor is cooperative and able to distribute assets according to the court-approved plan, then a trustee will not be appointed. However, if the debtor is uncooperative or lacks the skills necessary to successfully implement the bankruptcy plan, a trustee may be appointed.
Another advantage is that the debtor and creditors are allowed to propose payment plans to the bankruptcy court. Although the court is not required to adopt the plans, creditors are given an opportunity to vote on a proposed plan before the court decides whether to adopt it. This gives the interested parties an opportunity to create a reasonable solution that addresses the needs of both the debtor and creditors.
A final advantage of Chapter 11 is that it provides an expedited process for small business bankruptcies. The process allows small businesses to resolve their bankruptcies quickly so that they can move forward with their reorganization plans.
Chapters 7 and 11 have an interesting relationship. Businesses may file for bankruptcy under Chapter 11 with an intent to reorganize their debt and stay in business. However, if creditors do not believe that reorganization is viable for a business, they may request the court to convert the bankruptcy to Chapter 7. For example, in March 2016, Sports Authority filed for Chapter 11 bankruptcy. When creditors discovered the extent and nature of Sports Authority’s debt, they successfully requested the court convert the bankruptcy to Chapter 7. When the court granted the creditors’ request, Sports Authority was forced to liquidate its assets and wind up its affairs.
Chapter 13 Reorganization
Chapter 13 bankruptcy is only available to individual debtors. The purpose of Chapter 13 is to adjust the debts of individuals whose debts are small enough and income is large enough that a substantial repayment plan is feasible. In other words, the proceedings help individuals keep most of their existing assets but must use most, if not all, future income to pay off debts.
A primary advantage of Chapter 13 is that it allows individual debtors to stop the cycle of compound interest on debts from spiraling to a point where they are forced to file for bankruptcy under Chapter 7. Chapter 13 provides for an automatic injunction against collection efforts and wage garnishments, except for child support. And debtors are allowed to keep their property as long as they make the required payments under the bankruptcy plan.
One characteristic of Chapter 13 is that it provides for long periods to pay off debts. The average payment plan under Chapter 13 lasts between 3 to 5 years. This can be either an advantage or disadvantage to a debtor. On one hand, it allows for reasonable payment plans that balance the interests of the debtor and creditors. On the other hand, it ties up future income for a long time to pay off existing debt. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/24%3A_Bankruptcy/24.01%3A_Introduction.txt |
Although there are some differences among Chapter 7, 11, and 13, bankruptcy proceedings have some common characteristics.
Bankruptcy Estate
The bankruptcy estate is the debtor’s legal and equitable interests in property at the time a bankruptcy petition is filed. Under the bankruptcy code, the bankruptcy estate includes real and personal property, bank and investment accounts, life insurance benefits, and inheritances. Debtors are allowed to claim some property as exemptions. In other words, certain property is returned to the debtor from the bankruptcy estate.
Common exemptions include:
• Equity interest in a residence, vehicle, and personal property (up to a certain value);
• Prescribed health aids, such as walkers and wheelchairs;
• Benefits, such as social security, unemployment compensation, public assistance, disability benefits, and child support;
• Retirement funds and pension (up to a certain value); and
• Education savings accounts.
Debts that Cannot be Discharged
Bankruptcy does not discharge all debts. There are some types of debts that a debtor remains legally liable for, regardless of being bankrupt.
Common debts that are not discharged through bankruptcy include:
• Child support and maintenance to a former spouse;
• Taxes and fines payable to a governmental agency;
• Debt incurred by fraud;
• Liability for intentional torts;
• Liability for accidents caused while driving while intoxicated;
• Student loans less than 5 years old; and
• Debts owed under a prior bankruptcy plan.
Grounds for Denying Bankruptcy Relief
Discharge of debts through bankruptcy is a privilege, not a legal right. Therefore, Congress specified certain situations in which a debtor is not eligible for bankruptcy relief. These grounds include:
• Fraudulent transfers;
• Keeping inadequate records;
• Committing a “bankruptcy crime,” such as perjury, making a false claim, bribery, and withholding or destroying records;
• Failure to explain a loss or deficiency of assets;
• Refusing to testify in the proceedings or to obey a court order; and
• Failure to complete the required consumer credit education course.
The grounds for denying a discharge in bankruptcy usually exist when wrongful conduct occurs by the debtor, the debtor does not fully cooperate in the proceedings, or the debtor does not maintain sufficient records to allow the proceedings to move forward.
Procedural Steps
Bankruptcy proceedings begin when a debtor or creditor files a petition for bankruptcy with the bankruptcy court. Married couples may file a joint petition. The petition lists the identity of the debtor(s), the identity of all secured and unsecured creditors, the property in the bankruptcy estate, any claimed exemptions, and a statement of affairs of the debtor.
Filing a bankruptcy petition results in an automatic stay, which prevents creditors from beginning or continuing collection efforts against the debtor. The stay is designed to protect both the debtor and creditors. Debtors are protected from collection efforts while they focus on creating plans for reorganization and repaying debts. Creditors are protected from assets being transferred to prevent payment of debts and the inequitable distribution of assets among creditors.
The bankruptcy court has decision-making power in bankruptcy cases. The court decides matter connected with a bankruptcy case, from the filing of the petition through final discharge of the bankruptcy. The court determines whether a debtor is eligible for bankruptcy, approves the bankruptcy plan, and oversees the bankruptcy proceedings.
If a trustee is required or needed, a trustee will be appointed by the U.S. Trustee and approved by the bankruptcy court. The trustee takes charge of and administers the debtor’s estate during bankruptcy proceedings. A trustee is the representative of the estate and is responsible for prioritizing and satisfying creditors’ claims. To achieve this goal, trustees may hire professionals such as accountants, attorneys, and appraisers.
The main job of the trustee is to execute the bankruptcy plan. The bankruptcy plan is a detailed plan of action for the liquidation or reorganization of the debtor’s assets and to satisfy creditors’ claims.
Bankruptcy plans identify and prioritize debts. The first debts to be paid off are to secured creditors who have interest is a particular property to “secure” the debt. Mortgages, car loans, and liens are common examples of secured debts. If the individual or business defaults on the loan payments, a secured creditor may force the debtor to sell or forfeit the property to satisfy the debt. The second category of debts are to unsecured creditors, who do not have an interest in any particular property.
The bankruptcy code prioritizes claims from unsecured creditors as follows:
1. Child support and maintenance to a former spouse;
2. Administrative expenses of the bankruptcy estate, including the trustees’ and accountants’ fees;
3. Creditors who loan money to the debtor during the bankruptcy;
4. Wages, salaries and commissions;
5. Contributions to employee benefit plans;
6. Consumer deposits;
7. Specific taxes and governmental fees;
8. Wrongful death and personal injury claims; and
9. General creditors.
Once the bankruptcy plan is completely implemented, a discharge occurs. A bankruptcy discharge releases the debtor from monetary obligations that existed at the time the petition was filed and ends the bankruptcy case.
24.04: Concluding Thoughts
A fundamental goal of bankruptcy is to give debtors a financial “fresh start” from overwhelming debts. This goal is accomplished through discharging debts, which releases the debtor from liability from specific debts and prohibits creditors from undertaking collection actions against the debtor. However, bankruptcy does have a cost to it. It negatively impacts a debtor’s credit history and impacts an individual or business’s ability to get a loan or build up assets again. Businesses also run the risk of liquidation and the business terminating, even if intending only to reorganize. Before filing for bankruptcy a business should consider if there are better alternatives available to manage and pay off their debt. | textbooks/biz/Civil_Law/Fundamentals_of_Business_Law_(Randall_et_al.)/24%3A_Bankruptcy/24.03%3A_Bankruptcy_Proceedings.txt |
Thumbnail: US Patent (Public Domain; U.S. Patent & Trademark Office via Wikipedia)
01: Patent Basics
Learning Objectives
After completing this section, you will be able to
• Describe the philosophical logic behind granting patents.
• Describe the role of patents in fostering invention.
Do Patents Really Promote Innovation?
Before reading this section, please watch the overview video below covering the usefulness of patents - how ironic that a system for granting exclusive rights to inventors is the greatest vehicle for knowledge-sharing and technology transfer ever devised by human beings.
What Is A Patent?
A patent is an intellectual property right granted by the government of a nation to an inventor that gives them the exclusive right to the invention for up to 20 years, in exchange for disclosing the details of the new technology to society for its ultimate benefit.
In the United States, a patent is a legal instrument in the form of a document issued by the United States Patent and Trademark Office (USPTO). It gives the inventor of any new, useful, and non-obvious machine, process, manufacture, or composition of matter the right “to exclude others from making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States” for a limited time in exchange for public disclosure of the invention.i A U.S. patent is only recognized domestically, and cannot be enforced in another country.
History of Patents in the United States
The legal foundation for U.S. intellectual property rights was laid by the Founders in 1787, in the very first Article of the U.S. Constitution, which outlined the precepts of our democratic society. In Article 1, Section 8, Clause 8 of the Constitution, Congress was given the authority 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”.ii
America was the first country in the world to enshrine intellectual property rights in its national constitution. And the Founders did this quite deliberately, says B. Zorina Khan, an economic historian at Bowdoin College whose book, The Democratization of Invention: Patents and Copyrights in American Economic Development, was awarded the Alice Hanson Jones Prize for an outstanding work in economic history.iii “To the men who gathered in Philadelphia to ‘promote the general welfare,’” Khan wrote, “it was self-evident that ideas, industrial and cultural inventions, and democratic values were integrally related. American democratic institutions would ensure that rewards accrued to the deserving based on [merit] rather than on the arbitrary basis of class, patronage, or privilege.”
Indeed, the Founders viewed intellectual property rights as vital to the new nation’s economic survival. As George Washington himself stated in his first annual address to Congress in 1790, “The advancement of agriculture, commerce, and manufactures by all proper means will not, I trust, need recommendation. But I cannot forbear intimating to you the expediency of giving effectual encouragement to the introduction of new and useful inventions.”
The question is, with all the challenges they faced, why did the Founders think it so crucial to create a strong intellectual property system? Their reasons were both universal—i.e., applying to all societies—and also very particular to America’s revolutionary experience.
"Bargain" Theory vs. "Natural Rights" Theory
Every society that affirms intellectual property rights offers two justifications for doing so: the bargain or contract theory and the natural rights theory.
"Bargain" Theory
The “bargain” theory starts with the commonsense premise that people will be encouraged to invent new products and services that benefit society if they are likely to profit by doing so. The U.S. Constitution thus offers inventors a bargain: If you invent something useful—e.g., a cotton gin in 1794 that boosted agricultural production a hundredfold, or a semiconductor 163 years later that sparked the creation of a trillion-dollar new industry and millions of jobs—then the Constitution and statutes say that, as a quid pro quo, you can have the exclusive right to that invention for a “limited time,” after which it goes into the public domain and belongs to society.
There is something so simple yet economically potent about this concept. As Abraham Lincoln—America’s only presidential patentee (No. 6469 for a device to lift boats over shoals)—noted, the beauty of the patent system is that it “added the fuel of interest to the fire of genius.”
"Natural Rights" Theory
The “natural rights” theory, meanwhile, invokes another commonsense premise that most of us instinctively hold to be true: that the product of mental labor is by all rights the property of its creator, no less than the product of physical labor is the property of its creator (or of the person who purchases it from that creator). This is what Daniel Webster was referring to when he said, “The American Constitution does not attempt to give an inventor a right to their invention, or an author a right to his composition; it recognizes an original, pre-existing, inherent right of property in such invention or composition.”
This right is not absolute, of course, and inventors’ inherent rights may at times be circumscribed by national security or other concerns. But in exchange for disclosing to the public the nature and details of the invention, the Constitution authorizes the government to enforce the inventor’s exclusive property right to that invention for a limited time.
Two important public policy goals are thus served. The inherent property rights of inventors and authors to their creations are protected, thereby helping to ensure that the wellsprings of creation and productivity do not dry up for lack of incentive. And yet the benefits derived from these inventions and creations are ultimately harnessed to the public good through disclosure, thus promoting the progress of the nation and “the general welfare” of its citizens.
How Patents Foster Innovation
To help understand why patent rights not only encourage inventors but also promote the wider diffusion of new technology for the benefit of society, economic historians Naomi Lamoreaux and the late Kenneth Sokoloff suggested the following thought experiment:
Imagine a world in which there was no patent system to guarantee inventors property rights to their discoveries. In such a world, inventors would have every incentive to be secretive and to guard jealously their discoveries from competitors [because those discoveries] could, of course, be copied with impunity. “By contrast, in a world where property rights in invention were protected, the situation would be very different. Inventors would now feel free to promote their discoveries as widely as possible so as to maximize returns either from commercializing their ideas themselves or from [licensing] rights to the idea to others. The protections offered by the patent system would thus be an important stimulus to the exchange of technological information in and of themselves. Moreover, it is likely that the cross -fertilization that resulted from these information flows would be a potent stimulus to technological change. iv
It’s more than just “likely.” Extensive research in the United States and other nations shows that patents have served as a powerful stimulant to technological knowledge sharing. A 2006 survey published by the French economists Francois Leveque and Yann Meniere, for example, found that 88 percent of U.S., European, and Japanese businesses rely upon the information disclosed in patents to keep up with technology advances and direct their own R&D efforts.v
Patents Don't Block Innovation, They Promote It
From the earliest days of the United States, patent and legal records show how inventors (including Thomas Edison) regularly kept abreast of developments in their fields. They did this by studying patent descriptions published by both the USPTO as well as by industry publications such as Scientific American, which was founded in 1845 by Munn and Company, the leading patent agency of the nineteenth century, expressly to spread new technological knowledge and facilitate the buying and selling of patents. For example, Elias E. Reis—inventor of a number of devices to exploit the heat generated by electrical currents—reported that when he read in the Official Gazette in 1886 about a patent issued to Elihu Thomson for a new method of electric welding, “there immediately opened up to my mind a field of new applications to which I saw I could apply my system of producing heat in large quantities.”vi In many industries, specialized journals kept readers informed about new patents of interest.
In fact, new research in 2012 discovered that rather than blocking development, Thomas Edison’s seminal 1880 incandescent lamp patent (No. 223,898) actually “stimulated downstream development work” that resulted in “new technologies of commercial significance [including] the Tesla coil, hermetically sealed connectors, chemical vapor deposition process, tungsten lamp filaments and phosphorescent lighting that led to today’s fluorescent lamps.”vii
Even the word “patent” signifies its social purpose of disclosure. It is derived from the Latin patent meaning “open,” and is the present participle of “pate¯re,” meaning “to stand wide open.”
This explains the origin of the term “letters patent” (“letters that lie open”), which refer to the patent documents issued by the English Crown. These were not closed with a seal but were instead kept open, with the seal hanging at the bottom, notifying all not to infringe upon the patent.
As with any economic and legal instrument, patents have the potential to slow innovation if their grant of exclusive rights is too broad. But the overwhelming preponderance of economic research and real-world experience demonstrate that, on balance, intellectual property rights tend to stimulate invention, economic growth, and the diffusion of new technological knowledge in every country where they exist.
This fact by itself, however, does not explain why the U.S. patent system became a model for much of the world. To understand why it did—and how it helped build the most successful economy in the history of the world—we must examine the revolutionary design of the U.S. patent system itself and the ways in which it overcame the weaknesses of earlier patent systems.
Footnotes
• i United States Patent and Trademark Office. (2012, January 26). Patents. Retrieved from www.uspto.gov/patents/index.jsp
• ii U.S. Constitution Arr. 1, § 8
• iii B. Zorina Khan, The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920, Cambridge University Press, 2005.
• iv Naomi R. Lamoreaux and Kenneth L. Sokoloff, “Inventors, Firms, and the Market for Technology: U.S. Manufacturing in the Late Nineteenth and Early Twentieth Centuries,”Historical Paper 98, National Bureau of Economic Research, Cambridge, Mass., 1997.
• v Francois Leveque and Yann Meniere, “Patents and Innovation: Friends or Foes?” CERNA (Centre d’economie industrielle Ecole Nationale Superieure des Mines de Paris), December, 2006.
• vi See “Record of Elias E. Reis,” 8, Thomson v. Reis, case 13,971, box 1,845, Interference Case Files, 1836-1905, Records of the Patent Office, Record Group 241, National Archives, courtesy of B. Zorina Khan.
• vii Ron D. Katznelson, “Inventing Around Edison’s Incandescent Lamp Patent: Evidence of Patents’ Role in Stimulating Downstream Development,” May, 2012, derived from: http://works.bepress.com/cgi/viewcon...xt=rkatznelson | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.01%3A_The_Foundations_of_Patent_Protection.txt |
Learning Objectives
After completing this section, you will be able to
• Outline the history of patents from antiquity through the 1700s.
• Identify flaws in early European patent systems.
History of Patents: 500 BC to the 1700s
Given the commonsense logic of granting patents to stimulate invention, it comes as no surprise that patentlike incentives date all the way back to antiquity. In the ancient Greek city of Sybaris (located in what is now southern Italy) in 500 BC, “encouragement was held out to all who should discover any new refinement in luxury, the profits arising from which were secured to the inventor by patent for the space of a year.”viii
The first formal patent legal institutions were developed in the Republic of Venice in the mid-1400s. The Venetian Statute of 1474 decreed that the inventors of new and useful devices would be protected from infringers and copiers for ten years so long as they disclosed the details of their inventions. Most Venetian patents were granted in the field of glass making, and when a large number of these glass makers emigrated to other countries in Europe, they sought similar protections from the local authorities. This is how the notion of patent rights, and their expression in patent legal systems, began to spread and gain acceptance throughout Europe.
Initially, however, English and French monarchs used patents not simply to stimulate invention, but also to grant exclusive trade monopolies to those favored by the court. In the reign of Elizabeth I in the latter 1500s, some 50 patent monopolies were granted over the trade in such staples as salt, soap, starch, iron, and paper. Critics said these “enriched the monopolist and robbed the community” while doing absolutely nothing to stimulate new technology or industry.
A growing public outcry ultimately forced Elizabeth’s successor James I to revoke these grants of trade monopolies in 1610. In 1624, the Statute of Monopolies formally repealed the practice and henceforth restricted patent rights solely to new inventions.
European countries made several other important innovations in their early patent systems. In the mid-1500s, France became the first to publish patent descriptions from inventors who chose to submit them. England under the reign of Queen Anne (1702–1714) was the first to require inventors to submit a written description of their patent to “describe and ascertain the nature of the invention and the manner in which it is to be performed.” And in 1729, France began to publish abbreviated digests of patent descriptions, but these were intermittent and subject to delays of up to 60 years after the patents were originally granted. As might be expected, this lack of regularity limited the technological knowledge sharing that is one of the great benefits of a patent system.
Flaws of Early Patent Systems
Old World patent systems suffered from other major weaknesses as well. Patents for inventions imported from other countries were regularly granted, increasing the incentive for would-be patentees to copy the creative work of others rather than invent for themselves. And there was generally no systematic examination of patents by technical experts, in part because this was viewed as an intrusion upon the prerogatives of the Crown.
But the biggest problem with early patent systems was that they all shared a tendency to reinforce the wealth and prerogatives of elites, not the welfare and productive capacity of the whole of society. In Britain, patents were favors granted “by grace of the Crown” and were often only secured through court connections. They were also “subject to any restrictions the government cared to impose, including the expropriation of the patent without compensation.”ix
What’s more, patent application fees were prohibitively high—more than 11 times the per capita annual income of the average British citizen—which put the system out of reach of all but the wealthy. Yet ironically, in the parliamentary debates over the patent system, the exclusion of the “working classes” was regarded as one of the chief virtues of the British patent system.
British patent law also severely limited the ability of inventors to sell or license the rights to their discoveries, as noted in a contemporary 1832 book entitled A Practical Treatise on the Law of Patents for Inventions. x This restriction, along with “working requirements”—these were regulations that forced patentees to manufacture products based on their patents within two or three years of issuance or lose their patent rights—limited innovation activity mainly to those who had the factories (or the ready capital to build them) needed to produce such products.
These rules had two significant effects upon the British economy. They restricted innovation to only a small sector of the population rather than unleashing the creativity and productivity of the whole people. And they created a bias toward inventions that enhanced the market dominance of incumbent, capital-intensive industries rather than opening up new markets for the sorts of disruptive new industries that usually drive economic progress.
“European societies were organized in ways that concentrated power in the hands of elites and facilitated [parasitic] rent-seeking by favored producers,” notes historian B. Zorina Khan. “The organization of invention was no exception. A society that restricts [invention] to elites can generate exceptional gains early on, but the initial spurt is unlikely to be maintained.”
Indeed, the result in Britain was unbalanced and narrowly focused economic growth. Inventors faced high transaction and monetary costs, a limited market for their inventions, and a great deal of uncertainty. Diffusion of new technological knowledge was severely inhibited, and the rate of technological change was adversely affected as a result. Eventually, Britain’s initial leadership of the Industrial Revolution had more to do with its large existing commercial holdings and manufacturing base, and its vast stores of amassed capital, than with systemic or broad-based encouragement of innovation within British society.
The Changing Tide
The elitist nature of early patent systems reflected the feudal economic relations that dominated that era. But by the late eighteenth century, capitalist economies were beginning to emerge across Europe, and in Britain, nationwide lobbies of manufacturers and patentees called for an overhaul of the patent system to bring it in line with this new economy. The needed reinvention would come not from Britain, however, nor even from France, which had its own democratic revolution soon after America’s. Instead, it took place in the newly liberated United States, where a vibrant capitalism unburdened by centuries of entrenched feudalism was developing.
This, then, is the story of one of the most admired of all American inventions—the modern democratized patent system, now used widely throughout the world.
Footnotes
• viii Charles Anthon, “A Classical Dictionary,” Harper & Bros, 1841.
• ix Op. cit., Khan.
• x Richard. Godson, A Practical Treatise on the Law of Patents for Inventions and of Copyright, Saunders and Benning, 1832. Retrieved from Google books, at bit.ly/QmPhaZ | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.02%3A_The_Weakness_of_Early_Patent_Systems.txt |
Learning Objectives
After completing this section, you will be able to
• Explain the role of the Founding Fathers in developing the U.S. patent system.
• Explain the six uunique features of the U.S. patent system.
A Patent System For Everyone
Before reading this section, please watch the overview video below covering why America developed the world’s first patent system for the common man, and what we got out of it as a result (hint: the strongest economy on the face of the earth).
Never mind that intellectual capital accounts for 55 percent of total U.S. GDP today.xi Or that it represents up to 80 percent of the market value of all public companies in the U.S.xii To most citizens today, patents and other intellectual property are inscrutable mysteries. But to America’s Founding Fathers, they were matters of the highest national importance.
The Challenge Facing the Founders
The people who led the revolution and were later tasked with writing a Constitution were not concerned simply with creating lasting political structures that could defend the hard-won freedom and sovereignty of the newly liberated colonies. They also struggled to stimulate the rapid growth of industry to ensure the new nation’s economic survival.
The survival of the United States of America was far from certain in those days. It was a backward agrarian economy, dependent on imports and lacking major domestic industry, with a population of barely three million inhabitants. Britain, meanwhile, with whom the United States had just fought a war and would soon fight another, had three times the U.S. population, boasted the most powerful economy on Earth, and was the unrivaled leader of the emerging Industrial Revolution.
It was, therefore, a critical task of the leaders of the new American nation to design institutions—including a patent system—that would encourage economic activity and investments to spur the growth of America’s primitive economy.
It’s important to note that although the Founders deeply believed in democratic ideals of government, they were not wild-eyed idealists. They were very practical people who faced an overwhelming challenge: How do you build a national economy from scratch, one that can prosper without British imports? To do that, they needed to mobilize every asset they had.
Unlike Britain, however, America had no significant capital or commercial assets. In fact, the American standard of living at that time was actually lower than in many of their South American neighbors.xiii All America had was abundant, but still untapped, natural resources, and a population widely regarded in the world as uniquely enterprising and independent minded.
Ours was the world’s fastest-growing population, doubling in size every 20 years. Americans were also widely literate (albeit mostly lacking in higher education) and informed by what Washington Irving called “the general diffusion of knowledge.”
Most important, unlike the tenant farmers and laborers who made up the bulk of England’s rigid class society, the vast majority of Americans were free-holding small farmers, merchants, shopkeepers, artisans, and mechanics—the forerunners of what we today call the middle class—who were possessed with what publisher Hezekiah Niles called “a universal ambition to go forward.”
This was America’s principal asset, their ace in the hole. And men such as George Washington, Thomas Jefferson, and James Madison knew they had to find a way to unleash the creative and productive potential of these independent citizens if the country was to industrialize and survive.
Incentives Needed to Spur Economic Growth
As Jefferson wrote to his daughter Martha in 1787, it was precisely because America was bereft of Europe’s vast resources and left to its own devices that “we are obliged to invent and execute; to find means within ourselves, and not to lean on others.”
But how to do that? From the historical record, it appears that the Founders quite consciously sought to construct a patent system that would do what no other patent system in the world had ever done before—namely, stimulate the inventive genius and entrepreneurial energy of the common man.
As noted earlier, the first thing they did was to affirm inventors’ and authors’ rights in the U.S.Constitution itself. Although the intellectual property clause was ultimately adopted by unanimous consent of the delegates on September 5, 1787, there had been some debate about the issue. Thomas Jefferson in particular had expressed reservations about the wisdom of granting “temporary monopolies” (i.e., patent rights), given that Americans had just waged a bloody war of independence to overthrow the British monopoly of trade and political power. But as other delegates noted, and Jefferson eventually came to realize, a monopoly of trade is a far cry from the temporary incentives granted to inventors in return for the benefits they provide society.
“How can the exclusive right of an invention be compared with a monopoly in trade?” D.P. Holloway, a Commissioner of Patents, would later argue in his 1863 annual report to Congress. “How can the exclusive privilege to sell salt in Elizabeth’s time, which added not one bushel to the production, but which enriched the monopolist and robbed the community, and the exclusive right of Whitney to his cotton gin, which has added hundreds of millions [of dollars] to the products and exports of the country, be both branded, with equal justice, with the odious name of monopoly?”xiv
In the words of Louis Wolowski, Chair of Industrial Economics at the Conservatoire des Arts et Metiers: ́ “[Inventors’] rights under patents, are called ‘monopolies’ only from the poverty of language, which has failed to express in words a distinction which no less clearly exists.”
The Founders understood this distinction clearly. “Rather than monopolists,” says historian Khan, “patentees were viewed as beneficent contributors to progress, and the consistent goal of those who shaped the system was to encourage domestic ingenuity, whatever the social class of the inventor.”xv
Or as James Madison put it in Federalist Paper 43, “The public good fully coincides with the [patent rights] of individuals.”
Creating a New Type of Patent System
The real genius of the Founders, however, lay in the way they consciously integrated democratic principles into the design of the world’s first modern patent system—principles that had a profound impact on the pace and direction of U.S. economic growth. These were reflected in six fundamental innovations in our patent system that departed from European practice.
Low Fees: Making Patents Affordable
The original patent law passed by Congress on April 10, 1790, deliberately set patent fees to a level any ordinary citizen could afford—initially \$3.70, but three years later raised to \$30. This was still less than 5 percent of the rate in Britain. Patent fees remained \$30 for the next 70 years, ensuring that virtually any citizen could participate in the Industrial Revolution.
The results were dramatic. Whereas most of Britain’s handful of inventors came from privilege, the vast majority of America’s thousands of inventors came from humble beginnings. They included farmers, factory workers, merchants, mechanics, and other artisans.
Of the 160 so-called “great inventors” of nineteenth-century America, over 70 percent had only a primary or secondary school education. Many had no formal schooling at all. And some of the most famous names in American invention—Matthias Baldwin (locomotive), George Eastman (roll film), Elias Howe (sewing machine), and Thomas Edison (electric light and phonograph)—had to leave school early to support their families.
What’s more, in another sign of economic democratization, most U.S. inventors had no formal scientific or technical training. They had only the general knowledge common to citizens of the day, plus whatever they taught themselves. What distinguished them was their ingenuity in applying that general knowledge to the practical problems of daily existence, and then exploiting the commercial opportunities that arose as a result. In short, they were entrepreneurial.
The rapid growth of inventive activity during early American industrialization was characterized by a disproportionate increase in the involvement of segments of the population with relatively common sets of skills and knowledge,” note Sokoloff and Khan. “Rather than being accounted for by an elite who possessed rare technical knowledge or commanded large amounts of financial resources, the rise in patenting coincided with a broadening of the ranks of patentees to encompass many individuals, occupations, and geographic districts.”xvi
Making the patent system inexpensive invited everyone’s participation. In the words of Englishman John Standfield, quoted in an 1880 issue of Scientific American, “The cheap patent law of the United States has been and still is the secret of the great success of that country.”
Simplifying Application Procedures
The Founders greatly simplified administrative procedures in applying for a patent. This was no small thing when you consider that British applicants were forced to seek approval from seven different offices, and then twice—twice!—obtain the signature of the King. If they wanted a patent that covered Scotland and Ireland as well, they needed approval from ten more offices. British patent procedures were so Byzantine, in fact, that author Charles Dickens wrote a spoof of them entitled A Poor Man’s Tale of a Patent, in which his main character, an inventor, is forced to seek approvals from 34 offices, some of which had been abolished years before and no longer existed. Obviously, few inventors could hope to run this gauntlet successfully unless they had the wherewithal to hire very expensive patent agents to assist them.
In the United States, on the other hand, applications only needed the approval of a single patent office, which created repositories throughout the country where inventors could drop off their applications and models and have them forwarded to the patent office at government expense. Rural inventors could even apply for a patent through the mail—postage free!
This last perk for rural inventors turned out to have a big impact on the course of U.S. economic development. While most British industrial breakthroughs were confined to London or other big cities, U.S. inventions were widely distributed across the country, in urban and rural areas both. The result was broader- based economic growth and less income inequality in the United States.
Spreading New Technological Knowledge
Another unique feature of the U.S. patent system was its systematic effort to spread new technological knowledge throughout society, thereby creating a virtuous circle of innovation begetting more innovation. In Britain, patents were only open to public inspection after paying a fee, and until 1852 were not even officially printed, published, or indexed. In France, printed information about patents was limited to brief titles in patent indexes, intermittently published and only available in the office in which these had been originally filed.
By contrast, the first U.S. patent law explicitly stated that “copies of patent Specification together with similar Models [are] to be made at the public Expence and lodged in each state.”xvii In addition, as noted in the previous section, a plethora of publications by government and industry enabled any citizen with an interest to keep abreast of the latest patented technologies.
Examining Patents for Validity
In a very crucial departure from Old World practice, the Founders created the world’s first examination system for patents to ensure their novelty, non-obviousness, and utility. The examinations were initially conducted by a committee composed of the Secretary of State (Thomas Jefferson), Secretary of War (Henry Knox), and Attorney General (Edmund Randolph). But this was found to be cumbersome, so in 1793 a simple registration system was established. It turned out, however, that without the examination of applications for novelty, non-obviousness, and utility, the validity of issued patents began to be questioned. So the reforms of the 1836 Patent Act specified that henceforth applications would be scrutinized by technically trained examiners to ensure that the invention represented a genuine advance in the state of the art.
For the first time anywhere in the world, the criteria for granting a patent depended solely upon the merits of the application rather than the identity or the mere say-so of the inventor.
The situation was very different in Europe. In France, the following caveat was printed on each patent: “The government, in granting a patent without prior examination, does not in any manner guarantee either the priority, merit or success of an invention.” Imagine trying to interest a group of investors in your new invention with that kind of warning label attached to it!
In Britain, meanwhile, the lack of any examination of patent validity made the purchase of a patent right highly speculative and costly, thereby limiting investment in new technology.
By contrast, says Khan, “the U.S. examination system reduced uncertainty about the validity of patents, and provided [interested parties] with a signal of [their] potential value.” This proved to be crucial in facilitating the growth of an extensive market in the sale and licensing of valuable patent rights—the first large-scale market of this type in the world.
No "Working Requirements" Reduced Monopoly Control
The fifth distinguishing feature of the U.S. patent system was the lack of any sort of “working requirements.” In the debate over HR-41, the bill that became the first U.S. patent law in 1790, “the Senate suggested requiring patentees to make products based on the patent or license others to do so. But the House rejected this as an infringement of patentees’ rights.”xviii
Indeed, the Founders believed working requirements would only strengthen monopoly power and skew invention toward incumbent industry by limiting patents to those with the factories (or the capital to build them) needed to manufacture products from their inventions. xix
In short, the Founding Fathers of this nation deliberately and quite consciously created what we now call “non-practicing entities” (NPEs) in order to expand the pool of inventors in their then backward economy to include ordinary citizens without the wealth or resources to commercialize their own inventions. And it worked, leading to a dramatic surge in innovation in nineteenth-century America as large numbers of ordinary citizens started inventing and then licensing their discoveries to enterprises for commercialization.
By 1865, the U.S. per capita patenting rate was more than triple that of Britain’s, according to the annual reports from the commissioners of patents in both countries, and by 1885, it was more than quadruple that of Britain. Each U.S. patentee was also far more prolific than their British counterpart, so by mid-century, the United States was patenting five times the number of inventions as Britain each year, even though the populations were then equal in size.
Creating a Market for New Technology
The sixth unique feature of the U.S. patent system—and along with the refusal to impose working requirements, the one that had the greatest impact on future U.S. economic growth—was “an explicit provision for the sale of patent rights [that] both the courts and the U.S. Patent Office acted to facilitate.”xx
Why facilitate the buying and selling of patents? Because doing so enabled ordinary worker or farmer inventors without the capital to commercialize their own discoveries to still participate in inventive activity and earn income by licensing or selling their patents to enterprises that could. This ability to license patent rights (along with the low application fees) turned inventing into a new career path for thousands of poor but technically creative citizens.xxi It also proved to be a powerful means of mobilizing capital for investment in new technologies and their commercialization into new products and services for society.
That patents could be used as tradable assets by non-practicing entities without the wealth to commercialize their own discoveries was a wholly unique feature of the American patent system. By 1880, 85 percent of all U.S. patents were licensed by their inventors, compared with 30 percent of British patents.xxii
Patent licensing, in fact, was the principal means by which new discoveries were commercialized in the decades before the early twentieth- century emergence of in-house corporate R&D departments. Publications such as Scientific American were founded specifically to facilitate the trade in patents, and it regularly featured lists of new and interesting patents, which commercial enterprises then licensed or purchased to use in their product development efforts.
American Bell Telephone’s new product pipeline, for example, operated like most others at the time. According to its 1894 annual report, the company’s R&D department licensed 73 patents from outside inventors, while developing only 12 from its own employees.
Thomas Blanchard was a typical inventor-licensor. He was the son of a small farmer who invented and patented a mechanical tack-maker in 1806 that could fabricate five hundred tacks per minute, each superior to tacks made by hand. He sold the rights to his machine for \$5,000, quite a sum in those days. He then invented a lathe to produce uniform gun stocks, and the patent he received for it enabled him to attract investors for the production of those gun stocks for the local Boston market. Blanchard also leased his patent rights to gun producers nationwide, as well as to manufacturers of tool handles and wheel spokes. The income he generated from patent licensing enabled him to make inventing his full-time career. He went on to invent a wood-bending machine, an upriver steamboat, and a steam wagon that was used until the introduction of railroads in the United States, and received a total of 25 patents during his career.
According to a 2013 Congressionally mandated Government Accountability Office (GAO) report on NPEs, “History is filled with examples of successful inventors who did not develop products based on the technologies they patented.” It specifically cited the case of Elias Howe, who patented a method of making a lockstitch but did not produce sewing machines. Instead, Howe licensed his patents to the Singer Company, which then deployed Howe’s invention in its sewing machines.xxiii
Patent licensing, scholars have found, was facilitated by an array of intermediaries—lawyers, venture financiers, and patent licensing agents—who “lowered the transaction costs and improved the efficiency” of the trade in and commercialization of patented technology. “By enabling, indeed encouraging, inventors to focus on what they did best [i.e., invention], this division of labor gave rise to the most technologically fertile period in American history.”xxiv
The Positive Effects of Licensing
The Founders’ decision to foster NPEs and patent licensing proved crucial to America’s rapid technological progress and economic growth. Indeed, patent records from the nineteenth century reveal that more than two-thirds of the “great inventors” of the Industrial Revolution, including Thomas Edison and Elias Howe, were NPEs who specialized in invention and licensed some or all of their patents to outside enterprises for development into new products.xxv
Had the United States followed the approach of older European patent systems and limited patent rights solely to inventors who made or sold products—or prevented them from licensing their patents—America might not have even had an Industrial Revolution.
In any event, the result of this division of labor between invention and production was exactly as Adam Smith predicted:
“The growth of market trade in patents raised the returns to invention and encouraged a division of labor whereby technologically-creative individuals increasingly specialized in their comparative advantage—invention,” noted Lamoreaux and Sokoloff. “It was the expanded opportunities to trade in patented technologies that enabled the independent inventors of this golden age to flourish—and that stimulated the growth of inventive activity generally.”
The benefits of that division of labor remain visible today, embodied in the thousands of university and other NPE patents licensed by companies large and small each year, as well as by the positive U.S. balance of trade in patent licensing, estimated to be worth at least \$150 billion annually as of 2006. More than 5,000 new products and 7,000 new companies have been created with the help of university NPE patents alone in the last 30 years.xxvi And licensors of patented technology help the United States maintain its technology leadership in critical economic sectors.
A New Species called "Patent Trolls"
To be sure, there is new a species of NPE known as “patent trolls” who use low-quality patents to extort socalled “license fees” from small businesses unable to pay the cost of standing up to them in court. But their activities have nothing in common with real patent licensing.
Typically, these patent owners send form letters to hundreds, or in some cases thousands, of random small businesses, claiming with little or no evidence that they are “infringing” their patents. These letters then demand so-called “licensing fees” ranging from one to several thousands of dollars to avoid a patent infringement lawsuit that could cost those businesses far more to defend against in court—even if the business owner is innocent of any infringement.
Beginning in mid-2013, a torrent of bad faith demand letters began targeting small businesses, sparking wide protest. The National Federation of Independent Businesses (NFIB) and many other business groups and trade associations demanded action, and Washington responded in 2014 with several pieces of proposed reform legislation. By early 2015, the Federal Trade Commission (FTC) had acted against one sender of bad faith demand letters, and federal legislation to rein in such abuses seemed likely to pass.
At the state level, meanwhile, by early 2015, 15 states had enacted laws to curb abusive patent demand letters, and 11 others were actively considering similar bills. In addition, the attorneys general of several states have used consumer protection laws against making false claims to force these “patent trolls” to stop sending their extortionist demand letters.
These abusive patent litigants should not be confused with legitimate NPEs, however, whose primary business is invention and technology licensing, not extorting so-called “license fees” from innocent businesses. Patent licensing facilitates the transfer and commercialization of technology into new products and services and promotes U.S. economic growth.
A Patent System for Everyone
In sum, these six unique features of the U.S. patent system—low fees, simplified procedures, examination of applications by trained experts, systematic disclosure of new technological knowledge, lack of “working requirements,” and encouragement of robust trade in patent rights—all had a powerfully beneficial impact on the nation’s economic growth.
But none of that would have been possible were it not for the broad-based democratic rule of law in the United States and the critical role played by the U.S. legal system in interpreting and enforcing America’s revolutionary patent laws.
Footnotes
• xi Kevin A. Hassett and Robert J. Shapiro, “What Ideas Are Worth: The Value of Intellectual Capital and Intangible Assets in the American Economy,” Sonecon, 2012.
• xii “Intangible Asset Market Value,” Ocean Tomo, derived from http://bit.ly/bAPJVH
• xiii Stanley Engerman and Kenneth Sokoloff,“Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies,” in Stephen Haber (ed), How Latin America Fell Behind, Stanford University Press, Palo Alto, California, 1997.
• xiv United States Patent Office, Annual Report of the Commissioner of Patents 1863. Retrieved from Google Books at http:// bit.ly/Meh0Pv
• xv Opt. cit., Khan.
• xvi Kenneth Sokoloff and B. Zorina Khan, “The Democratization of Invention During Early Industrialization, 1790O1846,” Working Paper No. 578, Department of Economics, University of California, Los Angeles, December, 1989.
• xvii Patent Act of 1790, HR-41,
• xviii Op. cit., Khan.
• xix B. Zorina Khan, “Antitrust and Innovation Before the Sherman Act,” Antitrust Law Journal, No. 3, 2011.
• xx Naomi R. Lamoreaux and Kenneth L. Sokoloff, “Inventive Activity and the Market for Technology in the United States: 1840O1920,” Working Paper 7107, National Bureau of Economic Research, Cambridge, Mass. 1999.
• xxi B. Zorina Khan, “Institutions and Technological Innovation During Early Economic Growth: Evidence From the Great Inventors of the United States, 1790-1930,” Working Paper 10966, National Bureau of Economic Research, Cambridge, Mass., 2004.
• xxii B.Zorina Khan,The Democratization of Invention Patents and Copyrights in American Economic Development, 1790-1920, Cambridge University Press, 2005.
• xxiiiIntellectual Property: Assessing Factors that Affect Patent Infringement Litigation Could Improve Patent Quality,” U.S. GAO, August 2013.
• xxiv Naomi Lamoreayx and Kenneth Sokoloff, “Intermediaries in the U.S. Market for Technology, 1870-1920,” Working Paper No. 9017, National Bureau of Economic Research, Cambridge, MA. June, 2002.
• xxv B.Zorina Khan and Kenneth L.Sokoloff,“Intellectual Property Institutions in the United States: Early Development and Comparative Perspective,” World Bank Research Workshop, July 17-19, 2000
• xxvi Joseph Hornett and David Johnson, Purdue Research Foundation. Derived from: bit.ly/O7iA18 | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.03%3A_America%27s_Uniquely_Democratic_Patent_System.txt |
Learning Objectives
After completing this section, you will be able to
• Describe the differences between the U.S. and European patent laws.
• Describe the history of patent litigation in the United States.
U.S. Patent Law vs. European Patent Law
Just as with any other property right, patent rights would be meaningless without the ability to enforce them in court. And from the earliest days of the patent system, says Khan, “Our legal system remained true to the Constitution in the belief that the defense of rights in patented invention was important in fostering industrial and economic development.”
In Britain and other European countries, patents were viewed as “pernicious monopolies that restricted community rights and [Had] to be carefully monitored and narrowly construed.”xxvii The enforcement and interpretation of patent laws by the courts in Europe also tended to be highly variable and dependent upon the whims of each individual judge.
In the United States, however, early courts treated inventors’ patent rights with deference, just as they did the rights of other property owners. Famed Supreme Court Justice Joseph Story repeatedly declared that patent rights were “sacred” and were the just reward for inventive ingenuity. As he noted in Lowell v. Lewis (https://openstax.org/l/Lowell_v_Lewis) (1817), “the proper duty of the court” is to ensure that “wrongdoers may not reap the fruits of the labor and genius of other men.”
The relative uniformity and certainty of enforcement of patent rights by the courts also proved critical in encouraging capital to invest in commercializing those patent rights.
Contrasting the patent laws and policies of the United States and Britain, Supreme Court Justice Henry Baldwin went to some lengths in Whitney v. Emmett (https://openstax.org/l/Whitney_v_Emmett) (1831) to show how English courts saw patents as a zero-sum trade-off between private rights and the public good. The explicit intention of U.S. patent law, however, was “to benefit the inventor, in the belief that maximizing individual welfare leads to maximum social welfare.”
Nonetheless, U.S. intellectual property laws did try to strike a balance between the needs of the many and the few. “Patent laws ensured the security of private property rights in invention. However, it was also necessary to balance the just claims of inventors against the dangers of exclusive monopolies that might restrict the scope of current and future invention.”xxviii
Changes in the U.S. Patent Law Through the Years
Over the years, of course, that balance has moved back and forth between relatively stronger versus weaker enforcement of patent rights. With the rise of the robber barons in the late nineteenth century, government and the courts increasingly viewed patents through the prism of antitrust, in some cases even compelling large firms like IBM to license their patents to competitors. Then with the advent of the high-tech revolution in the 1980s, antitrust concerns faded and the courts began once again to view stronger patent rights as helpful in fostering innovation.
Interestingly, the U.S. legal system has always operated on the theory that the best way to achieve the proper balance between private rights and public interest was not through government decree, centralized management, or compulsory licensing but rather through the decentralized decision making and market interactions of inventors themselves. The court’s role was to resolve the inevitable conflicts that arose, on a case by case basis.
Throughout all the twists and turns in patent enforcement over the centuries, however, the federal courts have remained unwavering on four key principles of U.S. patent law.
An "Explosion" of Patent Litigation?
Patent litigation, of course, has always been an integral feature of the U.S. patent system. The first patent case on record was that of Benjamin Folger, whose patent for the production of candles was invalidated by the district federal court for New York in 1792. This was merely the first of many hundreds (and eventually thousands) of cases in which patent litigation served the important function of settling either the validity or the disputed ownership of the rights to critical new technologies—the litigation between telephone inventors Alexander Graham Bell and Elisha Gray being perhaps the most famous case in point. By doing so, the courts provided greater certainty regarding the value of such rights to entrepreneurs and investors alike.
Today, some critics contend that an “explosion of patent litigation” unlike any in history is harming business and diverting resources better spent on innovation. No responsible observer would deny that the courts have seen an increase in patent infringement suits in recent years, just as they have seen a rise in personal injury claims and product liability suits. But that said, the evidence shows that the rate of patent litigation today is actually below historical norms.
According to USCourts.gov (https://www.USCourts.gov) figures, the number of patent infringement suits filed in the United States increased 59 percent between 2001 and 2011—from 2,520 cases in 2001 to 4,015 cases in 2011. Meanwhile, the number of patents granted in that same period increased by only 35 percent, which supports the view that patent litigation has become more frequent over the last decade as the role and value of intellectual property has increased in the Knowledge Economy.
Statistics from USCourts.gov (https://www.USCourts.gov) show an even sharper rise in the number of patent suits filed in 2012, to 5,189 cases. But analysts attribute most of this increase to the anti-joinder provisions of the Patent Act of 2011, which curtailed the practice of naming multiple defendants in a single infringement suit. According to Carla Rydholm of the patent analytics firm Lex Machina, “Plaintiffs must [now] meet more stringent requirements to file a case against multiple defendants. So instead of Plaintiff X filing one case naming 20 defendants, Plaintiff X might file 20 lawsuits (one per defendant) each with unique civil action numbers.”
When looked at over the longer term, however, it turns out that 96 percent of all the increase in patent infringement suits since 1991 can be explained by a corresponding increase in patents granted, reports the PricewaterhouseCoopers’s 2013 Patent Litigation Study.xxix
In case you’re wondering if the increase in patents granted is itself a sign of a patent system being increasingly gamed by speculators wanting to cash in on the new “patent gold rush,” note that the average number of patents issued per billion dollars of GDP has remained at or below the same level—13 patents per billion dollars of GDP—since 1963.xxx
Interestingly, although the number of suits filed has increased in rough correlation to patent grants, the number that actually go to trial has remained fairly constant over the last 30 years. About 90 percent of the suits filed each year are abandoned or settled. Of the three hundred that remain, two-thirds never go to trial, and are adjudicated on summary judgment (of noninfringement in most cases).
The nation is thus left with, at most, between 90 and 112 patent infringement trials per year—exactly the same number that went to trial 10, 20, and even 30 years ago.xxxi
To be sure, there can be significant costs to business even in litigating and settling patent suits that never go to trial. But no one has shown that the relative cost of patent litigation today is higher than it was historically, or that the cost of patent litigation is more burdensome than other customary legal costs in business, especially the huge cost of regulatory compliance.
The evidence does not suggest that patent litigation is “out of control” today. As retired Chief Judge Paul Michel of the U.S. Court of Appeals for the Federal Circuit, the main court for patent appeals since 1982, notes, “The level of patent litigation today is rather modest for a nation with two million active patents and hundreds of thousands of businesses competing against each other.”
History supports Judge Michel on this point. The estimated 124-plus smartphone patent suits filed between 2009 and 2012xxxii are less than one- quarter the number of patent suits filed during the first “Telephone Wars” of Alexander Graham Bell’s time. Back then, the American Bell Telephone Company and its successor, AT&T, litigated 587 patent cases alone.xxxiii
Even more surprising, given the common belief in a patent litigation “explosion” today, patent and legal records from the golden age of invention during the mid-nineteenth century U.S. Industrial Revolution show that the patent litigation rate at that time—defined as the number of patent suits filed in a decade divided by the number of patents issued in that decade—reached 3.6 percent.xxxiv
In contrast, USCourts.gov (https://www.USCourts.gov) figures show the patent litigation rate during the decade 2001 to 2011 was less than half that—only 1.52 percent. From 2002 to 2012, reflecting the increased suits but also the increased (276,788) patents issued, the litigation rate was 1.57 percent.
Over the entire period from 1790 to 1860, the patent litigation rate averaged 1.65 percent.
Today’s smartphone wars, then, are simply “back to the future” when it comes to the ways in which disruptive new industries are developed. Historians have noted that every major industrial breakthrough of the last 150 years—from the development of the sewing machine, telephone, automobile, radio, aircraft, medical stent, and even disposable diaper industries, to the birth of the semiconductor and Internet e-commerce industries—witnessed exactly the same surge in patenting and patent litigation that we see in today’s smartphone field.xxxv
And just as with smartphones today, the most competitive technology arenas have always been the most litigious. In Edison’s time, the inventors of electrical discoveries were four times more likely than other inventors to be involved in patent litigation, and accounted for 41 percent of all patent suits filed during that period.xxxvi
In any event, by early 2015, it had already become clear that a noticeable decline in patent litigation was under way. Most analysts attributed the decline to a series of U.S. Supreme Court rulings in 2014 limiting the patentability of software and increasing the ability of the courts to impose sanctions on abusive litigants, which will be discussed later in this chapter. Also driving this decline in litigation was the availability of new post-grant review proceedings under the new America Invents Act, which allow third parties to challenge patents and, if the evidence so warrants, have their claims invalidated by the USPTO’s Patent Trial and Appeal Board.
Although patent litigation is costly, the historical record suggests that it serves a vital function by settling the validity and disputed ownership of patent rights so these can be commercialized into new products, new services, and new medical treatments.
This is, in fact, the proper role of the courts. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.04%3A_The_Role_of_the_U.S._Legal_System.txt |
Learning Objectives
After completing this section, you will be able to
• Explain the effects of the U.S. patent system on American economic development.
• Describe trends in U.S. patenting over the years.
Creating the World's Most Successful Economy
In 1630, the puritan John Winthrop, future governor of Massachusetts colony, declared that “We shall be as a city upon a hill, the eyes of all people are upon us.”
One hundred and fifty years later, the Founders of the United States of America proved Winthrop right, offering the world a vision of liberty and democratic governance that continues to inspire people to this day. As noted previously, the men who led the Revolution and wrote the Constitution were not wild-eyed revolutionaries. They were eminently practical people who managed to create the longest- living modern democratic political and economic system on the planet.
In other words, they must have done something right. And one of those things was surely the patent system they created. Because almost from the moment of its inception, it began to spark innovation and economic growth on a scope and scale never before seen in the world.
Only two months after America’s first patent law was signed in 1790, in fact, Thomas Jefferson himself noted that it had “given a spring to invention beyond my conception.” Within 13 years, America surpassed Britain—until then, the unrivaled leader of the industrial revolution—in the number of new inventions patented, even though Britain still had more than twice America’s population. By 1870, as noted earlier, the United States was patenting more than five times the number of inventions as Britain, although their populations were by then roughly equal in size.
At first, most British observers were dismissive of American innovation efforts, declaring that the former colony would never be able to progress beyond the simple imitation of superior European technologies. But eventually Britain and other nations took note of the way the U.S. patent system seemed to be stimulating invention and economic growth at an unheard-of pace.
Sir William Thompson (pictured above), a British inventor and scientist attending the 1876 Centennial Exhibition in Philadelphia, looked at the amazing array of American inventions—including Bell’s telephone, the Westinghouse airbrake, Singer’s sewing machines, and Edison’s improved telegraph—and had this to say: “If Europe does not amend its patent laws, America will speedily become the nursery of useful inventions for the world.”xxxvii
Meanwhile, the Swiss Commissioner in attendance, the shoe manufacturer Edward Bally, offered a similar warning to his Old World countrymen: “American industry has taken a lead which in a few years may cause Europe to feel its consequences in a very marked degree.”
Then, there’s Japan’s Assistant Secretary of State Korekiyo Takahashi, who visited the U.S. Patent Office. Upon his return home, he said, “What is it that makes the United States such a great nation? We investigated, and we found it was patents. And we will have patents.”
Even the British jurist Sir Henry Sumner Maine, who had once argued that “the establishment of the masses in power is the blackest omen” for the future of invention, later changed his tune. He conceded that the U.S. patent system was “one of the provisions of the Constitution that have most influenced the destinies of the American people” and that it had made the United States “the first in the world for the number and ingenuity of [its] inventors”.xxxviii
As historians Lamoreaux and Sokoloff noted, “[Foreign] observers attributed much of the country’s rapid technological progress to its distinctive patent system. Quite revolutionary in design at inception, the U.S. patent system came to be much admired for providing broad access to property rights in new technological knowledge and for facilitating trade in patented technologies. These features attracted the technologically creative, even those who lacked the capital to directly exploit [i.e., commercialize] their inventions . . . and also fostered a division of labor between the conduct of inventive activity and the application of technical discoveries to actual production. It is no coincidence that Britain and many other European countries [later] began to modify their patent institutions to make them more like those of the Americans.”xxxix
Every Breakthrough Spurs Patenting Spikes
The patent system’s central role in fostering innovation can be seen in the patenting spikes that occur with every major industrial breakthrough. A major surge in patenting took place in the 1880s, for example, when the number of new patents issued each year jumped 56 percent to about 20,000, compared with the 12,000 issued yearly during the previous decade. This patent boom corresponded with rapid advances in the emerging railroad, telegraph, telephone, and electric light and power industries that signaled the industrialization of the U.S. economy.
The next sharp surge in patent issuances began around 1902 and lasted until 1916 or so, when the number of patents granted doubled from 20,000 per year to around 40,000 per year. This was the period of the newborn automobile and aircraft industries’ most rapid early-stage growth. Patenting levels then remained relatively stable at about 40,000 per year until around 1960 or so, when the revolution in plastics and other synthetic materials along with boom-time growth in the aerospace and computer industries pushed patenting levels to 60,000 per year. There they remained until the mid- 1980s, when the personal computer and emerging hightech industries of Silicon Valley began to power the whole of the U.S. economy and propel us toward the age of the Internet. Patenting levels then rose to around 80,000 to 100,000 yearly.
With the rise of the Internet, social media, mobile telephony, and smartphones over the last two decades, the number of patent applications filed each year with the U.S. Patent and Trademark Office (USPTO) has surged fourfold. In 2014, the USPTO received 578,802 applications, finding 300,678 of these applications worthy of receiving a patent. This is but the latest spike in innovation and patenting.
Clearly, whenever the United States has undergone a major industrial renaissance during which technology advances lead not only to the birth of new industries, but also to the reshaping of existing ones, patenting levels rise dramatically. It is no surprise, therefore, that Silicon Valley, midwife of many of the new Knowledge Economy industries of the past 60 years, is home to less than 1 percent of the nation’s population but earns 12 percent of its patents each year. The Valley is now the site of a new USPTO satellite office serving high-tech innovators there.xl
The patent system has also been crucial in facilitating the growth of new start-up businesses, with 67 percent of entrepreneurs reporting that they find patents valuable in obtaining venture financing.xli This is important because although large companies contribute enormously to American innovation and industrial growth through their in-house research and development operations as well as via their partnerships with research universities, start-up companies play a particularly strong role in the creation of entirely new industries. Indeed, virtually every innovative new industry of the last 150 years—From the telegraph, telephone, and electric power industries of the 1800s, to the auto, aircraft, materials, and aerospace industries of the twentieth century, to the semiconductor, personal computer, software, biotech and Internet e-commerce industries of the last 60 years—was launched by an entrepreneurial start-up company.
The Founders would not be surprised by this. They created the world’s first democratized patent system, after all, for a reason: to stimulate the ingenuity of the common man. They had asked themselves a question—the same question reiterated two generations later by Supreme Court Justice Joseph Story when he spoke before an audience of ordinary mechanics: “Ask yourselves, what would be the result of one hundred thousand minds ... urged on by the daily motives of interest, to acquire new skill, or invent new improvements.”xlii
The result was the most successful economy on the face of the earth.
Patents and the American Dream
It’s not only the economy that the patent system helped shape, but the culture and consciousness as well. As the eminent historian Gordon S. Wood observed in his 2010 book Empire of Liberty,
“By the early nineteenth century, technology and prosperity were assuming for Americans the same sublime and moral significance that the enlightenment had reserved for the classical state and the Newtonian universe. Eli Whitney, inventor of the cotton gin, and Robert Fulton, creator of the steamboat, became national heroes.”
And for the first time in human history, a nation had come to see its greatness not in empire or military might or royal lineage, but in its capacity for technological progress. There was nothing preordained about America’s economic success, no special “Yankee ingenuity” gene in their hereditary stock. As Scientific American noted in 1876, the United States advanced “not because we are by nature more inventive than other men. Every nationality becomes inventive the moment it comes under our laws.”
Rather, the secret of America’s success was a uniquely democratic patent system that “added the fuel of interest to the fire of genius” in generations of ordinary citizens—and in so doing, helped in a very real way to give birth to the American Dream itself.
Ironically, few people today even know the origin of the term “the American Dream.” In fact, it was coined in 1931, by the historian James Truslow Adams in his book Epic of America, and it is instructive to read what Adams meant by it:
“The American Dream, that has lured tens of millions of all nations to our shores in the past century, has not been a dream merely of material plenty, though that has doubtless counted heavily. It has been much more than that. It has been a dream of being able to grow to fullest development as a man and woman, unhampered by the barriers which had slowly been erected in the older civilizations, unrepressed by social orders which had developed for the benefit of classes rather than for the simple human being of any and every class.”
Only in America could a working class youth named Thomas Edison with less than three years of schooling develop himself into the world’s greatest inventor—a visionary who gave the world some of the most important technologies of late nineteenth- and early twentieth-century life.
This is exactly what the Founders had in mind when they created the U.S. patent system.
Footnotes
• xxxvii Scientific American, October 21, 1876, courtesy of B. Zorina Khan.
• xxxviii Henry Sumner Maine, Popular Government, courtesy of B. Zorina Khan.
• xxxix Naomi R. Lamoreaux and Kenneth L. Sokoloff, “Financing Innovation in the United States: 1870 to Present,” MIT Press, Cambridge, Mass. 2007.
• xl “Silicon Valley wins in securing U.S. patent office,” San Francisco Chronicle, July 3, 2012.
• xli “Patenting by Entrepreneurs: The Berkeley Patent Survey Part III of III,” PatentlyO, July 21, 2010.
• xlii Reported in American Jurist and Law Magazine, vol. 1 (1829), courtesy of B. Zorina Khan. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.05%3A_What_the_U.S._Patent_System_Wrought.txt |
Learning Objectives
After completing this section, you will be able to
• Identify the characteristics of a patentable invention.
• Understand what is not patentable and why.
What, Exactly, Can You Patent?
Title 35 of the United States Code (the Patent Act) allows anyone who invents or discovers any new, nonobvious, and useful machine, manufacture, process, or composition of matter—or who makes an improvement of any of the above—to obtain a patent.xliii
These four kinds of patentable inventions fall into one of two categories: They are products or processes.xliv
Product or Process?
Products are physical things—whether they be machines (a new type of robotic welder), manufactures (an artificial knee made of titanium), or compositions of matter (a new chemical “superglue” for binding materials together). In this photo, Elon Musk observes the robotic arms in the Tesla Motors factory. Specialized manufacturing equipment like this are patentable products.
Processes (or methods), on the other hand, are a means to an end—either a means of doing something new (being able to pay for purchases directly from your smartphone), or a new way of doing something old (using “pinch, swipe, and zoom” gestures on a touchscreen, rather than clicking drop-down menus, to manipulate text, music, and images on a smartphone).
You Cannot Patent Ideas
All patented inventions fit into one of these four categories: machine, manufacture, process, or composition of matter. But not everything that fits in one of these four categories can be patented. And the most important reason why one thing is patentable and another is not lies in the difference between ideas and applications.
You cannot patent an idea for a better mousetrap—not unless it can be developed into a new, non-obvious, and useful machine, manufacture, process, or composition of matter that can actually accomplish the task. You may have a genius idea for faster-than-light travel, but that will not get you a patent unless you can outline how to develop a tangible process or device for actually doing so, in which case you can seek to patent it.
Put another way, “talk is cheap” when it comes to securing a patent. The U.S. Patent and Trademark Office offers no judgment as to the wisdom or desirability of any particular invention—patent No. 2,882,858 for a bird diaper is certainly proof of that. But it absolutely will insist that every invention include a tangible device or process for achieving its intended purpose before it deems the invention worthy of a patent.
Mathematical Formulas Not Patentable
There are other discoveries that fall into the broad category of abstract ideas and are thus unpatentable. You cannot patent a mathematical formula. You cannot patent a law of nature, such as Einstein’s E=MC2 . And you cannot patent natural phenomena like electricity (discovered by William Gilbert in 1600) or the Higgs particle that gives all matter its mass (discovered by researchers at the Large Hadron Collider on July 4, 2012). These all exist independently of human intervention, whether we have discovered them or formulated their rules yet or not, and must be freely available to all of humanity for its understanding and betterment.
To restate the distinction, you cannot patent electromagnetism but you can patent a telegraph that uses electromagnetism to communicate rapidly over great distances, as Samuel Morse did in 1840 with patent no. 1647. And although you cannot patent light waves, you can patent a fiber optic wire that employs light waves to communicate even more rapidly and over greater distances, as Corning Glass researchers did in 1970 with patent no. 3,711,262.
Can You Patent Computer Software?
The boundary between ideas and applications might seem clear, but it has become blurred since the advent of computer technology 40 years ago, especially regarding the patentability of software.
To learn more, watch this video from PBS Digital Studios about the first software patent ever awarded and to learn a bit about the debate around software patentability.
Mixed Verdicts on Software Patentability
The federal courts and the U.S. Supreme Court have tried to clarify the limits of patentability in the computer age. Three Supreme Court cases in particular—often called the “patent-eligibility trilogy”—reveal the evolution of its thinking about software patentability. In 1972, the Supreme Court held in Gottschalk v. Benson that an algorithm in a computer program—in this case, a mathematical procedure executed electronically that was similar to long division with paper and pencil—was in and of itself not patentable. Phenomena of nature, mental processes, and abstract intellectual concepts are the basic tools of scientific and technical research, the court noted, and therefore could not be patented lest it foreclose others from using the algorithm and thereby stifle rather than promote technological progress. Granting a patent in this case, the court said, would be analogous to having granted Samuel Morse a patent covering all possible uses of electromagnetism in communications, rather than for the specific method and apparatus he actually invented.
The court made a point of saying, however, that its decision did not mean that computer software could not be patented—only that software whose only useful characteristic was an abstract algorithm could not be patented.
The Supreme Court further refined its thinking on software patentability in the 1978 case Parker v. Flook. Unlike the attempt to patent all uses of an algorithm in the Benson case, here the use of a software algorithm was limited to a specific application—setting off an alarm during the catalytic chemical conversion of hydrocarbons. This was a specific and tangible use of an algorithm, but the Court still ruled the software unpatentable because it felt the application itself was not inventive.
But once again, the Court left the door open: “Even though a phenomenon of nature or mathematical formula may be well known, an inventive application ... may be patented.”
Three years later, the Supreme Court made its third attempt to define the patent-eligibility of software. In Diamond v. Diehr , the Court ruled that although algorithms by themselves are not patentable, a software program that used algorithms to govern the molding of raw synthetic rubber into cured precision products was in fact patentable because it involved “transforming or reducing an article to a different state or thing.”
The Software Picture Blurs Even More
Taken together, the three rulings appeared for a time to arrive finally at a coherent definition of software patentability—namely, that although algorithms by themselves are abstract concepts and therefore unpatentable, software programs may be patented if they employ algorithms to produce a tangible and inventive or transformative result. This view was further augmented by a 1998 U.S. Court of Appeals for the Federal Circuit decision in State Street Bank v. Signature Financial Group, which extended software patentability to software-enabled methods of doing business so long as these produced a “useful, concrete, and tangible result.”
But this definitional equilibrium was not to last. The “useful, concrete, and tangible result” test in State Street Bank was rejected ten years later by the same court in In re Bilski, which upheld the USPTO’s denial of a patent for a method of hedging risk in commodities trading. The court instead offered a “machine or transformation” test, which allows a software program or business method to be patented only if it is implemented on a specific machine to achieve a special purpose that is novel, nonobvious, and useful; it transforms an article from one thing or state to another.
But in its review of Bilski v. Kappos , the Supreme Court ruled that while the “machine or transformation” test was useful, it was not the only test for patentability. In addition to the “machine or transformation” test, the court decreed (rather vaguely) that any future test should be “grounded in the examples and concepts” expressed in its original “patent-eligibility trilogy” of opinions. They thus reaffirmed that business methods may indeed be patentable.
Finally, a “Pretty Clear” Message
While businesses and the courts were trying to figure out what the other tests for patentability might be, the Supreme Court provided further input with its March 2012 decision in Mayo Collaborative Services v. Prometheus Laboratories . Here, the court ruled that a process enabling physicians to correlate blood test results with medication levels to achieve the most appropriate dosages was ineligible for patent protection.”
But then in June of 2014, The Supreme Court issued what may prove to be its most consequential decision on the patentability of software in the 33 years since Diamond v. Diehr. In Alice v. CLS Bank, the Court ruled that taking some activity that people have been doing for centuries—in this case, holding funds in escrow until a transaction is completed—and then merely “doing it through a computer” did not turn this age-old activity into a patentable new invention.
At first, many observers believed that the effects of the Alice v. CLS Bank ruling would be very limited. Only the patent in the suit was invalidated, after all, not all software patents. What’s more, the abstract reasoning of the court in its decision did not provide clarity on how the ruling may or may not apply to other kinds of software patents—for example, the sort of software used in manufacturing that was ruled patentable in the 1981 Diamond v. Diehr case.
But by October of 2014, a series of lower court decisions applying the new Alice v. CLS Bank standard had invalidated 13 additional software patents. As technology policy journalist Timothy B. Lee noted, “The courts are sending a pretty clear message: you can’t take a commonplace human activity, do it with a computer, and call that a patentable invention.”
The courts are sending a pretty clear message: you can’t take a commonplace human activity, do it with a computer, and call that a patentable invention.”
-Timothy B. Lee, technology policy journalist
How far reaching will the impact of Alice v. CLS Bank be? “This doesn’t necessarily mean that all software patents are in danger,” Lee noted, because the patents involved “were particularly vulnerable to challenge under the new Alice precedent. But it does mean that the pendulum of patent law is clearly swinging in an anti-[software] patent direction.”
Overcoming the Alice Paradox
By late 2015, however, it was clear that the Alice ruling was having an impact not only on patent law, but also on the innovation process itself within corporate America.
As John Cronin, a former top inventor at IBM and now the CEO of the innovation-on-demand firm ipCreate, observes: “The highest-value products and services today—the ones that increasingly drive margins in business—involve cloud computing, Big Data, machine learning, connectivity, mobility and location-based services, and on-demand and anything-as-a-service software applications and business processes. But ironically, these high-value innovations are also the most difficult to patent nowadays as a result of the Supreme Court’s Alice decision.”
Cronin calls this the “Alice Paradox,” and it has left many in-house patent groups struggling for a solution. One thing is clear: To be patentable nowadays, software has to take a genuinely-inventive step and either trigger an action, employ a device, or in some other way produce a tangible transformative result.
In addition, smart companies are trying to address patentability issues involving software and business processes much earlier in the innovation cycle, before huge investments are made in R&D that may turn out to be not patentable.
Overall, addressing the “Alice Paradox” will be critical for many companies because patenting clearly adds value to a new product or service. In a groundbreaking joint study from Carnegie Mellon University, Georgia Institute of Technology, and Duke University entitled “R&D and the Patent Premium,” economists found that “the patent premium for innovations that were patented is substantial. Firms earn on average a 50% premium over the no patenting case, ranging from 60% in the health-related industries to 40% in electronics.”xlv
The Debate on Software Continues
The debate over the dividing line between patentable versus unpatentable computer software-related inventions continues—in corporate R&D labs and in the courts.
However, there are some who don’t believe that software and business methods should be patented under any conditions. They argue first of all that software is different from other industries—more iterative and more incremental, with each advance building upon thousands of previous advances. Therefore, their thinking goes, software should not be entitled to patents that ought to be more properly reserved for truly breakthrough or revolutionary inventions.
There are two problems with this argument. First, as anyone in the semiconductor, chemical, or medical device industries can attest, innovation is no more iterative, incremental, or cumulative in software than is innovation in many other industries. Indeed, there are probably just as many or more patents for incremental semiconductor inventions that build modestly upon earlier work as there are patents for incremental software inventions that do the same.
As patent scholar and veteran practitioner Paul Janicke of the University of Houston put it, “There really are no breakthrough inventions—at least not in the sense imagined by these critics. Everything moves one step at a time. In fact, every time I thought I encountered a large leap, it turned out that I didn’t know the full extent of the prior art.”
The second problem with their logic is that the Founding Fathers specifically designed the patent system to encourage precisely this kind of incremental invention, so that ordinary people—using only the basic technical skills possessed by most citizens—could participate in rapidly developing the economy from the ground up. This was a very different approach than that of elitist European patent systems of the day, and it produced results that the rest of the world very soon came to envy (see “Section 1.5: What the U.S. Patent System Wrought”).
As the October 21, 1876, issue of Scientific American noted, “In the aggregate the little things—which in England or the continent would not or could not be patented—probably add more to the wealth and wellbeing of the community … than the great things do.” Or to quote Thomas Jefferson himself: “A smaller [invention], applicable to our daily concerns, is infinitely more valuable than the greatest which can only be used for great objects.”xlvi Any uncertainty over the validity of incremental patenting was removed once and for all by the Patent Act of 1952. Consistent with the Founders’ intentions, U.S. law now explicitly holds that patent eligibility is not restricted solely to revolutionary inventions or “flash of genius” discoveries, but also includes more iterative advances in the state of the technological art so long as these meet the requisite novelty, nonobviousness, and utility criteria.
Evidence Shows Software Patents Don’t Hinder Innovation
Another argument made by critics of software patenting is that patents stifle innovation and foster monopolization in the software industry. Research, however, suggests that this is decidedly not the case.xlvii If anything, in fact, the software industry has become even more innovative, more diversified, and more start-up friendly since patenting became common in the 1990s. You need only look at the huge proliferation of highly innovative start-ups in today’s social media and apps software fields to see just how erroneous the claim is that software patents stifle innovation. Or consider for a moment the fate of the Blackberry, once dominant but within the space of a couple of years superseded by more innovative competing smartphone makers.
Finally, some critics insist that the intangible nature of software ought to disqualify it from patentability. But as noted earlier, the Supreme Court has affirmed repeatedly that although abstract concepts cannot be patented, software that employs algorithms to produce a tangible and inventive result—e.g., software that governs the molding of raw synthetic rubber into cured precision products—may be patented.
It’s also helpful to view this issue in a larger context. Forty years ago, 80 percent of the market value of all public companies resided in their tangible physical assets—their plant, equipment, and raw materials. In today’s Knowledge Economy, however, it is intangible assets—intellectual property—that make up 80 percent of the market value of public companies.xlviii
Indeed, the entire history of economic progress on our planet may be described as one long climb by humanity up the ladder of abstraction—from brute force to the subtle use of energy, from wealth derived from tangible resources and industrial machinery to wealth derived from ever-more ingenious ways to deploy that energy and those resources. It seems only logical, therefore, to expect that invention itself should follow a similar trajectory—from the realm of the tangible to the realm of the intangible.
Ironically, the debate over patents for software, business methods, and other intangible inventions is nowhere more heated than on the Internet, itself an intangible realm in which “virtual” businesses launched with little more than hope and electrons (e.g., Facebook) are creating real and substantial wealth in the form of new products, new services, new jobs, and new economic growth for society. Yet strangely, those who have no trouble accepting the Internet as the intangible fruit of information age invention seem to get stuck in industrial age conceptions of what should and should not be patentable.
Odd perhaps, but not surprising. The expansion of patentable subject matter into new and more intangible realms has always met with resistance. Patents involving the use of electricity were condemned 140 years ago, as were biotechnology patents 30 years ago, and of course software patents when they began to appear in large numbers 20 years ago. In each case, critics warned that these new kinds of patents would hold back further scientific discovery and innovation. Yet in each case, innovation and discovery actually intensified and their benefits to society multiplied.
When Gene-Related Inventions Are Patentable
A similar resistance is also developing toward gene-related patents. These began to be issued in significant numbers after the Supreme Court’s 1980 ruling in Diamond v. Chakrabarty, which upheld the first patent on a newly-created living organism—a bacterium for digesting crude oil in oil spills. Since then, patents have been granted for isolated gene sequences, but so far only on those with known functions and not on naturally occurring genes in humans or other organisms. Patents have also been granted for gene sequences used in diagnostic testing, and on gene sequences that have been altered to make them more useful in a specific application.
In March of 2010, however, a federal district court judge ruled in the case of Myriad Genetics that even isolated DNA is fundamentally the same as naturally- occurring DNA and is therefore ineligible for patenting. His ruling was reversed by the U.S. Court of Appeals for the Federal Circuit in July, 2011. But the Supreme Court then set aside that decision and directed the appeals court to once again review the case in light of its March, 2012 Prometheus decision. On August 16, 2012, however, the U.S. Court of Appeals for the Federal Circuit once again reaffirmed Myriad’s right to patent the isolated genes BCRA1 and BCRA2, which are involved in most inherited forms of breast and ovarian cancer.
On June 13, 2013, however, the U.S. Supreme Court finally determined in a unanimous decision that a naturally occurring DNA segment is a product of nature and cannot be patented merely because it has been isolated, thereby invalidating Myriad’s patents on the BRCA1 and BRCA2 genes. The Court did rule, however, that the manipulation of a gene to create something not found in nature—such as a strand of synthetically-produced complementary DNA (cDNA)—could still be eligible for patent protection.
To the average citizen—and perhaps to many patent lawyers as well—all this legal hairsplitting over the limits of patentability in the computer age must seem a bit like the debates in medieval times over how many angels can dance on the head of a pin. But two critical points must be borne in mind regarding these debates.
First, no matter what anyone thinks the limits of patentability in an ideal world ought to be, out in the real world where we actually live, software, business method, and gene patents are multi- billion-dollar facts of life that businesses ignore only at their peril.
Second, whatever confusion may exist today, the debates over patentability in the computer age will almost certainly be resolved eventually to most people’s satisfaction, just as all previous debates over patentability have. For if nothing else, the two hundred year-plus history of the courts and the patent office demonstrate a remarkable ability on the part of these institutions to adapt to the challenges posed by new technologies and new economic conditions.
Footnotes
• xliii 35 U.S.C § 101.
• xliv Arthur R. Millerand Michael H. Davis,Intellectual Property: Patents, Trademarks, and Copyright in a Nutshell. (5th ed., p. 25). St. Paul MN: West Publishing Co., 2007.
• xlv Ashish Arora, Marco Ceccagnoli, and Wesley M. Cohen, “R&D and the Patent Premium,” Science Direct, International Journal of Industrial Organization Issue 26, 2008.
• xlvi From Jefferson’s letter to George Fleming in 1815, excerpt from The Jefferson Cyclopedia, courtesy of B. Zorina Khan.
• xlvii Robert Merges, “Patents, Entry and Growth in The Software Industry,” University of California at Berkeley School of Law, Berkeley, California, 2006. Retrieved from: http://papers.ssrn.com/sol3/papers.c...ract_id=926204
• xlviii Op. cit., Ocean Tomo. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.06%3A_Patent-Eligible_Inventions.txt |
Learning Objectives
After completing this section, you will be able to
• Identify the criteria that an invention must meet to earn a patent.
• Understand why non-obviousness is the most difficult hurdle to overcome.
Can I Patent That?
Before reading this section, please watch the overview video below covering what you can and cannot patent. You can’t patent an idea (like an idea for a better mousetrap), only an application of that idea in a practical invention. Novelty, utility, and non-obviousness—the holy trinity of patents.
Now that you’ve learned what can be patented and what cannot, we will next examine the criteria for determining if a patent-eligible invention actually merits one. These criteria center around three concepts mentioned in the previous section and enumerated in the Patent Act: novelty, utility, and non-obviousness.xlix
Let’s discuss these three concepts in greater detail.
Novelty
The requirement in Sections 101 and 102 of the Patent Act for novelty in an invention means that to qualify for a patent, a machine, manufacture, process, or composition of matter must not have been previously described or known. Specifically, it must not have been patented, described in an unpublished or published patent application, explained in a printed publication such as an article or technical paper, or publicly known prior to the filing date of the new patent application. In addition, it must not have been published, used in public, or offered for sale by the applicant or their colleagues more than 12 months prior to the filing of a patent application.
If any of the above is true of an invention, it is said to have been “anticipated” and cannot be patented. These novelty requirements exist whether the “prior art”—the catchall term for any previous patent, publication, or use—is domestic or foreign.
This does not mean, of course, that your faster-than-light warp drive is unpatentable simply because it was envisioned in a general way in episodes of Star Trek and its successors’ television shows, and in many Star Trek books.
“It is not enough that an invention be suggested by the literature,” explains the eminent New York University scholar Arthur R. Miller and his coauthor Michael H. Davis’ in their textbook for law students.l “Nor is it sufficient that the literature made the invention inevitable—that bears on the question of non-obviousness. The test, with one major exception, is whether enough of the invention has been disclosed to enable a person skilled in the applicable art to duplicate the product or process.”
That one exception, writes Miller and Davis, is public use of the invention. In that case, even a limited disclosure that does not reveal the secrets of the invention can still foreclose a patent if the public use of it “discloses the invention’s benefits.”
Prior Art Must Be Enabling
In the era of social media, the previously mentioned requirements could pose a novelty barrier if not handled properly.
For instance, if you develop a new watch that displays information from an iPhone, and then disclose it on the crowdsourced funding site Kickstarter in order to raise capital from thousands of small-time investors, then you will probably want to file a patent application prior to, or certainly no later than a year after, your disclosure of the benefits of your watch to the public.
But in the absence of such public use, disclosure in prior art must be substantial and enabling to be disqualifying.
As patent attorney and writer of the widely read IP Watchdog blog Gene Quinn explains:
“What Star Trek teaches is the idea of warp speed wit some suggested articulation of how it could be achieved. But that’s not informing enough. Someone could not make and use the device based on what is taught in Star Trek. So if you actually figure out how to make a faster-than-light warp drive work—and can describe it sufficiently so that someone skilled in the science of space propulsion could build it—then yes, it would be patentable.” Take heart, Star Trek fans!
Utility
As the Star Trek example suggests, the novelty issue can also touch on the question of utility—the second patentability criteria. Utility has a special meaning in patent law, which is simply that an invention must function and be of some benefit qualitatively—although no minimum quantum of benefit is necessary. The landscape of business is littered with companies that have invented not very useful or necessary products. But these may satisfy the requirement for utility if at least someone would find them useful.
But snake oil medicines and other products that do not work in any meaningful way will not meet the requirement for utility. “The inventor of an ineffective drug may not obtain a patent merely because he convinces gullible patients that it has a non-existent curative effect,” Miller and Davis note. “It is not so much that it lacks a minimum quantum of benefit (the patients may find it subjectively useful), but it is, instead, that it has an impermissible fraudulent quality.”
Even when no fraud is intended, the utility of a product or process must be demonstrate in a patent application—not presumed, but affirmatively demonstrated. Simply put, the thing or the method you have invented must actually work as it is intended and claimed to work.
“Forget Star Trek for a moment,” says Quinn. “On a more mundane level, the USPTO used to deny patents for methods and compositions for re-growing hair. These were seen as lacking utility because re-growing hair was believed to be impossible. Finally, someone was able to prove that his method and composition actually regrew hair on a bald scalp. The patent examiners withdrew their rejection, and patents for such products have issued ever since.”
Interestingly, Quinn explains, since the earlier patent applications on hair-growing products didn’t describe anything that actually worked, they could not be used under the novelty bar to block later patent applications for hair-growing products that did work.
Non-Obviousness
An invention may be new. It may also have utility. But to meet the criteria for a patent, it must also be nonobvious under Section 103 of the Patent Act. Let’s now dig deeper into the requirements of the concept of non-obviousness.
Requirements
The requirement for non-obviousness may be illustrated with a fanciful example. If the number 4 were an invented product rather than a mathematical symbol, then even though the number 4 had never been invented before and was thus novel, it would still not be patentable. That’s because someone skilled in the art could have put 2 and 2 together to come up with it.
But to offer a more practical example, say you invent a wheeled cart to move office supplies more easily between departments. If this is the first such wheeled office cart in history, you can get a patent for it. But if you then decide, “Hey, why not put those wheels on a chair?” you won’t get a patent for it. That’s because combining two such widely-known and available elements would be obvious to anyone skilled in the art of office furniture design.
But things are not so obvious when it comes to inventing a camera phone. Even though it’s composed of wellknown and widely-available components, combining the two did satisfy the requirement for non-obviousness because it became more than the sum of its parts and met a large and previously-unfilled need in the marketplace. The millions of people who take selfies everyday is certainly proof of that.
There are various ways of presenting evidence that your invention satisfies the non-obvious requirement for patentability. You can demonstrate that the existing elements of your invention, although individually already known, yield an unexpected or hidden result. Or you can show that your invention, although composed of well- known and widely available components, when combined satisfies a long-felt but previously unfilled need in the marketplace, thus indicating its non-obviousness. Both of these demonstrations of non-obviousness apply to the camera phone example above.
The One-Click Patent
Some people criticized the so-called “one-click” patent granted by the USPTO to Amazon.com in 1999 for Amazon’s system enabling customers to buy an item with a single click of the mouse—with the payment information needed to complete the purchase already having been entered by the user previously.
They contended that although Amazon might have been the first company to employ the process, it was an obvious and inevitable iteration of already- existing mouse-clicking procedures for making a purchase online. The patent office reexamined the patent, however, and in 2007 upheld the validity and the bulk of its major claims.
It is important to note that it’s an invention’s function that is often examined to determine obviousness. “Even though it may be obvious that a certain object can be constructed in a certain way, its utility and novelty may lie in its functional use, not its construction,” write Miller and Davis. “Therefore, the prior art must be used to determine whether the invention’s new and useful function, not its construction, is non-obvious.”
During the first half of the twentieth century, the courts often saw an invention as obvious when it lacked a “flash of genius” and was merely an incremental advance over the state of the art as opposed to what they imagined would be a “revolutionary” breakthrough discovery. But that subjective interpretation of inventiveness was overturned by the 1952 Patent Act, which codified a more objective standard—namely, that whether an invention is developed through laborious trial and error or through a eureka flash-of-genius moment has no bearing on its obviousness or non-obviousness.
Overcoming Patent Hurdles
Taken together, the three patenting criteria—novelty, utility, and non-obviousness—function like the obstacles in an Olympic hurdles race. The utility hurdle is easiest to overcome. The novelty hurdle less so. But by far, the highest hurdle facing inventors is non-obviousness.
“The vast majority of all rejections at the patent office are for obviousness reasons,” explains retired Chief Judge Paul Michel of the U.S. Court of Appeals for the Federal Circuit, the main court that handles patent appeals. “And it’s not very difficult to see why. Given the millions of patented inventions over the decades, the tens of millions of past and current products on the market, it’s not all that easy to come up with an invention that is not only novel but also truly non-obvious to someone with ordinary skill in the state of the art.”
Many believe that the criteria for patenting weakened in the late 1990s and early 2000s, and that as a result, too many poor-quality patents were issued. To the extent this problem exists, one of its likeliest causes is the fivefold increase in patent applications that has taken place over the last 30 years without a commensurate increase in USPTO funding, resources, and capabilities.
Despite these challenges, the USPTO has made substantial progress in the last five years in improving examiner training and tools, reducing the backlog of pending applications, and strengthening the quality of the examination process for patent applications. This progress has been made despite oftentimes-unclear or contradictory patentability rulings from the courts.
Patent quality is essential to the maintenance of public confidence in the patent system. After all, when property rights (either real or intellectual) are seen as overbroad, ill-defined, or illegitimate, individuals and businesses are more willing to trespass on them.
Footnotes
• xlix 35 U.S.C.§101, §102, and §103
• l Op. cit., Miller & Davis. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.07%3A_Criteria_for_Patenting.txt |
Learning Objectives
After completing this section, you will be able to
• Explain the differences among utility, plant, and design patents.
• Describe common patent misconceptions.
Up to this point, we have focused only on the most common types of patents, called utility patents, which preclude others from making, using, or selling the invention during the term of the patent, which begins on the grant date and ends 20 years from the filing date (for an average of 17 to 18 years). But in addition to these, the Patent Act also provides for two other types of patents—plant patents and design patents.
Plant Patents
Plant patents were first created by the Patent Act of 1930, which had been proposed by Luther Burbank to protect new species of asexually reproduced plants, mostly flowers. These are different than the utility patents granted to bioengineered plants used in agriculture. The United States was the first country in the world to grant plant patents, and even today many countries continue to deny protection for plants. Indeed, even some signatories to the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) administered by the World Trade Organization (WTO) reserve the right to deny patents for plants.
Although the requirements for plant and design patents are substantially the same as those for utility patents, there are some crucial differences. The most important of these is the substitution of a different test for one of the three criteria for patentability discussed in the previous section.
Instead of novelty, utility, and non-obviousness, the criteria for plant patentability are novelty, distinctiveness, and non-obviousness. To be patentable, plants must be cultivated rather than found in the wild, and plant patents are granted only to protect a new, distinct, and non-obvious variety of asexually reproduced plant—i.e., those grown not with seeds but by grafting, budding, or cutting. A plant need not be useful to qualify for a patent, but it must be distinctive in its color, habit, soil, flavor, productivity, form, or other aspects.
Design Patents
Design patents are granted to protect new, original, and non-obvious ornamental designs for articles of manufacture. Examples include Apple’s 2009 and 2010 patents—No. D593087 and No. D618677—which covered among other things the unique, rounded-corner design of the iPhone, as well as its 2005 design patent No. D504889 for the look and feel of the iPad. Design patents can be just as valuable as utility patents, as Apple discovered when a jury awarded it \$1 billion in damages against Samsung in August 2012, for the latter’s infringement of Apple’s utility and design patents. The case is currently on appeal.
Like plant patents, design patents also substitute a different test than utility in their requirements for patentability. Instead of the novelty, utility, and non-obvious requirements for utility patents, the criteria for design patents are novelty, ornamentality, and non-obviousness.
It was on the subject of design patents that one example of media confusion appeared. The New York Times published an article November 16, 2012, declaring in a sensational headline that “Apple Now Owns the Page Turn.” The article claimed that a new Apple design patent “gives Apple the exclusive rights to the page turn in an e-reader application.” According to the article’s author, this showed “just how broken the patent system is.”
Had the author of the article even read an obvious and easily-available source as the Wikipedia entry on design patents, however, he would have learned that design patents are granted only for nonfunctional ornamental designs. In fact, says Wikipedia, “design patents can be invalidated if the design has practical utility.”
What Apple actually “owns,” therefore, is not the “page turn” function itself but merely the particular ornamental design of the way a page turn is executed in their devices.
Another example of confused media reporting on patent matters was the February 6, 2013, Forbes article headlined: “Is the Patent System Broken? Well, Amazon’s Just Patented the Sale of Second Hand Goods.” Amazon actually did no such thing, but the author of that article probably made this assumption after reading the abstract of the patent describing its general subject matter. Like many reporters new to patent issues, the author didn’t realize that the abstract tells you literally nothing about the exclusive rights conferred by a patent. Only the claims of the patent detail the specific exclusionary rights of the patent holder.
Indeed, when you read the claims of the Amazon patent in question, you discover that Amazon hasn’t claimed ownership of the idea of a “market in second-hand digital goods” at all. Instead, the claims involve merely a very specific and novel method of conducting such a market. Meanwhile, Apple, ReDigi, and other firms have patented their own alternative methods of conducting a secondary digital market. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.08%3A_Other_Types_of_Patents.txt |
Learning Objectives
After completing this section, you will be able to
• Describe the steps in the patent application process.
• Discuss the importance of proper claims drafting.
Applying for a Patent
Much is at stake in the process of applying for a patent. Depending upon how you draft the claims and write the specification of your application, you could win or lose patent rights at any point in the examination process. In addition, any patent rights you win can be worth a considerable amount of money, and can be enforced by the U.S. federal courts.
An applicant must first determine whether to file an application for a utility, design, or plant patent. Then, the applicant must determine their filing status: large entity, small entity, or the new category of micro entity created by the America Invents Act of 2011 (AIA). Small entities, which are universities, non-profits, and small businesses with fewer than 500 employees who also meet certain other criteria, receive a 50 percent discount on the application fees paid by large entities. Micro entities, which are small entities who have a gross income less than three times U.S. median household income or meet certain other criteria, receive a 75 percent discount. These discounts on USPTO fees for small and micro entities do not apply to the attorneys’ fees often involved in applying for a patent, which can be significant.
Provisional vs. Nonprovisional Patent Application
Finally, the applicant must decide whether to file an abbreviated, “provisional” patent application or a complete, “nonprovisional” one. A provisional application consists only of the specification describing the invention for which a patent is sought, as well as any drawings that might be necessary to understand the invention. A provisional application is not subject to examination, and is viable for one year.
The chief benefits of a provisional application are twofold. It is much less expensive to file than a regular nonprovisional application—only \$1,000 in official fees for large entities, \$500 for small entities, and \$250 for micro entities. It also gives the inventor the benefit of the earlier provisional filing date of the nonprovisional application based on the same specification, while measuring the term of the patent from the nonprovisional application’s filing date.
In a sense, the provisional application serves as a placeholder for up to one year while the inventor does all the prior art searching, claims drafting, and other work required of a full and complete nonprovisional application. This priority date placeholder function can be important given that many companies and inventors are working on new products and services aimed at the same markets. This is especially so under the United States’ new “first inventor to file” rather than “first to invent” priority regime, which some fear may give an edge to large companies with the legal and financial resources to file early and often. To the extent this concern may be valid, provisional applications can serve to mitigate any large company filing advantage.
The main disadvantage of a provisional application is that because the written description cannot be changed when filing the follow-on, nonprovisional application, all the subsequent claims in that follow-on application must be completely consistent with the earlier description language. As most inventors can attest, the understanding of an invention and its potential market—as well as the claims best suited to protect it—inevitably evolves and matures over time.
Here’s how an experienced entrepreneur describes the value of a provisional application in the “first inventor to file” environment:
“What I recommend to every entrepreneur is that if you write a new, non-obvious, and useful line of code, put it in the specification of a provisional patent application and file it. It only costs \$1,000 at most. You then have a year in which to honestly evaluate where the industry is going, where the market is going, and whether your invention is truly valuable enough to pursue a patent for it.”
A year might not seem very long. But a lot can happen to markets and to technology in that amount of time. Thanks to the rapid rise of smartphones, for example, it took merely a year for netbooks to go from the “next big thing” to “who cares?”
The Critical Importance of the Claims
When it comes to filing a full nonprovisional application, the most critical task of the inventor (and patent attorney) is to draft the claims. This is an art in and of itself, one that will determine the inventor’s rights and an infringer’s liability.
Each claim serves as a stand-alone definition of the patent coverage—as a sort of mini-patent unto itself. After a patent is granted, a claim is the only thing that someone can be accused of infringing. Accordingly, broad claim language is essential if a commercially meaningful patent is to be obtained.
On the other hand, the broader the claim, the more likely it is that prior art may exist somewhere that anticipates the claim or renders it obvious and, therefore, invalidates the claim. So the competent draftsperson submits a dozen or more claims, typically moving from broader to narrower scope, in case the broader claims turn out to be disallowed by the USPTO or later invalidated by a court.
Some applicants make the opposite mistake and draft claims that are too narrow—“a programmable multifunction computer in the shape of a metal clamshell,” for example. Such a claim is of little value because others can easily design around it simply by using plastic or other nonmetal materials in the design. Some claims are so narrow they are even referred to as “picture claims” because they paint a literal and limiting picture of the invention. You may get a patent with such picture claims, but it probably won’t be worth the paper it’s printed on.
The strongest claims usually define powerful functionality. They capture something fundamental or seminal in the functioning of the invention.
A good example is the claims in the aforementioned Amazon one-click patent. The algorithms for “one-click” shopping are not very complicated. Yet the claims capture a very profound functionality—the idea that a user should not have to type in credit card and shipping information every time he or she wants to buy something. The consumer-friendly functionality captured in that patent’s claims has won Amazon a lot of customers and made it a lot of money.
Reviewing the Patent Application
Once the patent application with all necessary forms is filed and all fees are paid, the patent examiner will review the patent application to determine if the invention meets the statutory requirements for patentability. The examiner will also conduct a search of patent and other databases to determine if the invention appears to be truly novel and non-obvious. Once a determination has been made, the patent examiner will send the applicant a document known as a first office action, in which the patent examiner approves, rejects, or requires additional information about the claims and/or other elements of the application.
If all the claims are allowed, which is rare in a first office action, the patent prosecution process is complete. A more common next step requires the applicant to respond to the patent examiner’s rejections and requests for more information. In this response, the applicant will address all of the examiner’s concerns and either rebut them or amend the application, typically by revising some or all of the claims.
But according to the Manual of Patenting Examination Procedure (MPEP) Section 1.121, “No amendment may introduce new matter into the disclosure of an application.”li Thus, an applicant cannot file an application disclosing a new compound and how to make it, and then later, after discovering that the compound’s structure and method are incorrect, amend the description.
After responding to the office action by perhaps amending the application, the examination process continues until the patent examiner either allows all of the claims or finally rejects them. If all claims are allowed, then the patent prosecution process is complete. If some claims are finally rejected, then the applicant’s options at this point are more limited.
According to MPEP Section 706.07, “In the second or any subsequent examination or consideration by the examiner, the rejection can be made final.”lii At that point, the applicant must usually choose one of three approaches: Cancel the rejected claims, leaving only allowed claims to issue as a patent; continue the fight by filing what is called a “continuation application” and drafting new claims; or appeal to the Patent Trial and Appeals Board arguing that the patent examiner erred in not allowing the claims.liii Any appeal to the Patent Trial and Appeals Board, as with any other office action, must occur within six months.liv
Finally, if the patent has been vetted through the patent prosecution process and is ready for issuance, the patent holder must pay the applicable fee. If the applicant pays the issue fee, the USPTO will issue the patent in due course. Additionally, utility patents are subject to maintenance fees. These fees are due 3 years and 6 months, 7 years and 6 months, and 11 years and 6 months from the date of the original patent grant. Plant and design patents are also required to pay maintenance fees.lv | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/1.09%3A_The_Patenting_Process.txt |
1.
A patent gives an inventor the exclusive right to which of the following?
1. The ability to profit from their invention.
2. The ability to prevent others from making, using, offering for sale, or selling the invention.
3. The ability to prevent others from learning the secrets of the invention.
4. All of the above.
Answer
B. The ability to prevent others from making, using, offering for sale, or selling the invention.
2.
The “bargain” theory, a theoretical justification for patents, argues which of the following?
1. In exchange for inventing something useful, society gives the inventor the exclusive right to their invention for a limited time.
2. The product of mental labor should be the property of its creator.
3. Government negotiates with inventors to determine the value of an invention.
4. None of the above.
Answer
A. In exchange for inventing something useful, society gives the inventor the exclusive right to their invention for a limited time.
3.
Which two public policy goals are served by granting patent rights?
1. By protecting the property rights of inventors, the wellsprings of creation do not dry up for lack of incentive.
2. Patent rights ensure equal treatment for all.
3. From each according to their ability, to each according to their need.
4. The public interest is served by disclosing the details of the invention and thereby promoting the progress of the nation.
Answer
A. By protecting the property rights of inventors, the wellsprings of creation do not dry up for lack of incentive. and D. The public interest is served by disclosing the details of the invention and thereby promoting the progress of the nation.
4.
Through which of the following means do patents also promote knowledge sharing?
1. To get a patent, inventors must disclose the secrets of their inventions.
2. Patents represent the world’s greatest library of technical knowledge.
3. Innovators keep up with technical trends by reading other inventors’ patents.
4. All of the above.
Answer
D. All of the above.
5.
The Statute of Monopolies in 1624 ended the practice of granting patents for which of the following?
1. Inventions that were not truly novel.
2. The Crown’s favored inventors.
3. Trade in staples such as salt or soap rather than for actual inventions.
4. Inventions that helped industrialists monopolize whole industries.
Answer
C. Trade in staples such as salt or soap rather than for actual inventions.
6.
Which of the following practices were common in early patent systems?
1. Exorbitantly high patent fees.
2. Limited or no disclosure of the details of the invention.
3. No examination for patent validity.
4. All of the above.
Answer
D. All of the above.
7.
Early patent systems tended to have which of the following effects on the overall economy?
1. Innovation was limited to a small sector of the population.
2. Biased toward incumbent industries, early patent systems did not encourage disruptive change.
3. Early patent systems reinforced the wealth of elites, not the productive capacity of society.
4. All of the above.
Answer
D. All of the above.
8.
The Founding Fathers created the U.S. patent system with which overarching goal in mind?
1. To defend America’s newly won independence.
2. To rapidly stimulate the growth of domestic industry.
3. To create advanced new weapons for America’s young army.
4. None of the above.
Answer
B. To rapidly stimulate the growth of domestic industry.
9.
The U.S. patent system was designed to tap the creative and productive potential of which of the following?
1. Their abundant natural resources.
2. Their large stock of imported goods and machinery.
3. Rich agricultural lands.
4. An enterprising population with a “universal ambition to go forward”
Answer
D. An enterprising population with a “universal ambition to go forward”
10.
Which of the following was NOT a unique feature of the U.S. patent system?
1. It was affordable by the common person.
2. It had an examination system to determine patent validity.
3. Patentees were required to make or sell products based on their inventions.
4. It had simplified application procedures.
5. It required full disclosure of the details of the invention.
6. It allowed for the sale and licensing of patent rights.
Answer
C. Patentees were required to make or sell products based on their inventions.
11.
Which of the following is NOT true of the U.S. patent system?
1. Novelty, non-obviousness, and utility determine patent validity, not the identity or business model of the inventor.
2. Patents are freely transferable and tradable property rights.
3. You can’t infringe a patent if you honestly don’t know that it exists.
4. Patent holders are not required to make or sell products based on their inventions.
Answer
11. You can’t infringe a patent if you honestly don’t know that it exists.
12.
Compared with the Industrial Revolution, what is the overall patent litigation rate today?
1. It is twice what it used to be.
2. It is about the same as it used to be.
3. It is less than half what it used to be.
Answer
C. It is less than half what it used to be.
13.
Historically speaking, patent litigation has served to which of the following?
1. Slow innovation and R&D.
2. Settle disputed rights to new technology so commercialization can proceed.
3. Block others from designing around patents.
Answer
B. Settle disputed rights to new technology so commercialization can proceed.
14.
How many years after the first patent law was signed in 1790 did it take for the United States to surpass Britain in the number of new inventions being patented?
1. 13 years.
2. 75 years.
3. 40 years.
4. 100 years.
Answer
A. 13 years.
15.
Historically, in the United States, there have been major surges in new patent filings after which of the following?
1. A sharp increase in patent litigation.
2. New technological advances leading to the birth of new industries.
3. A Supreme Court decision on a major patent case.
4. None of the above.
Answer
B. New technological advances leading to the birth of new industries.
16.
What percentage of entrepreneurs say that patents are vital to securing venture funding?
1. 20 percent.
2. 40 percent.
3. 67 percent.
Answer
C. 67 percent.
17.
The United States was the only nation to define its greatness in its capacity for which of the following?
1. Economic growth.
2. Military superiority.
3. Bringing freedom to oppressed elsewhere in the world.
4. Technological progress.
Answer
D. Technological progress.
18.
A patentable invention is a new, novel, and non-obvious machine, manufacture, process, or composition of matter. Which of the four types of inventions categories do these hypothetical mousetrap inventions represent?
1. A mouse ray gun.
2. Exploding mouse glue.
3. A new way to catch mice using sound waves.
4. A mouse-destroying missile.
Answer
A. A machine—a tool with moving parts and uses energy.
B. A composition of matter—a synthesized chemical compound or molecule.
C. A process—a way to do something new or a new way to do something old.
D. A manufacture—a part or product produced according to design.
19.
All patentable inventions fall into two broad categories—they are products or processes. Which category do the following fall into?
1. A machine.
2. A means to an end.
3. A composition of matter.
4. A manufacture.
Answer
A. It’s a product—a physical thing.
B. A process—a way to do something new or a new way to do something old.
C. It’s also a product—a physical thing.
D. Also a product—a physical thing.
20.
Can an idea for a better mousetrap be patented?
1. Yes, so long as you outline the idea in detail.
2. No, you can’t patent a mere idea.
Answer
B. No, you can’t patent a mere idea.
21.
Which of the following is NOT patentable?
1. Electricity.
2. A random number generator.
3. A device that uses electricity to communicate.
Answer
A. Electricity.
22.
When might a software be patentable?
1. If it contains a new, non-obvious, and useful algorithm.
2. If it takes a genuinely-inventive step to either trigger an action, employ a device, or in some other way produce a tangible transformative result.
3. If it records the sale of T-shirts over the Internet.
4. None of the above.
Answer
B. If it takes a genuinely-inventive step to either trigger an action, employ a device, or in some other way produce a tangible transformative result.
23.
Which of the following cases was NOT one of the Supreme Court’s “software-eligibility trilogy” of cases?
1. Gottschalk v. Benson
2. Williams & Wilkins v. United States
3. Parker v. Flook
4. Diamond v. Diehr
Answer
B. Williams & Wilkins v. United States
24.
Which court case most severely limited software patentability?
1. State Street Bank v. Signature Financial Group
2. In re Bilski
3. Mayo Collaborative Services v. Prometheus Laboratories
4. Alice v. CLS Bank
Answer
D. Alice v. CLS Bank
25.
What is the so-called “Alice paradox”?
1. The highest-value new software products and services are also hardest to patent.
2. You can get software patents, but you can’t enforce them.
3. You can only patent software that replicates human activity.
4. None of the above.
Answer
A. The highest-value new software products and services are also hardest to patent.
26.
Patents should only be granted for big revolutionary breakthroughs. True or False?
1. True.
2. False.
Answer
B. False.
27.
Which of the following Supreme Court cases held that a naturally occurring DNA segment CANNOT be patented?
1. Mayo Collaborative Services v. Prometheus Labs., Inc.
2. Association for Molecular Pathology v. Myriad Genetics, Inc.
3. Nautilus, Inc. v. Biosig Instruments, Inc.
Answer
B. Association for Molecular Pathology v. Myriad Genetics, Inc.
28.
Which of the following is NOT a requirement for patent eligibility?
1. Novel.
2. Revolutionary.
3. Non-obvious.
4. Useful.
Answer
B. Revolutionary.
29.
What does the term “prior art” refer to?
1. Any previous private discussions of an invention or its components.
2. Any previous patent, publication, or public use of an invention.
3. Any previous speculation about an invention.
4. None of the above.
Answer
B. Any previous patent, publication, or public use of an invention.
30.
If you invent a functioning starship warp drive, Star Trek would be considered prior art and your invention would be ineligible for a patent. True or False?
1. True.
2. False.
Answer
B. False.
31.
To meet the requirement for utility, which of the following must an invention do?
1. Work or function as intended.
2. Be of some benefit to society.
3. Be a worthwhile product, process, or composition of matter.
4. All of the above.
Answer
A. Work or function as intended.
32.
Why would combining a camera with a cell phone in a smartphone pass the test for non-obviousness, whereas putting wheels from a chair onto an office cart would not?
1. The technology in a smartphone is much more complicated.
2. Putting wheels from a chair onto a cart is less difficult.
3. Combining a camera and a cell phone produced an unexpected result.
Answer
C.
33.
Of the three criteria for patenting, which is the most difficult to surmount?
1. Utility.
2. Novelty.
3. Non-obviousness.
Answer
C. Non-obviousness.
34.
For which of the following are plant patents granted?
1. Bioengineered plants.
2. Naturally grown plants that are distinctively different.
3. Plants that are asexually cultivated, not grown from seeds.
4. All of the above.
Answer
C. Plants that are asexually cultivated, not grown from seeds.
35.
What are the three patentability criteria for plant patents?
1. Novelty, utility, and non-obviousness.
2. Novelty, distinctiveness, and non-obviousness.
3. Novelty, beauty, and non-obviousness.
Answer
B. Novelty, distinctiveness, and non-obviousness.
36.
What are design patents granted for?
1. Functional designs for manufactured items, like the shape of a chair.
2. Ornamental designs for items of manufacture, like the fabric design of a chair.
3. All of the above.
Answer
B. Ornamental designs for items of manufacture, like the fabric design of a chair.
37.
What are the three patentability criteria for a design patent?
1. Novelty, utility, and non-obviousness.
2. Novelty, beauty, and non-obviousness.
3. Novelty, ornamentality, and non-obviousness.
Answer
C. Novelty, ornamentality, and non-obviousness.
38.
By what percentage are filing fees reduced if the applicant is on of the following:
1. Universities, non-profits, and small businesses with fewer than 500 employees.
2. Those with gross income less than three times U.S. median household income or meet other certain critera.
Answer
A. These are called small entities, and receive a 50% discount in application fees.
B. These are micro-entities, and receive a 75% discount in filing fees.
39.
What is the advantage of a provisional patent application, which lasts only one year?
1. It is less expensive.
2. It is not subject to examination.
3. It grants an early filing date while the inventor continues working on the invention.
4. All of the above.
Answer
D. All of the above.
40.
What is the main disadvantage of a provisional patent application?
1. It reserves an early filing date for a later, non-provisional application.
2. The claims in a later, non-provisional application must be completely consistent with the early description contained in the provisional application.
3. The provisional patent only contains the specifications, and drawings, if any.
4. All of the above.
Answer
B. The claims in a later, non-provisional application must be completely consistent with the early description contained in the provisional application.
41.
What is the most critical part of a patent application that determines both the inventor’s rights and an infringer’s liability?
1. The claims.
2. The specification.
3. The drawings.
4. The abstract.
Answer
A. The claims.
42.
Which of the following is the best strategy in drafting claims in a patent application?
1. Draft them as broadly as possible, to cover every possible use of the invention.
2. Draft them as narrowly as possible, so the examiner won’t reject them.
3. Draft them as broadly as the specifications and the prior art allows, then back up those broad claims with successively narrower claims as backup.
Answer
C. Draft them as broadly as the specifications and the prior art allows, then back up those broad claims with successively narrower claims as backup.
43.
In a “first office action,” the examiner usually does which of the following?
1. Allows all the claims in the patent application.
2. Rejects some claims and/or requests further information.
3. Rejects the entire application.
Answer
B. Rejects some claims and/or requests further information.
44.
In a second or subsequent examination, if the examiner finally rejects some or all of the claims, what can the applicant do at that point?
1. Cancel the rejected claims, leaving only allowed claims.
2. File what’s called a “continuation application.”
3. Appeal to the Patent Trial and Appeal Board.
4. All of the above.
Answer
D. All of the above. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/01%3A_Patent_Basics/Chapter_1%3A_Assessment_Questions.txt |
Thumbnail: Lady Justice. (Unsplash License; Tingey Injury Law Firm via Unsplash)
02: Patent Enforcement
Learning Objectives
After completing this section, you will be able to
• Understand the basic rights of patent owners.
• Gain an appreciation of the complex process of patent litigation.
Patents issued by the United States Patent and Trademark Office (USPTO) can be enforced by their owners in U.S. federal courts. The USPTO is responsible only for examining and issuing patents—it does not enforce them. It is up to the owner of the patent to enforce it against infringers by filing a civil case in federal court for patent infringement.
A patent owner is called the “patentee.” The patentee has the statutory right to exclude others from making, using, offering for sale, selling, or importing the invention covered by the patent throughout the United States.iecall that these are rights to exclude others from using the patentee’s invention. The Patent Act does not grant the patent owner the right to practice the invention covered by the patent. Indeed, it may be that the invention, if practiced in the United States, could infringe someone else’s patent! For example, if you obtain a patent on an improvement to a patented product (e.g., a faster-acting version of a patented painkiller), you might not be able to sell the improved product unless you obtain a license under the patent for the underlying product.
Infringement is a strict liability violation—you do not need to know that you are infringing a patent, or that a patent even exists, to be liable for patent infringement. If someone makes, uses, offers for sale, sells, or imports what is covered by a claim of a valid patent, that person is an infringer. Neither lack of knowledge of the patent, nor lack of intent to infringe it, is a defense to patent infringement. ii
Enforcing a patent is almost invariably a long and expensive process. The first step is to decide whether someone is infringing your patent—i.e., making, using, selling, offering to sell, or importing your invention without your permission. To decide whether someone is infringing your patent, the elements of each claim of the patent must be compared with the elements of the potential infringer’s device or process. If the elements of a patent claim match (or “read on”) the elements of the device or process, an infringement has occurred.
Even if some elements of a claim do not literally read on the infringing device, but are sufficiently equivalent in what the device does and how the device does it, they may nevertheless be infringed under the legal rule called the “doctrine of equivalents.”This doctrine prevents an infringer from copying the essence of the invention, but making insignificant modifications in an effort to avoid infringement. If the accused device or process performs substantially the same function in substantially the same way and yields substantially the same result, infringement exists so long as any differences between the claim elements and the accused device are not substantial. A patent calling for an “adhesive” connection (describing glue as the preferred adhesive) could be infringed by a device using a hook-and-loop fastener(e.g.,Velcro). That’s because the hook-and-loop fastener arguably performs substantially the same adhesive function in substantially the same way and with substantially the same result as the glue adhesive.
If a patent owner believes their patents are being infringed, the person typically hires a patent trial lawyer who specializes in enforcing patents. Often, but not always, this is a different person at a different law firm than the lawyer or agent who previously assisted the inventor(s) in obtaining a patent from the USPTO. Once the patent trial lawyer is retained, that lawyer will evaluate the patent and the accused device or process, and will provide the patentee a legal opinion about whether or not an infringement exists. If an infringement is found, the patentee then must decide how to proceed. Several options exist.
Options for Pursuing a Patent Infringement Claim
• Demand that the alleged infringer stop infringing, and pay damages for past infringement.
• Offer the alleged infringer a license to practice your invention for money, called a “royalty.”
• Ignore the infringement, or postpone any action for a time.
• File a patent infringement lawsuit in federal court against the alleged infringer.
Each option has benefits and risks, which should be carefully considered before proceeding.
Footnotes
• i 35 U.S.C. §154(a)(1).
• ii 35 U.S.C. §271(a). An exception, where lack of knowledge may be a defense, is indirect infringement, of which there are two principal types: (1) actively inducing someone else to infringe, which requires knowledge of the patent and an intent to cause the infringement (35 U.S.C. §271(b)), and (2) contributing to someone else’s infringement, which requires selling or offering for sale a component to a patented combination knowing that it is specially made or adapted for use as a material part of an infringing combination and that it is not suitable for substantial noninfringing use. 35 U.S.C. §271(c). | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.01%3A_The_Right_to_Enforce_Patents.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the variety of options one has in enforcing patent rights.
• Appreciate the time and expense involved in doing so.
The decision of how to proceed depends on the patentee’s objectives and a clear understanding of the risks and rewards of each potential course of action. If you do not know your objectives, you cannot decide on a course of action to achieve them.
For example, if your goal is to stop a competitor from offering a competing product that infringes your patent, you have little choice but to file a lawsuit and pursue it to completion. This can easily cost from \$1 million to over \$10 million, depending upon the complexity of the case and the intensity of the defense. If you do not have the resources to pursue such expensive litigation on your own, there are contingency fee lawyers, who may be willing to take your case in return for a share of any damages (typically 30 to 40+ percent) that are collected from the infringer. As of 2014, a wide variety of litigation finance firms exist that may be willing to fund your litigation in return for a share of any damage award or settlement payment you receive.iii
However, if your goal is to obtain a royalty for the use of your invention, you may be able to negotiate a license agreement without the need for litigation. Even if the infringer balks at an agreement unless you initiate a lawsuit, often the lawsuit can be settled via a license agreement short of trial. About 95 percent of patent lawsuits settle before trial, many with the defendant(s) taking a license for which they pay a royalty.iv
Even small entities and individuals can successfully license a patent without filing a lawsuit if they have a good patent and a reasonable licensing plan. Most prospective licensees know that lawsuits are very expensive and would prefer to settle a dispute with a license rather than fight a lawsuit and end up taking a license later. The key is to have a plan, and implement it diligently, with good counsel supporting the effort.
Thus, the first step in deciding if and how you will enforce your patent is deciding what you want to achieve and how much effort, and money, you are willing to devote to the endeavor. The “costs” of enforcement are not limited to the out-of-pocket expenses for lawyers and litigation expenses. Any enforcement effort requires the time and attention of the patentee, whether an individual or company, which disrupts normal business activities. The time and attention required includes providing information and documents, reviewing pleadings prepared by your lawyers, analyzing information received from your opponent during the litigation, appearing for depositions and other pretrial proceedings, and appearing at trial. Just the information and document gathering can consume hundreds, even thousands, of person hours and disrupt the normal operations of virtually every part of an organization.
Enforcing a patent also takes time. Lawsuits typically take two to four years to reach trial. Post-trial proceedings can take another six months to a year, and appeals take several additional years before the lawsuit is “finished.”
On the positive side, successful patentees can reap huge monetary damages for another’s patent infringement, including lost profits, treble damages (i.e., triple the amount of money damages found), and, in exceptional cases, an award of the patentee’s attorneys’ fees. Awards of tens to hundreds of millions, and occasionally even billions, of dollars can be achieved, even if they are not typical. If you sell a product or service and are asserting your patent against a competitor, you can also obtain an injunction barring your competitor from continuing its infringement. This can reap huge additional rewards, measured in increased market share and pricing power.
Patents not only offer patentees the opportunity to play offense in the marketplace, but also provide a very potent defense against charges of infringement (or other claims) by others. Competitors are wary of attacking businesses with extensive patent portfolios. The recent “smartphone wars” are a timely example. After becoming embroiled in patent litigation with Apple and Oracle over its Android operating system and the phones that use it, Google spent \$12.5 billion to acquire Motorola Mobility in August 2011 to gain access to its extensive patent portfolio so that it would have patent weapons of its own.v Google also acquired 1,023 more patents from IBM for an undisclosed amount around the same time.viPerhaps this was also partly in response to Apple joining with BlackBerry maker Research In Motion (RIM), Microsoft, Ericsson, Sony, and EMC to buy 6,000 patents owned by Nortel for \$4.5 billion in July 2011, largely to keep them from falling into the hands of competitors like Google and Samsung.vii
Expert assistance in making the decision to enforce your patent, and to map out the “who, what, where, when, and how” of doing so, is critically important. A variety of lawyers and law firms specialize in patent trials, from solo practitioners to multinational law firms. The choice depends on your needs, means, and objectives. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.02%3A_Deciding_Whether_and_How_to_Enforce_a_Patent.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the pros and cons in deciding who, what, where, when, and how to sue an infringer.
Once a decision is made to enforce a patent via litigation, a complex series of steps begins that determine the “who, what, where, when, and how” of events that will unfold.
Who
First you decide whom to sue. Many options may exist. If the infringer is a corporation, you can sue it. But you can also sue its owners and/or officers if it is a closely held company or is dominated by a single shareholder or manager. If the infringer has subsidiaries, you must choose which of them to include as defendants. Recall that your patent gives you the right to exclude others from making, using, selling, offering for sale, or importing your invention in the territory the patent covers. (We will assume for simplicity that you own a U.S. patent; foreign patents can be obtained in other countries and enforcement of those foreign patents is subject to their local laws.) Any person or entity that violates one of these exclusive rights is a potential defendant.
Strategic issues should be considered in deciding whom to sue. For example, the location of one or more defendants may make it hard to include them in a lawsuit filed in a place (“forum”) convenient to you. Although the infringer’s customers are also infringers (i.e., they “use” the infringing product or service), most patentees disfavor suing customers because these are also the patentee’s customers or potential customers—and suing them may be bad for business. Often, the manufacturer or seller of the infringing product or service indemnifies and defends its customers. In other words, in many cases the manufacturer or seller of a product will agree to “cover” its customers in the event of a patent infringement claim. So, if the infringing manufacturer and/or seller is already a defendant, you gain little by suing customers, except their ire! Thus, select your defendants carefully, with your desired end result in mind.
Another strategic decision, when more than one infringer exists, is whether to sue them one at a time or collectively.viii Common sense might suggest suing them one at a time, to avoid having them gang up on you. But experience shows that suing multiple defendants simultaneously is often a better strategy. It turns out that, in many cases, rather than encouraging them to gang up on you, they spend most of their energy trying to sort out differences among themselves and trying to present a united front.
Although the America Invents Act narrowed the joinder rule in patent cases beginning in September, 2011 to cases where a plaintiff can show a “common question of law or fact” as well as a true “transaction or occurrence” between the defendants (which must be more than infringement of the same patent), judges still typically consolidate separate cases involving the same patent for their own convenience in handling discovery and pre-trial issues. Thus, proceeding simultaneously against multiple defendants can still be an effective strategy.
What
Which patents (if you have more than one) and which claims of those patents you assert in a lawsuit is another important decision you must make. Twenty years ago, you could simply file a lawsuit against an alleged infringer, listing your patent(s) and little more. You could defer deciding which claims to assert against which allegedly infringing products or services until after you received information from the defendant(s) through discovery in the litigation. However, courts now routinely require that you provide details in the complaint you file, or shortly after, about which patent claims are asserted against which product or service, and also that you provide a “claim chart” that details those assertions precisely. Although it is possible to revise these assertions after receiving more information during the discovery process, your initial assertions remain in the court’s record and can come back to haunt you if they are not consistent with your revised assertions. Therefore, careful pre-filing investigation and analysis is crucial to a successful pursuit of the infringers.
Ideally, hire not only an experienced patent trial lawyer to guide this effort, but also the experts you will rely on in the litigation, and who will testify during the trial on how and why the accused products or services infringe your patent(s). Experts can provide essential evidence of the infringement during the trial. Good experts are critical to success in litigation, as much as experienced trial lawyers, but are sometimes surprisingly hard to find. First, you must find an expert who is neutral, or at least appears so. Most experts are employed in the same field as the patentee and the alleged infringer, making them potentially unsuitable candidates because they have allegiances to existing companies that suggest the possibility of bias. Second, a good expert must not only know their subject thoroughly, but also be able to communicate it to a lay audience (i.e., the nonexpert judge and jury). Such communication skills are not always found in experts with strong technical credentials. Finally, you want an expert who has the right skills, but not one who appears to be a hired gun (exemplified by someone who spends most of their time testifying for a fee).
Thus, prepare in advance, and hire experts early in the process, both to assist your preparations and to remain available during the progress of the lawsuit and for trial.
Where
The selection of where to file is an important, perhaps determinative, decision. As we have noted, patent infringement cases seeking damages can only be filed in U.S. federal courts (as opposed to state courts). If your defendant is a private party, the proper location for the case (called “venue”) is the federal district court in the geographic location where the defendant is incorporated or resides, or where the claim arose.ix
The first two criteria are usually easily determined—i.e., a company’s state of incorporation is a matter of public record, as are the places where it has facilities. The place where the claim arose includes every place the infringing product or service is made, sold, offered for sale, used, or imported. If it is a low volume product or service, or is very new or lightly distributed, the proper venues may be quite limited. But typically products or services with enough sales to justify a multimillion dollar patent infringement lawsuit are broadly available throughout the country, opening up virtually any federal court as a possible venue.
Thus, you can, and should, select a venue that meets your objectives as closely as possible. Some venues (e.g., the Eastern District of Virginia and the Western District of Wisconsin) have reputations (and rules) for moving cases through to trial very quickly, often in less than a year. Speed is desirable in terms of reaching a conclusion quickly, but has its downsides in terms of accelerated costs and maximum disruption to the normal business operations of you and your opponent. Other districts exhibit much slower progress toward trial, which may be desirable or undesirable in meeting your particular objectives.
Another factor is experience. Some district courts have handled many complex patent cases, have detailed rules about what must be done to get the case ready for trial, and an excellent track record on appeal. Still other districts have reputations for being “plaintiff friendly” or “defendant friendly,” although these reputations are often more “urban legend” than accurate. In any given case, the outcome is dependent on the parties, the facts, the lawyers, and the judge/jury assigned.
Experienced patent trial counsel can assist you in making an appropriate choice of venue for your case, taking into account the myriad factors pertinent to your case.
When
The timing of filing suit is often dictated by when you discover the existence of the infringement and have gathered the required information for drafting a complaint and the necessary initial disclosures. But other considerations may be relevant also, such as the timing of industry trade shows, holiday sales pushes, or the financing activities of your opponent. Absent any other constraints or objectives, lawsuits should usually be filed as soon after the infringing activity is discovered as possible, given the need to investigate and prepare before filing a complaint.
At the outside, any suit filed more than six years after the infringement began and was reasonably capable of being discovered can give rise to a defense of “laches” and/or “estoppel”by your opponent. In other words,the accused infringer is arguing that you waited too long to bring your infringement claim. It may be necessary for you to prove that the defendant was not prejudiced by your delay. If laches applies, which simply means you waited an unreasonable time tomake your claim, prejudicing your opponent, your damages will be limited to those that arise after you filed your lawsuit. If estoppel applies, which means that you not only delayed, but affirmatively misled your opponent into believing you would not file suit, your claim is barred altogether.
Another issue you face is whether to notify the alleged infringer before filing suit. This seems prudent—demand that the infringer cease the infringement before filing a lawsuit aimed at enforcing such cessation. But such a strategy is fraught with pitfalls. First, accusing someone of infringement allows them to sue you preemptively, asking the court for a quick decision that no infringement exists. This type of judicial decision is called a declaratory judgment of noninfringement.x If the accused infringer sues you before you sue them, the accused infringer becomes the plaintiff and can sue in a forum of their choice. Ceding to your opponent the initiative and the choice of forum for the litigation is a strategic blunder that could cost you not just that battle, but the war. Second, an old adage applies here: If you are going to kick someone, don’t warn them, because they will prepare to deflect the blow. Patent litigation (like all litigation) is like war, albeit civilized war. Ceding to your opponent important strategic advantages, such as the choice of forum and the element of surprise, is costly and can be fatal.
So, do these considerations dictate that you ambush your opponent and appear to be unreasonable by suing without notice? No, a middle ground does exist. Consider filing the lawsuit simultaneously with, or immediately after, making a demand that the infringer cease the infringing activities. You can defer formally “serving” the lawsuit on your opponent (that is, providing notice by delivering the complaint) for at least 30 days, and as long as 90 days in some courts. This allows you to negotiate with your opponent from a position of strength and with your choice of forum firmly established, without appearing unreasonable.
How
Once you choose to file suit in federal court, the how is largely dictated by the Federal Rules of Civil Procedure, the Federal Rules of Evidence, and the loal rules of the chosen venue. However, one important decision remains-judge or jury.xi Until the 1990s, almost all patent cases were tried to a judge because they were thought to be too complex for juries. but then some enterprising plaintiffs' lawyers decided to request that a jury decide their case, perhaps seeking to take advantage of the complexity of the cases and the belief that juries trust patents because they are issued by the federal government after examination by USPTO experts. That has led to the current reality, which is that almost all patent cases filed now request a jury trial. Interestingly, statistics show that this trend does not always benefit plaintiffs. Depending on the venue, plaintiffs only win 60 to 75 percent of the time, despite having the advantage of being able to pick what cases they file (presumably they self-select only the strongest cases) and where they file them (i.e., they can select what they think is the most favorable forum—often their own hometown).xiiOf course, the outcome of a particular case depends on a myriad of factors unique to that case. No party can be assured victory when a jury is involved.
Footnotes
• viii Prior to the America Invents Act (AIA) in 2011, joinder rules allowed you to sue multiple infringers in the same lawsuit, even if their products were different. The AIA limited this ability by restricting joinder. Nevertheless, you can still file a separate lawsuit against each alleged infringer, and ask the court to consolidate them for discovery and other pretrial purposes. Courts are usually eager to do this because it simplifies their work. The practical effect is almost the same as a single case with multiple defendants.
• ix If the alleged infringer is the federal government itself, or a government contractor, the proper venue is the Court of Federal Claims. 28 U.S.C. §1491 Another forum for enforcing a U.S. patent against imported goods exists at the U.S. International Trade Commission (ITC) in Washington, D.C. 19 U.S.C. §1330. The ITC has the power to investigate alleged infringement and bar goods found to infringe from entering the country. This can be a very effective tool against infringing imports, especially if all the sources of those imports are unknown. The ITC’s jurisdiction is “quasi in rem” so that the infringing goods themselves provide the basis for jurisdiction, allowing their adjudication and prohibition even if the source of the goods is unknown. Proceedings before the ITC are extremely expedited, usually taking 18 months or less, and can be very expensive.
• x 28 U.S.C. § 2201(a); See MedImmune, Inc. v. Genentech, Inc., 127 S.Ct. 764 (2007) and SanDisk Corp. v. STMicroelectronics, Inc., 480 F.3d 1372 (Fed. Cir. 2007).
• xi See Rules 38-39, Fed. R. Civ. P.
• xii PricewaterhouseCoopers, 2013 Patent Litigation Study, at 9; https://www.pwc.com/us/en/forensicse...ion-study.html. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.03%3A_Patent_Litigation.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the various pretrial motions available to parties in a litigation.
Once the decision to file suit is made, and all the factors noted above are considered, the complaint is filed in the clerks’ office of the selected federal court and served in due course on the defendant(s).xiii The defendant(s) must then decide whether to move to dismiss or transfer the case to a different venue, or file an answer (a response to the infringement claim).xiv The defendant(s) can also file a counterclaim, asserting claims back against the plaintiff.xv Motions to dismiss may be based on any number of issues—improper jurisdiction (e.g., the court does not have power over the defendant because it does not reside or do business within the geographic jurisdiction of that court), improper venue (e.g., the defendant does not reside or did not commit any act of infringement in the jurisdiction of the court), failure to state a proper claim, etc.xvi Such a motion must be accompanied by a legal brief explaining the reasons for the motion, to which the plaintiff can file an opposing brief. The defendant who filed the motion usually has an opportunity to file a reply brief. After the briefing is completed, which can take one to two months, the court will decide the motion with an order, either granting or denying it.
Motions to transfer can be filed by a defendant who believes another court would be a “better” place to proceed with the case.xvii The factors considered by the court as to whether it or another court is “better” include which court is most convenient in terms of the location of necessary witnesses and/or documents, and whether another court already has experience with the subject matter because a related case is pending or was handled there and it can handle the new case more efficiently. Such motions usually fail, but can delay the progress of the case by several months, sometimes longer, while the court considers how to rule on the motion. The parties must present detailed arguments about why the case should be moved, or not, and often the court will order oral argument during which each party can present its position and answer questions the court may have.
If no motions are filed by the defendant(s), or if they are denied, the defendant(s) must file an answer, which responds to the allegations in the complaint and sets forth any defenses the defendant(s) may have.xviii Such defenses can include that the patent is not infringed, that the patent is invalid, that the defendant has a license, that the plaintiff waited too long to file suit (laches) or misled the defendant into believing he or she would not complain about the alleged infringement (estoppel), that the alleged infringer is entitled to prior user rights,xixor myriad other defenses that may be available.xx
The defendant(s) may also file one or more counterclaims, which are essentially new charges filed against the plaintiff.xxi If such counterclaims are related to the subject matter of the initial case, they may be tried at the same time. If not, they may be severed and tried separately, either before or after the initial case.
The plaintiff has an opportunity to file a reply to the answer and an answer to any counterclaim that the defendant(s) file.xxii If a counterclaim is filed, followed by an answer, then the defendant(s) can file a reply to the plaintiff’s answer.xxiii
Once these initial pleadings are filed, which usually takes about 60 days from when the initial complaint is filed, the case is considered “at issue” and the pretrial proceedings commence.
Defendants in patent cases are increasingly turning to a strategy of filing requests for post-grant review in the PTO to derail a patentee’s efforts to enforce the patent. Although beyond the scope of this chapter, a post-grant review essentially asks the PTO to take another look at whether the patent is valid, i.e., whether it should have been granted in the first place. The requestor of any post-grant review must present supporting evidence to show that some issue renders one or more of the patent’s claims invalid. The post-grant review request can be either ex parte reexamination (meaning the patentee does not get to participate) or inter partes review (in which the patentee is allowed to participate), or covered business methods review (to review patents that claim a method or corresponding apparatus for performing data processing or other operations used in the practice, administration, or management of a financial product or service). Complex rules govern these proceedings, and they changed in 2011 under the America Invents Act (AIA), which substantially revised the nation’s patent laws in a number of important ways.xxiv
The significance to a patentee of an opponent requesting post-grant review is twofold. First, the patentee risks losing its patent if the PTO finds it is invalid, and this is exactly what has happened in a majority of inter partes review hearings as of March, 2016. Second, a defendant requesting post-grant review usually asks the court to stay (i.e., temporarily suspend) the patent case filed against it while the PTO evaluates the patent, arguing that the result of the PTO’s actions may either invalidate or modify the patent such that the court should await the outcome before proceeding with the litigation. This strategy has been successful in many courts.
Footnotes
• xiii See Rules 3-5, and 7-8, Fed. R. Civ. P.
• xiv See Rules 7-8, and 12, Fed. R. Civ. P.
• xv See Rule 13, Fed. R. Civ. P.
• xvi See Rule 12(b), Fed. R. Civ. P.
• xvii See 28 U.S.C. §1404(a)
• xviii See Rules 8-9, Fed. R. Civ. P.
• xix 35 U.S.C §273, which provides a defense to patent infringement for someone who can prove, by clear and convincing evidence, that they acted in good faith and commercially used the subject matter of the patent in the U.S. at least one year before the effective filing date of the patent or the invention’s first public disclosure.
• xx See Rules 8-9, and 12, Fed. R. Civ. P.
• xxi See Rule 13, Fed. R. Civ. P.
• xxii See Rule 7, Fed. R. Civ. P.
• xxiii See Rules 8 and 13, Fed. R. Civ. P.
• xxiv See the PTO’s discussion of the AIA at http://www.uspto.gov/aia_implementation/index.jsp. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.04%3A_Getting_Started.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the multiple procedures involved in the pretrial phase of patent litigation.
• Appreciate the costs involved and the ways they affect the ultimate trial outcome.
The first steps in the pretrial procedure are the filing by the parties of their “initial disclosures” and the holding of the preliminary pretrial conference.xxv Initial disclosures must provide preliminary information about each party’s positions in the case, and disclose the identity and location of witnesses and documents likely to be relevant to the issues in the case.xxviThese disclosures help frame the “discovery,” or information that the parties can request of each other, which is one of the hallmarks of litigation in the United States and one of the drivers of the expense of litigation. The concept is laudable—require each party to disclose the information it has relevant to the case to preclude a “trial by ambush.” But, in practice, discovery can become an endless game of cat and mouse, with costs escalating exponentially. We will talk more about discovery shortly.
The preliminary pretrial conference is usually the first time the parties appear in court before the judge, unless there has been a hearing on a pretrial motion (as discussed above). At this conference, the judge discusses with the parties the issues likely to arise in the case, the time that pretrial discovery is expected to take, and any issues that make the case unique (such as witnesses in foreign countries that require extraordinary means to obtain their testimony for trial). Each party is usually required to submit a report to the court in advance of this conference, proposing what the timeline for the case should be and identifying any unique issues. The court typically issues a scheduling order at, or shortly after, the pretrial conference, specifying dates by which certain activities must be concluded. This order often “splits the baby” between the plaintiff’s and defendant’s proposed schedules (the plaintiff usually seeks speed while the defendant usually seeks delay). The figure below shows a typical scheduling order.
The scheduling order will also usually specify a length of the trial (e.g., 8 trial days), subject to revision at the final pretrial conference. A typical patent trial is scheduled to last from 5 to 20 trial days, but some can take much longer. Let’s look at each step of this schedule to understand what is happening.
Protective Order
Before information is shared between the parties, they usually agree on a protective order, which they will ask the court to enter, that specifies who has access to the confidential information produced during discovery in the litigation.xxvii This is important to all parties, and even third parties that may be asked to produce information during discovery, because sensitive business, technical, and financial information is routinely requested by and produced to each party during the lawsuit. The protective order proscribes that the disclosure of confidential information during discovery is limited to lawyers involved in handling the case, outside experts retained by the lawyers to assist them, and court reporters (who record testimony during the case), videographers (who videotape deposition testimony, as is now common), and court personnel. It is also typical that certain employees of each party (usually in-house lawyers and/or business people directly involved in the oversight of the case) are also permitted to review certain materials, but not financial information of a competitor or future business plans, which are usually excluded from being disclosed to any party employees.
Everyone authorized to see confidential information is under court order to restrict use of the information to the pending lawsuit, not to disclose it to anyone not authorized by the protective order to see it, and requiring that all copies be returned or destroyed at the end of the case.
Discovery
After the preliminary pretrial conference, discovery begins, which results in the exchange of documents, written responses, and witness testimony.xxviii
A request for production allows a party to demand that another party turn over relevant documents and electronically stored information in its possession or control, as well as an inspection of property (such as a manufacturing facility) to take photographs, measurements, and the like.xxix Documents and other tangible items can also be requested from third parties (i.e., people and entities not named as a party in the lawsuit) via subpoena.xxx
Interrogatories are written questions that a party can ask of other parties in the litigation, but not of third parties. Such questions can request any nonprivileged information that is relevant to any party’s claim or defense—including the existence, description, nature, custody, condition, and location of any documents or other tangible things and the identity and location of persons who know of any discoverable information that may be relevant to the subject matter of the litigation.xxxi Interrogatories may also ask for opinions or the legal contentions of another party. The initial limit on the number of interrogatories is 25, including subparts. However, upon a showing of good cause, courts routinely permit additional interrogatories in patent litigation because the issues are usually complex.xxxii Answers to interrogatories are binding on the party providing them and may be used as admissions in the litigation, including at trial.
Depositions are interviews used to elicit testimony from witnesses having relevant knowledge.xxxiii This is similar to eliciting testimony during a trial, but occurs in a conference room with a court reporter present to record what is said. The judge is not present at depositions, but may intervene if a controversy arises. Testimony can also be requested by written questions to a witness, which the witness then answers and returns to the requesting party, called a deposition by written questions.xxxiv
Although in the United States, it is usually required that testimony at trial be presented live, with the opportunity for the opposing party to cross-examine the witness and for the jury and/or judge to assess each witness’s demeanor in person, testimony elicited via depositions during discovery may be used at trial under certain circumstances.xxxv For example, if a witness dies before trial, or is unavailable through no fault of the party seeking to use the deposition testimony, the deposition may be used as testimony at trial in lieu of live testimony from the witness. Also, the deposition testimony of an opposing party or an officer or manager of the opposing party corporation may be used at trial for any purpose. Usually, however, deposition testimony is used primarily to “impeach” a witness testifying live at trial—that is, to show that the witness at trial has changed prior testimony from when they gave the deposition. Videotaped deposition testimony is very effective to show to a judge or jury during trial that the witness has changed the testimony—such as from “No” to “Yes” or the equivalent!
The parties can also demand that another party admit, for purposes of the pending litigation only, the truth of any facts, opinions, or conclusions, or the genuineness of any documents relevant to any party’s claim or defense. Such demands are called requests for admission.xxxvi The responses to these demands are binding on the responding party and can be used to conclusively establish the matters admitted in the litigation, including at trial.
Amendments to the Pleadings
Once initial information is obtained via discovery, the parties may be permitted to amend or supplement their pleadings (i.e., the complaint, answer, counterclaim, etc.) to address information or issues uncovered during the initial discovery.xxxvii For example, the plaintiff may uncover information about other companies, products, or services involved in the infringement and seek to add them to the lawsuit. A defendant may uncover information about invalidity defenses not previously known to it and want to add those to its answer.
Close of Discovery
This is the date by which all requests for documents, information, and depositions must be complete. It is usually interpreted as requiring that all responses to requests for production, interrogatories, and requests for admissions be answered by the end date set by the court, which means that the actual requests must be made sufficiently in advance of this date (typically 31 days—because responses are due to most discovery requests within 30 days) to allow the responses to be due before the cutoff date. Any depositions must also be completed by the date for the close of discovery (although the parties usually agree to finish select depositions after this date in order to accommodate scheduling problems).
Claim Construction Briefing and Hearing
In virtually every patent case, a dispute arises over the meaning of certain language used in the asserted claims of the patents at issue. These are called “claim construction” disputes, and must be resolved by the judge before trial. The parties are permitted to provide their competing arguments in briefs to the court, usually after discovery is completed, and make an oral argument on their respective positions to the court at a claim construction hearing. These hearings are often called Markman hearings, after the name of the case that established that the judge, and not the jury, must decide the proper meaning of disputed claim language.xxxviii
This is a critical juncture in every patent case because the opposing parties try to craft an interpretation of the claim language that supports their respective positions. Most patent claims are drafted using a range of language, from specific to general, in an effort by the patentee (and lawyer) to cover as much territory for the claim as possible. The PTO interprets proposed claims in the broadest reasonable way possible, and then compares their scope with the prior art, before allowing them. The goal of the patentee in dealing with the PTO is to get allowed the broadest claims possible, in order to get the broadest patent coverage possible. But the use of broad, general language in claims permits the parties in later litigation to argue for different interpretations, depending on their interests at the time of litigation. Thus, a plaintiff seeks an interpretation that is broad enough to encompass the defendant’s products and services so that infringement can be proven. In contrast, the defendant proposes a narrow interpretation (or “construction”) that excludes its products and services.
The court resolves the dispute over the meaning of the contested claim terms by referring to the language of the claims, the language and drawings in the patent, and the history of the proceedings in the PTO that led to the issuance of the patent. The written record of that history is preserved in what is call a “file wrapper,” so named because all the written documents making up the history are contained in a three-part file folder, the two outer portions of which fold over and “wrap” the documents within it. The patentee is bound by what it told the PTO to secure allowance of the patent. The court interprets the language according to its ordinary meaning to someone of ordinary skill in the art to which the invention pertains, unless the patentee specially defined the language within the patent or its file wrapper.
Once the claim construction decision is made by the court, the scope of the patent(s) in the case is fixed, and the only remaining issue for trial is whether the claims of the patent(s) as interpreted by the court are broad enough to include the accused products and services of the defendant(s).
Summary Judgment Briefing and Hearing
Summary judgment is a procedure that obviates a trial where one of the parties can show that its opponent cannot win—as a matter of law.xxxix That is, if one party can show that the evidence is so clear that no fact dispute exists (i.e., no reasonable fact finder, whether judge or jury, could decide otherwise) and that the law requires the case be decided in favor of the party moving for summary judgment, the court can decide the case without holding a trial. The judge must decide such motions based only on the applicable law (which the judge determines), the evidence (i.e., documents, interrogatory answers, admissions, and deposition testimony) developed during discovery, and the court’s claim construction decision, giving the benefit of any doubt about the facts to the nonmoving party. If the court finds that a fact relevant to the outcome is in dispute, summary judgment must be denied and a trial held to resolve that factual dispute.
Understandably, these are hotly contested motions. The moving party hopes to avoid the need for a trial, and the uncertainty a jury introduces, by having the judge decide the case in its favor early on. The nonmoving party wants to go to trial, and hope that the fluid events that are the essence of a jury trial will convince the jury to decide the case in its favor.
In recent years, most patent cases are resolved on summary judgment and only a handful go to trial (about 100 per year throughout the country). The primary reason for this phenomenon is the advent of the claim construction (Markman) hearing and the decision by the court, before trial, about how the language of the asserted claims must be interpreted. The court’s claim construction decision resolves most of the uncertainty in a patent case, because what the accused products or services are, and how they operate, is rarely in dispute by the time discovery concludes.
The end result is that the case is often either settled after the claim construction decision, or decided in favor of one side or the other at the summary judgment stage. If summary judgment is granted, the losing party can appeal the decision to the United States Court of Appeals for the Federal Circuit, which is the appellate court to which all decisions in patent cases are appealed.
Final Pretrial Order and Conference
The final pretrial order is the document that sets forth the “ground rules” for the trial.xl It typically identifies all the positions of each party, every issue in dispute in the case that must be resolved by order of the court or at trial, all the documents the parties may seek to introduce into evidence at the trial, and each witness that is expected to be called to testify, either live or via their deposition. The judge issues the order based on a draft prepared by the parties and once issued, it defines the issues that may be raised at the trial. If there is to be a jury trial, the order can rarely be modified after the final pretrial conference. If the trial is before the judge only (referred to as a “bench trial”), the judge may be more lenient in allowing modifications to the final pretrial order because he is the person deciding the case and can adjust more readily than a jury.
Footnotes
• xxvSee Rules 12, 16, and 26, Fed. R. Civ. P.
• xxviSee Rule 26(a), Fed. R. Civ. P.
• xxviiSee Rule 26(c), Fed. R. Civ. P.
• xxviiiSee Rules 26-37, Fed. R. Civ. P.
• xxixSee Rule 34, Fed. R. Civ. P.
• xxxSee Rule 45, Fed. R. Civ. P.
• xxxiSee Rules 26(b) and 33(a)(2), Fed. R. Civ. P.
• xxxiiSee Rule 33(a), Fed, R. Civ. P.
• xxxiiiSee Rules 27-30, Fed. R. Civ. P.
• xxxivSee Rule 31, Fed. R. Civ. P.
• xxxvSee Rule 32, Fed. R. Civ. P.
• xxxviSee Rule 36, Fed. R. Civ. P.
• xxxviiSee Rule 15, Fed. R. Civ. P.
• xxxviiiMarkman, et al. v. Westview Instruments, Inc., 517 U.S. 370 (1996).
• xxxixSee Rule 56, Fed. R. Civ. P.
• xlSee Rule 16(e), Fed. R. Civ. P. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.05%3A_Pretrial_Procedures.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the importance of jury selection and opposing arguments.
• Grasp why patent trials are often called “morality plays.”
The following describes a jury trial. A bench trial is essentially the same, but without the elements involving the jury.xli
Jury Selection
The trial begins with the selection of the jury. The jury is selected (or “picked”) from a group of prospective jurors called to court to serve in accordance with the laws and practices of the local jurisdiction.
Each judge has a procedure for picking a jury. Most involve a questionnaire that each prospective juror must complete and provide to the judge and the parties’ lawyers. The answers are intended to reveal whether any reason exists why a prospective juror should not serve on the jury. Typical reasons for excluding a prospective juror include that the juror works for or knows one of the lawyers in the case, works for or does business with one of the parties, has a close relative that works for one of the parties, knows something about the subject matter of the case, or is unable to serve because of a disability or a previously planned vacation for which they have already purchased a nonrefundable ticket. The judge also typically asks the prospective jurors whether they have a bias or prejudice that would prevent them from making a fair decision.
Once the judge has “excused” from serving any prospective jurors for “cause” (i.e., because of one of the reasons listed above or some other reason that court believes provides good cause for excusing that person), the clerk selects at random from the remaining prospective jurors the number that will be seated as the jury, plus six. The number of jurors seated in a case depends on the expected length of the trial and the practices of that judge. At least six and no more than twelve jurors must decide a case, but any number between six and twelve can be seated.xlii The reason a court usually seats more than six jurors is to assure that the trial will end with at least the minimum of six jurors necessary to decide the case even if one or more jurors need to be excused during the trial, such as for illness or emergency. Judges typically seat seven to nine jurors for this reason. Only rarely do judges in civil patent cases seat a full twelve jurors, because once seated a juror must participate in reaching the decision (unless excused for cause), and all jury decisions in federal cases, including patent cases, must be unanimous.xliii The general rule is, the more jurors there are, the longer it takes for them to reach a unanimous verdict, and the higher the likelihood that the case will result in a “hung” jury (i.e., an inability for the jury to reach a unanimous decision).
The clerk selects the designated number for the jury, plus six, because each party gets three “peremptory challenges” to the proposed jury panel, whereby a party can remove a juror without having to give a reason why. Thus, if the judge has decided the jury should begin with eight jurors, the clerk will select 14 so that the plaintiff and defendant (collectively if there is more than one plaintiff and/or defendant) are each able to strike or eliminate three prospective jurors, leaving eight to hear the case.
Once the jury is picked and sworn in, the judge will give the jury preliminary jury instructions. These explain what the case is about, how the trial will proceed, and a description of what a patent is and how the patent system works. Occasionally, judges opt to show the jury the video below, entitled “An Introduction to the Patent System,” which was created by the Federal Judicial Center and is intended to be neutral.xliv
Opening Statements
The next step is the opening statements by the opposing parties, starting with the plaintiff and followed by the defendant. If there are multiple plaintiffs or defendants, the judge will give equal time to each side and let the individual parties work out the allocation of time. The opening statement is intended to provide a road map for the jury about what the party intends to prove, and is expected to be devoid of argument. But lawyers rarely present an opening statement without some argument. The judge can intercede, and an opposing party may object, if a party crosses the “no argument” line too far.
The opening statements are where many believe the trial is won or lost because the jury forms initial opinions about who is right and who is wrong in the case based on what they hear at this beginning stage. Thus, each party’s trial lawyer tries to craft a story to tell that casts their client in the best possible light. Trials can be likened to a morality play, in which each party tries to cast themselves as in the right, and the opponent as doing them wrong. In patent cases, plaintiffs often portray defendants as thieving freeloaders, attempting to benefit unfairly from the inventiveness of the plaintiff rather than invest in developing their own products. Defendants, on the other hand, often portray patentees as greedy monopolists, trying to stifle competition and deny consumers choice and less-expensive alternatives.
Whether or not the common wisdom is correct, it is with the opening statements that the jurors begin their struggle to find truth among the competing stories they will hear during the trial.
The Evidence is Presented
The plaintiff then presents its case, calling witnesses and introducing exhibits that support its positions. Each opposing party has the opportunity to object to exhibits and testimony, and to cross-examine witnesses. The judge rules on all objections and generally oversees the proceedings to assure that the trial is conducted properly. After the plaintiff rests its case, the defendant presents its defense, again by introducing exhibits and offering testimony from witnesses. The trial concludes with the plaintiff calling rebuttal witnesses, who are limited to rebutting testimony from the defendant’s witnesses. Each side usually calls one or more experts to testify on the issues of infringement and validity (or invalidity), as well as on damages.
Closing Arguments
After the evidence has been presented, the parties make their closing arguments. Usually the plaintiff goes first, followed by the defendant. The plaintiff has the opportunity to reserve time for rebuttal if it chooses. In some jurisdictions, the defendant must go first and the plaintiff next. In this case, the plaintiff has the last word, and the defendant does not have any opportunity for rebuttal.
Closing arguments give each party the opportunity to highlight what they believe is the critical evidence in their favor, and attack the deficiencies in their opponent’s case. It is here that an observer would see the greatest geographic diversity in style and practice. Quite apart from the different styles of trial lawyers and judges across the country, jurors in different parts of the country expect different things from trials, and especially from closing arguments. Thus, an observer would see a very different “show” during a closing argument in the Eastern District of Texas than in the District of Maine.
After closing arguments are concluded, the judge reads the final jury instructions. These set forth the law to which the jury must apply the facts they determine during their deliberations.xlv
Thereafter, the jury retires to the jury room, with copies of the exhibits admitted into evidence, to decide the case.
Deliberation and Verdict
In most patent cases, the jury must answer detailed questions listed in a verdict form, called a special verdict.xlvi These questions typically list the accused product(s) and the asserted claim(s) and require the jury to decide infringement and validity for each claim and accused product separately. If appropriate, the jury may also be asked to decide what damages, if any, are to be awarded the plaintiff and whether any infringement they may have found to exist was willful or not.
The jury deliberates as long as it takes to reach a unanimous decision on each question. During their deliberations, the jury may ask questions of the judge in writing, which the judge answers after consulting with the parties. Should the jury tell the judge that it cannot reach a unanimous verdict, the judge may provide additional instructions and return the jury to its deliberations to “try harder.” Most juries reach a unanimous decision, which is recorded on the verdict form and read by the clerk in open court with the parties present. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.06%3A_Trial.txt |
Learning Objectives
After completing this section, you will be able to
• Grasp the significance of equitable proceedings in the post-trial phase.
Following the jury’s decision, the court will set a schedule for any equitable proceedings required and for post-trial motions. Equitable proceedings deal with matters to be decided by the judge, not the jury. In terms of post-trial motions, the winning party will ask for entry of judgment.xlvii The losing party will file a motion for judgment as a matter of law and usually also a motion for a new trial.xlviii
Equitable Proceedings
Issues arise in most patent cases that must be decided by the judge and not the jury. Many of these are called “equitable” issues because they are left to the sound, equitable discretion of the court. The most common equitable issues are the defense of inequitable conduct and the affirmative claims of willfulness and exceptional case.
Inequitable Conduct
Misconduct by the patentee in dealing with the Patent and Trademark Office, through which the patentee or its attorney deceives or misleads the patent examiner in an effort to persuade the examiner to grant the patent, was historically called “fraud on the Patent Office,” but more recently has been renamed “inequitable conduct.” A defendant can raise this issue as a defense, which if proven results in the patent being unenforceable—that is, the patentee is unable to enforce the patent or recover any damages for its infringement. Many different types of inequitable conduct have been found to render patents unenforceable, from outright fabrications of alleged evidence of unexpected results in the development of the invention, to hiding relevant prior art showing prior solutions to the problem solved by the patent, to failing to tell the patent examiner that another patent examiner had rejected a related application.
Most district courts defer ruling on inequitable conduct defenses until after the liability trial addressing infringement, validity, and damages. This is a commonsense attempt at efficiency because if the patent is found invalid or not infringed at trial, the inequitable conduct issues became moot. Only if the patent is found valid and infringed does the court need to hold a separate hearing to adduce evidence of alleged inequitable conduct. The court then decides whether such conduct had been proven, which is exceedingly rare. Nevertheless, because the consequences of such a finding essentially kill the patent, defendants assert inequitable conduct whenever possible in a final effort to avoid liability.
By 1988, the Federal Circuit Court of Appeals stated: “the habit of charging inequitable conduct in almost every major patent case has become an absolute plague.”xlix In an effort to stem the spread of this plague, the Federal Circuit sought to restrict its use by holding that inequitable conduct must be established by clear and convincing evidence of deceptive intent. Gross negligence does not suffice and “does not of itself justify an inference of an intent to deceive.”l
Nevertheless, the plague continued, leading a Federal Circuit judge to write:
“‘Inequitable conduct’ in patent practice means misconduct by the patent applicant in dealings with the patent examiner, whereby the applicant or its attorney is found to have engaged in practices intended to deceive or mislead the examiner into granting the patent. It is a serious charge, and the effect is that an otherwise valid and invariably valuable patent is rendered unenforceable, for the charge arises only as a defense to patent infringement. As this litigation-driven issue evolved, the law came to demand a perfection that few could attain in the complexities of patent practice. The result was not simply the elimination of fraudulently obtained patents, when such situations existed. The consequences were disproportionately pernicious, for they went far beyond punishing improper practice. The defense was grossly misused, and with inequitable conduct charged in almost every case in litigation, judges came to believe that every inventor and every patent attorney wallowed in sharp practice.”li
Still the plague continued, leading Federal Circuit Judge Gajarsa in 2010 to then refer to it as a “pandemic.”lii Research showed that the percentage of patent cases in which inequitable conduct was charged grew from less than 5 percent in 2000 to 40 percent by 2009.liii
Finally, on May 25, 2011, the Federal Circuit restricted the doctrine of inequitable conduct by changing the standard for materiality and clarifying the requirements for finding intent to deceive.liv To find inequitable conduct, the court held that the party alleging unenforceability must prove a specific intent to deceive the USPTO by clear and convincing evidence. Moreover, the decision to deceive the USPTO must be knowing and deliberate. The court also clarified that district courts may not use a “sliding scale” to find intent. In other words, the Federal Circuit held it improper to find that a weak showing of intent was sufficient based on a strong showing that the information was material, or that a weak showing of materiality was sufficient based on a strong showing of intent. Although intent can be inferred to meet the clear and convincing evidence standard, specific intent to deceive must be “the single most reasonable inference able to be drawn from the evidence.”
Regarding materiality, the court required a “but- for materiality” standard. In other words, the standard for materiality now requires that “but for” the alleged deception, the USPTO would not have allowed the claim. Further, “[i]n making this patentability determination, the court should apply the preponderance of the evidence standard and give claims their broadest reasonable construction.” The court also recognized an exception to the requirement for but-for materiality, finding that “[w]hen the patentee has engaged in affirmative acts of egregious misconduct, such as the filing of an unmistakably false affidavit, the misconduct is material.”
The number of successful inequitable conduct defenses asserted has plummeted due to the strict new requirements for pleading and proving inequitable conduct imposed by theTherasense decision. District courts are dispensing with many allegations of inequitable conduct now at the pleading stage, eliminating the need for separate hearings on inequitable conduct issues.
Misuse of a patent is sometimes treated as a form of inequitable conduct, but it is more commonly treated as a separate affirmative defense. The elements of misuse are either a violation of antitrust laws or an effort to expand the scope or term of a patent beyond appropriate limits. For example, it is patent misuse for a patentee to file suit against products of a defendant that are far beyond the proper scope of any claims of the patentee’s patent, or to seek damages or an injunction beyond the expiration of the patent. Often such unreasonable demands are accompanied by threats to the defendant’s customers. If the misuse is proved, the patentee could be barred from recovering any damages until it has “purged” the misuse by abandoning its unreasonable assertions and dissipating any negative effects they caused.
Willfulness
If the jury (or judge, in a bench trial) finds that the asserted patent has been infringed, it is often asked to determine whether such infringement was “willful.”A finding of willful infringement allows the judge to award enhanced damages under 35 U.S.C. § 284, which provides in relevant part that the court may increase the damages award by up to three times the amount found. This is a potent consequence of a showing that a defendant’s infringement was willful.
The standard for showing willfulness has evolved over the years, but in 2007, the Federal Circuit significantly altered the standard governing willful infringement by requiring the patentee to prove that (1) the accused infringer “acted despite an objectively high likelihood that its actions constituted infringement of a valid patent,” and (2) the “objectively defined risk . . . was either known or so obvious that it should have been known to the accused infringer.”lv The first prong of this test is objective, whereas the second prong is subjective and involves the accused infringer’s actual state of mind. Each prong requires that the infringer knew the patent existed at the time it infringed.
Because an infringer cannot be shown to have willfully infringed if it did not know the patent existed, some companies have adopted a “head in the sand” approach to others’ patents. This practice is thought to make sense when the field is very crowded (i.e., there are many patents owned by different patentees covering many different aspects of a product or service) because trying to uncover all the potentially relevant patents that could be asserted against a new product or service is extremely costly, if not impossible. This practice is used most frequently by large companies that can afford to deal with a patent infringement lawsuit should one be filed. Small companies and entrepreneurs, especially in emerging fields, often take great care to search for and work around any existing patents that might be close to their new product or service because they can ill afford patent litigation. Of course, searching for potentially troublesome patents and trying to avoid them is no guarantee of not getting sued. Not only are there more than two million patents in force,lvi but creative patentees are not above taking a patent that was thought to cover one product and arguing it is broad enough to cover what a new market entrant has introduced.
In 2012, the Federal Circuit again addressed the willfulness standard, and adjusted it again.lviiWith regard to the objective prong of the willful infringement test, the Federal Circuit concluded:
“We believe that the court is in the best position for making the determination of reasonableness. This court therefore holds that the objective determination of recklessness, even though predicated on underlying mixed questions of law and fact, is best decided by the judge as a question of law subject to de novo review.”
This further restricts the opportunity for a patentee to prove that a defendant’s infringement was willful. The patentee must first convince the district court that the defendant acted despite an objectively high likelihood that its actions constituted infringement of a valid patent. Only after that will the patentee be able to present evidence of the defendant’s alleged subjective intent to the jury in an effort to convince the jury that the infringement was willful.
Patentees preferred the pre-Bard opportunity to present all of their willfulness evidence to the jury during the liability trial. They wanted this ability because they believed, probably correctly, that it helped the jury conclude not only that the defendant was a “bad actor” who willfully ignored the patentee’s rights, but also bolstered the underlying issue of infringement itself. Post-Bard, the patentee can only present willfulness evidence if it is able to convince a more dispassionate judge that the defendant acted objectively recklessly, which is a higher hurdle to overcome.
If the patentee convinces the judge on the objective prong, and the jury on the subjective prong, resulting in a jury verdict of willful infringement, the issue of enhanced damages passes back to the court for determination after the trial.
Because the Bard case was decided in mid-2012, little empirical evidence exists on its effect on the frequency with which significant enhanced damages are awarded by the courts. However, even before Bard, the evidence suggests that such awards were falling. Before the Seagate restrictions were imposed in 2007, 81.4 percent of cases finding willful infringement resulted in an award of enhanced damages, but after Seagate, that number fell to 54.9 percent.lviii
Exceptional Case
Courts have discretion to award reasonable attorneys’ fees in patent infringement cases that are deemed “exceptional.”lix The Federal Circuit has referred to this provision as a deterrent to bringing of clearly unwarranted suits on invalid or unenforceable patents.lx
Normally, the losing party is not liable to pay the winner’s attorneys’ fees—a practice referred to as the “American Rule.” The rationale for this is that any party should be able to approach the court for relief without fear of having to pay an adversary's attorney's fees. Thus, the provision of the Patent Act that permits an award of attorneys’ fees is an exception to the rule that each party bears its own costs in litigation.
Congress said that it intended the rule allowing an award of attorneys’ fees to be applied sparingly and “that recovery of attorneys’ fees will not become an ordinary thing in patent suits.lxi The Federal Circuit repeatedly limited district court discretion to award attorneys’ fees to only those cases in which the district court found clear and convincing evidence of bad faith or at least gross negligence by the losing party in bringing or maintaining the suit, and any such determination was reviewable de novoon appeal.lxii But in April 2014, the Supreme Court struck down these restrictive Federal Circuit interpretations and held:
“[A]n ‘exceptional’ case is simply one that stands out from the others with respect to the substantive strength of a party’s litigating position (considering both the governing law and the facts of the case) or the unreasonable manner in which the case was litigated. District courts may determine whether a case is ‘exceptional’ in the case-by-case exercise of their discretion, considering the totality of the circumstances [and without any] precise rule or formula for making these determinations.”
In a companion case, the Supreme Court also rejected the rule that exceptional case determinations should be reviewed de novo on appeal.lxiii
There are increasing calls for a change to the American Rule, to require losing parties to pay the winner’s attorneys’ fee. The principal purpose of such a change would be to deter so-called “patent trolls,” entities that acquire patents for the sole purpose of making money by filing lawsuits, threatening crippling litigation expenses, and demanding settlements at or slightly more than the cost of litigation.lxiv It is questionable whether such a change would in fact deter the so-called trolls or instead preclude small entities and entrepreneurs from pursuing legitimate claims due to the uncertainty of the outcome of any lawsuit. Even the most “bulletproof” patent can be subject to unexpected challenges from previously undiscovered prior art or the vagaries of a jury decision favoring the defendant for reasons other than the merits. Enforcing a patent requires resources, or the availability of a contingency fee lawyer willing to take the outsized costs, and risks that patent litigation can entail. Thus, shifting the responsibility for the winner’s attorneys’ fees to the losing party could effectively preclude small entities and individuals from even filing a lawsuit. The 2014 Supreme Court’s Octane Fitness and Highmarkcases, and how district courts exercise their newly expanded discretion in finding a patent case exception under 35 U.S.C. § 285, may dissuade Congress from enacting a “loser pays” exception for patent cases.
Entry of Judgment
The winning party seeks entry of a judgment that grants it the relief to which it is entitled, based on the jury’s verdict and the rulings of the court. First, the judgment will declare who the winning party is. Then, it will set forth the relief or remedies to which the winning party is entitled. The relief may include damages, as awarded by the jury and supplemented by the court if there was a timing difference in the calculation of the damages by the jury and the date on which they are finally awarded. A winning patentee is also entitled to prejudgment interest on the damage award, calculated at the rate specified by law, to compensate for the time value of money lost due to the delay in obtaining damages. The judgment may also set forth the post judgment interest due, for any delay between the entry of the judgment and the payment of the award to the patentee by the losing parties.
A successful patentee may also be entitled to injunctive relief, barring further sales of the infringing product or service. This is the most potent relief available to patentees. Prior to 2006, it was presumed that a patentee who proved patent infringement was irreparably injured and entitled to an automatic injunction. But in 2006, the Supreme Court rejected the presumption and ruled that, in all other kinds of cases, a successful patentee is required to prove each of the following requirements for injunctive relief: (1) that it has suffered an irreparable injury; (2) that remedies available at law are inadequate to compensate for that injury; (3) that considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; (4) that the public interest would not be disserved by a permanent injunction.lxv
Usually, patentees who are competitors of the infringer can meet these requirements. However, patentees who are not competitors of the infringer are usually unsuccessful in convincing courts that they are entitled to injunctive relief, and are left with only money damages(usually an on going reasonable royalty) to compensate for future infringement. This removes the most serious risk an alleged infringer faces—being barred from the market—making fighting cases through trial more palatable than before. This new rule from the Supreme Court has driven many plaintiffs out of federal court and into the International Trade Commission (ITC), when the allegedly infringing products are imported, because the ITC issues exclusion orders and cease and desist orders (roughly equivalent to federal court injunctions barring further sales) without regard to the requirements the Supreme Court laid down in the eBay decision.lxvi
Motion for Judgment as a Matter of Law
Called a “JMOL” motion, the premise of a motion for judgment as a matter of law is that the jury did not have a legally sufficient evidentiary basis for deciding the case as it did, and the court should intervene and decide the case in favor of the party moving for the JMOL. The moving party must explain in detail what legally required evidence is missing from the trial record. The opposing party (i.e., the party that won the jury verdict) then has the opportunity to identify in the trial record where the allegedly missing evidence is found, and the judge decides who is correct. The court must consider the evidence in the light most favorable to the nonmoving party. Thus, most JMOL motions fail. But the losing party always files such a motion because it is a chance to challenge the jury’s verdict and avoid the remedies the winning party is demanding.
Motion for a New Trial
JMOL motions are usually accompanied by a motion for a new trial, arguing that the jury’s verdict was against the manifest weight of the evidence or the jury’s verdict was grossly inadequate or excessive.lxvii Other grounds also exist, such as newly discovered evidence that could not have reasonably been discovered earlier.
The decision to grant or deny a new trial rests with the sound discretion of the judge, who typically presided during the trial and has a keen understanding of the evidence that was introduced and whether the jury’s verdict was against the weight of that evidence. The court’s decision is not whether the court would have decided the case the same way, but whether there is sufficient evidence in the record to support the jury’s verdict. The court must view the evidence in the light most favorable to the nonmoving party. Thus, most new trial motions, like most JMOLs, are unsuccessful.
Footnotes
• xlviiSee Rule 54, Fed. R. Civ. P.
• xlviiiSee Rule 50, Fed. R. Civ. P.
• xlixBurlington Indus., Inc. v. Dayco Corp., 849 F.2d 1418, 1422 (Fed. Cir.1988).
• lKingsdown Medical Consultants, Ltd. v. Hollister, Inc., 863 F.2d 867, 872 (Fed.Cir. 1988).
• liFerring B.V. v. Barr Laboratories, Inc. 437 F.3d 1181, 1195 (Fed. Cir. 2006)(dissenting opinion).
• liiTaltech Ltd. v. Esquel Apparel, Inc., 604 F.3d 1324, 1335 (Fed. Cir. 2010)(dissenting opinion).
• liiihttp://www.patentlyo.com/patent/2010...e-conduct.html.
• livTherasense, Inc. v. Becton, Dickinson & Co., 649 F.3d 1276, passim (Fed. Cir. 2011).
• lvIn re Seagate, 497 F.3d 1360, 1371 (en banc).
• lviSee Dennis Crouch, How Many US Patents are In Force?, http://www.patentlyo.com/patent/2012...-in-force.html.
• lviiBard Peripheral Vascular Inc. v. W.L. Gore & Assoc’s. Inc., 682 F.3d 1003, 1006-07 (Fed. Cir. 2012).
• lviiiChristopher B. Seaman, Willful Patent Infringement and Enhanced Damages After In Re Seagate: An Empirical Study, 97 Iowa Law Review 417, 466; http://www.uiowa.edu/~ilr/issues/ILR_97-2_Seaman.pdf.
• lix35 U.S.C. § 285
• lxMathis v. Spears, 857 F.2d 749, 754 (Fed. Cir. 1988).
• lxiS. Rep. No. 1503, 79th Cong., 2d Sess. (1946) (discussing the predecessor statute to 35 U.S.C. § 285)
• lxiiMathis v. Spears, 857 F.2d 749, 754 (Fed. Cir. 1988) and Brooks Furniture Mfg., Inc. v. Dutailier Int’l, Inc., 393 F. 3d 1378, 1381-2 (Fed. Cir. 2005).
• lxiiiHighmark Inc. v. Allcare Health Management System, Inc. (572 U.S._)(No. 12-1163. Argues February 26, 2014-Decided April 29, 2014).
• lxivSee Section 2.10, infra.
• lxveBay Inc. v. MercExchange, L.L.C, 547 U.S.388 (2006).
• lxviSee footnote 7, supra.
• lxviiSee Rules 50 and 59, Fed. R. Civ. P. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.07%3A_Post-Trial_Procedures.txt |
Learning Objectives
After completing this section, you will be able to
• Understand what happens after a jury verdict is entered.
• Appreciate the chances of success of appeals based on fact versus legal issues.
Once the post-trial motions are decided and the judgment entered, the losing party may appeal to the Federal Circuit Court of Appeals. This is the one federal appellate court in the United States that hears all appealed cases involving patent disputes. Almost all patent cases that conclude with a trial, or after a decision on summary judgment, are appealed. This is partly because the cost of an appeal is orders of magnitude less than the case up to that point (e.g., tens or hundreds of thousands of dollars vs. hundreds of thousands or millions of dollars). In addition, overall the Federal Circuit affirms in full less than 60 percent of the patent cases it decides on the merits.lxviii Thus, it is well worth it for the losing party to pursue an appeal, because overall it has a 40+ percent chance of partial or full relief from the judgment below. Of course, the reversal rate varies by the nature of the issues before the Federal Circuit and the standard of review the court applies. Legal issues (such as claim construction, summary judgment, and jury instructions) are reviewed de novo, without deference to the district court’s or jury’s decision. This makes it much more likely that the Federal Circuit will reverse a decision because it need not give any deference to the decision of the district court. Fact issues (like infringement, many aspects of validity, and damages) are reviewed on a less flexible standard (i.e., does substantial evidence support the decision), such that the Federal Circuit (like the district court) is not free to substitute its own judgment for that of the jury. Evidentiary rulings, and other issues associated with how the trial was conducted are reviewed under the least flexible standard of review—abuse of discretion. It is rare that the Federal Circuit finds that a district court abused its discretion.lxix
For example, the Federal Circuit reverses claim construction decisions at a rate nearly twice as high as decisions without claim construction issues (32 percent vs. 18 percent).lxx It is not surprising, then, that most appeals to the Federal Circuit focus at least in part on claim construction as a basis for the appeal.
Appeals at the Federal Circuit are usually resolved within 18–24 months. Oral argument is usually scheduled within a year, depending on how much time the parties take to file their appeal briefs. Oral argument is requested and granted in almost all patent appeals. The argument occurs in the Federal Circuit courthouse in Washington, D.C., before a panel of three judges, although yearly the Federal Circuit travels to other cities to hear arguments at local law schools, which allows students, local practitioners, and the public to attend more easily. The parties are typically given 15 minutes per side to make their arguments, and after the argument, the court renders a written decision within 3–6 months.
2.09: Litigation Alternatives
Learning Objectives
After completing this section, you will be able to
• Understand the various alternative methods of dispute resolution.
• Distinguish the pros and cons of arbitration versus mediation.
The high cost, delay, and disruption of litigation motivate many adversaries to seek alternatives to litigation to resolve their disputes. Mediation and arbitration are two popular alternative dispute resolution (ADR) methodologies. A thriving business exists in the United States providing adversaries the resources to conduct mediations or arbitrations. Retired or former judges or lawyers are available to serve as mediators or arbitrators.
ADR is an increasingly popular way to resolve disputes because it is often faster, less expensive, and private, as compared with the public lawsuit procedures outlined above. The interactions among the parties and the mediators/arbitrators can be kept confidential, as can any settlements reached. Confidentiality is a driving force behind ADR.
Mediation
Mediation is simply an exchange between adversaries overseen (i.e., “mediated”) by an individual with expertise and/ or training in helping parties reach agreement. Often, the mediator will require the parties to submit their positions and relevant documents in a pre-mediation brief. Usually, each pre-mediation brief is confidential and only seen by the mediator and the party submitting it (i.e., the opposing party does not see the other side’s mediation brief). The mediator will review the materials submitted and then set a date for the parties to meet with the mediator, usually in the mediator’s offices or a neutral location (such as a hotel conference room). Each party commits to bring to the mediation one or more people with the authority to settle, so that the people at the mediation can discuss the dispute and reach an agreement settling it without having to seek approval from others.
At the mediation, the mediator typically starts by meeting with all the parties together, and reviews the dispute and the issues that require settlement. The mediator will then meet with each party separately, engaging in “shuttle diplomacy,” in an attempt to bring the parties to a common middle ground. Occasionally, when it may appear that the parties’ respective positions leave a gap between them, the mediator may make a “mediator’s proposal” that tries to bridge that gap. If the parties agree, typically a written agreement will be signed before they end the mediation—which may be a list of terms for later fleshing out in a full agreement or an actual final settlement agreement. Because anything left to later discussion can give rise to further disputes, most mediators try to get the parties to a full, signed agreement before they depart the mediation.
Perhaps surprisingly to some, mediation often succeeds, if not the first time, then weeks or months later, after the parties have a chance to think things through. Mediations can be conducted while litigation is pending, or before litigation is filed. In the latter case, often the parties will sign a “standstill agreement” that promises that neither will file a lawsuit against the other on the subject matter of the mediation until they agree the mediation has failed.
District courts and the Federal Circuit often have mediation programs that attempt to help the parties resolve their disputes voluntarily. Increased attention is given to these programs as the resources of the courts have dwindled and the caseloads increased because each successful mediation is one less case that requires the resources of the court.
Arbitration
The principal difference between mediation and arbitration is decisiveness. Mediations result in settlements only if all parties agree to a resolution. In most arbitrations (so-called “binding arbitrations”), the parties agree to be bound by the decision of the arbitrator(s). There is a nonbinding version of arbitration, where the parties ask the arbitrator(s) to render a decision, but do not agree to be bound by it. In practice, these are actually mediations because they result in a settlement only if all parties agree to the result. Such nonbinding arbitrations are most often used when the parties have attempted to reach a mediated settlement but reach an impasse on one or more critical issues. They may then agree to submit those impasses to nonbinding arbitration, where one or more arbitrators (usually experts on the subject matter of the impasse issues) evaluate the facts, as presented by the parties, and render a decision that the parties can review to understand how an impartial third party looks at the issues. This often helps the parties craft a mediated settlement on their own.
Most arbitrations are binding, and resemble lawsuits and trials more than mediations. The parties may agree to submit their dispute to a single arbitrator (like a retired judge), but most often a panel of three arbitrators is appointed to hear the case. The parties may agree on all three arbitrators, drawn from a list of suitable candidates provided by the American Arbitration Associationlxxi or some other entity in the arbitration business, or each party selects one arbitrator and those two arbitrators pick the third.
The parties agree on the rules that govern the arbitration, which can limit discovery, evidence, witnesses, and trial time, in whatever manner the parties agree. Once the parties agree on the rules, the arbitration is controlled by the arbitration panel, which enforces the rules and renders a binding decision. Usually, arbitration decisions are not appealable (except for gross malfeasance by the arbitrators), but the parties can provide for appeal rights if they choose. But prolonging the resolution of the dispute by allowing an appeal is contrary to the cost and time-savings objectives of most arbitrations.
Arbitrations have become particularly popular for resolving patent disputes that cross international borders and involve multiple patents issued by different countries. No one court can resolve such disputes, so international arbitration, with arbitrators expert in different countries’ laws can fill the gap. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.08%3A_Appeals.txt |
Learning Objectives
After completing this section, you will be able to
• Appreciate the threat posed by patent trolls to innocent businesses.
• Understand the difference between legitimate patent holders enforcing their rights and extortionist patent trolls who try to game the legal system.
Starting in the 1990s, but increasing in the new millennium, a type of plaintiff with a particular litigation and settlement strategy gained notoriety in the United States—the so- called “patent troll.” By 2012, the majority of patent suits were brought not by businesses making products covered by patents they owned and seeking to halt competitors believed to be infringing their patents, or even by small entities and entrepreneurs pursuing legitimate claims, but instead by what some detractors call “patent trolls” (after the mythical creatures that demanded payment for safe passage over a bridge).lxxii Although some have more recently attempted to discern a difference between what they consider “good” and “bad” trolls by labeling the former “non-practicing entities” (NPEs) or “patent monetization entities” (PMEs), for the purposes of this section, we will refer to such entities as trolls.
As plaintiffs, trolls seek to take advantage of the fact that U.S. patent litigation costs have become so high that many defendants are willing to pay to make such cases go away. Trolls file lawsuits not to protect a business from an infringing competitor, but to derive settlement revenue from defendants willing to settle for less than litigation costs. Trolls often acquire patents of ambiguous scope and questionable value, file suit against multiple defendants, and rely on the presumption of validity accorded all issued patents to extract settlements for less than it would cost any one defendant to defend against the infringement claim. Because trolls have few documents other than the patents and their file histories, and even fewer employees, they are not subject to the outsized expense of discovery that a commercial business with warehouses of documents and scores of employees faces in patent litigation. Because discovery costs for such defendants are so much greater than for troll plaintiffs, defendants feel pressure to settle for less than the cost of litigation, lining the pockets of trolls. Such activities in the aggregate have proven very profitable for trolls, and expensive for defendants.
Spurred by target companies, the America Invents Act legislation in 2011 (see infra, Section X.3.3) included a change in rules governing the joinder of parties, stating:
“...accused infringers may not be joined in one action as defendants or counterclaim defendants, or have their actions consolidated for trial, based solely on allegations that they each have infringed the patent or patents in suit.”
This eliminated a tool of trolls—namely, filing a single case against scores or even hundreds of alleged infringers.lxxiii However, trolls simply adapted by filing multiple lawsuits and seeking consolidation for discovery, which increases their costs somewhat but avoids the purpose of the change.
More recently, politicians have scrambled to propose a myriad of different legislative fixes, from shifting the cost of unsuccessful litigation to plaintiffs, to staying litigation against customers of another’s product until a suit against the manufacturer is concluded.lxxiv Even President Obama was involved, asserting his administration’s own views for a solution.lxxv
Not everyone thinks legislation is appropriate, or even necessary. A panel at Yale Law School in April 2013 yielded decidedly mixed views.lxxvi And then Chief Judge Rader of the Federal Circuit Court of Appeals coauthored an op-ed piece in the New York Times, recommending that judges should use 35 U.S.C. §285 to foil patent trolls by imposing costs and sanctions at the judicial level.lxxvii But again, not everyone thinks that is realistic.lxxviii The Supreme Court embraced Judge Rader’s recommendation in its 2014 decisions in Octane Fitness andHighmark, significantly broadening the district court’s discretion in finding a case exceptional and awarding attorneys’ fees. (See supra, Section 2.7, “Exceptional Case.”) But even with such expanded discretion and power, trial judges cannot rule on the merits of a case without some basis for it, and that requires money spent by defendants. Thus, it is not easy for a district court judge to stop what trolls rely upon, namely the use of litigation expense and leverage to extract settlements. Getting to the merits of the claims takes time and significant expense—often more than the cost to settle, with no assurance as to outcome.
As of early 2015, the problem of trolls remains a subject of widespread discussion and debate. Legislation that was proposed in 2014 to address the problem is stalled, and although new legislation is still being discussed, many experts believe that the state and federal actions already taken to rein in abusive patent litigation—including important U.S. Supreme Court decisions in 2015 regarding software patentability and fee-shifting in exceptional cases—make it less likely that new legislation will be introduced any time soon.
District courts, for example, have already begun applying the standards recently announced by the Supreme Court in Octane Fitness andHighmark, and may be more willing to make abusive patent litigants pay attorneys’ fees. Time will tell if the new fee-award judicial regime will lessen the pressure to implement legislation against abusive litigants. The Eastern District of Texas, one of the most popular venues for patent litigation in the United States, has added a new Track B docket, which specifically addresses a number of proposals considered by Congress, including early disclosure of certain information, such as licensing information, as well as very early disclosure of both the damages sought and the method of calculating those damage.lxxix
Meanwhile, a growing number of state legislatures and state attorneys general have also begun using consumer protection laws to clamp down on patent trolls.lxxx And the White House in 2014 issued a series of Executive Orders intended to further curb patent litigation abuse and strengthen the patent system.lxxxi
Finally, a movement is taking hold within the patent licensing industry itself to develop a voluntary code of conduct or standards of ethical behavior. Companies like Conversant and Dominion Harbor Group have committed themselves publicly to a set of ethical guidelines for patent licensing, and other companies are also considering doing so.lxxxiiThe Licensing Executives Society of the U.S. and Canada (LES), the industry’s principal professional organization, is also developing a set of “best practice” guidelines for ethical patent licensing activity.
The importance of patents to America’s economic prosperity and competitiveness ensures that competing interests will continue to strive for an advantage commercially, legislatively, and judicially. Change will continue after the publication of this chapter. The status quo does not last long in our field. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/2.10%3A_Patent_Trolls_and_Efforts_to_Thwart_Them.txt |
1.
Responsibility for legally enforcing patents rests with which of the following bodies?
1. The U.S. Patent and Trademark Office (USPTO)
2. The U.S. Department of Justice.
3. The owner of the patent, suing in a federal civil lawsuit.
Answer
C. The owner of the patent, suing in a federal civil lawsuit.
2.
Patent owners have which of the following rights under the law?
1. The exclusive right to “practice” the patent—meaning the exclusive right to make or sell products based on the patent.
2. The right to exclude others from making, using, offering for sale, selling, or importing the invention covered by the patent throughout the United States.
3. Both of these.
Answer
B. The right to exclude others from making, using, offering for sale, selling, or importing the invention covered by the patent throughout the United States.
3.
Which of the following is required in order to infringe a patent?
1. Intending to infringe the patent.
2. Making, using, or selling the patented invention without authorization.
3. Knowing that the patent exists.
Answer
B. Making, using, or selling the patented invention without authorization.
4.
Which of the following is the legal definition of patent infringement?
1. One or more of a patent’s claims match (or “read on”) the features and functions of a device or process.
2. A device or process that performs a “substantially similar” functions to those described in a patent’s claims.
3. Both of the above are correct.
Answer
A. One or more of a patent’s claims match (or “read on”) the features and functions of a device or process.
5.
Which of the following illustrates the “doctrine of equivalents”?
1. If a device performs substantially the same function in substantially the same way as your patent claim, infringement exists if any differences are insignificant.
2. A patent calling for an “adhesive” connection (describing glue as the preferred adhesive) may be infringed by a device using a Velcro® fastener.
3. Both of the above are correct.
Answer
C. Both of the above are correct.
6.
If you believe your patent is being infringed, you have how many options for recourse?
1. Two. You can sue the infringer in federal court, or ignore the infringement.
2. Three. Besides the two above, you can simply demand he stop infringing.
3. Four. You can sue the infringer, demand he stop infringing and pay monetary damages, offer the infringer a license in return for royalties, or ignore it.
Answer
C. Four. You can sue the infringer, demand he stop infringing and pay monetary damages, offer the infringer a license in return for royalties, or ignore it.
7.
Patent infringement suits can take years and cost millions of dollars. Which of the following is another option patent owners have in seeking redress for infringement?
1. Litigation financing in exchange for a share of any damages.
2. Out-of-court license and royalty settlements.
3. Contingency lawyers take the case for a share of any damages.
4. All of the above.
Answer
D. All of the above.
8.
If you think multiple parties are infringing, what is your best strategy?
1. Sue them one at a time, so they don’t gang up on you.
2. Pick the one with the biggest pockets, as the settlement will likely be larger.
3. Sue them all simultaneously, and let them sort out their differences.
Answer
C. Sue them all simultaneously, and let them sort out their differences.
9.
Should you alert an infringer beforehand that you intend to file suit?
1. Always. This gives them the opportunity to settle prior to you filing a costly suit.
2. Never. They can then sue you preemptively, giving them the vital initiative in seeking a venue of their choice and a declaratory judgement of noninfringement.
3. Yes, but only if you file suit simultaneously or shortly afterwards.
Answer
C. Yes, but only if you file suit simultaneously or shortly afterwards.
10.
How often do plaintiffs win at trial?
1. 60 to 75 percent of the time.
2. 80 to 90 percent of the time.
3. 40 to 50 percent of the time.
Answer
A. 60 to 75 percent of the time.
11.
Which of the following is NOT a valid reason for filing a motion to dismiss once a suit is filed in a federal court?
1. Improper jurisdiction.
2. Improper venue.
3. Improper (or invalid) patent.
4. Failure to state a proper claim.
Answer
C. Improper (or invalid) patent.
12.
Which of the following is NOT a possible defense in a defendant’s answer to a claim?
1. The patent is invalid.
2. The patent is not infringed.
3. The plaintiff waited too long to file suit.
4. The patent covers a nonessential part of the allegedly infringing product.
Answer
C. The plaintiff waited too long to file suit.
13.
Why have defendants increasingly turned to post-grant review proceedings at the PTO, such as inter partes review, since the America Invents Act was passed in 2011?
1. The PTO is less likely to judge that a patent has been infringed.
2. It's quicker than waiting for a trial.
3. The PTO has shown a strong likelihood of finding challenged patents invalid.
Answer
C. The PTO has shown a strong likelihood of finding challenged patents invalid.
14.
What role does discovery play in an infringement case?
1. Through production of documents and interrogatories, either side may discover information that may be decisive in confirming or rebutting infringement claims.
2. Discovery is often an endless fishing expedition that escalates the costs to both parties exponentially.
3. Both of these describe the role of discovery in an infringement case.
Answer
C. Both of these describe the role of discovery in an infringement case.
15.
What is the most critical pretrial phase of every patent infringement case?
1. Discovery.
2. Summary Judgment.
3. Claims construction (or Markman) hearings.
4. The Verdict.
Answer
C. Claims construction (or Markman) hearings.
16.
Why do courts usually seat seven to nine jurors rather than six or twelve in most patent cases?
1. You need an odd number of jurors to break a tie vote on the verdict.
2. Six jurors won’t be enough for a legal verdict if one is excused during trial, and twelve jurors will likely take too long to decide the case.
Answer
B. Six jurors won’t be enough for a legal verdict if one is excused during trial, and twelve jurors will likely take too long to decide the case.
17.
Why are patent trials often thought of as morality plays?
1. The facts of the case, not each party’s moral views, are all that matters to a jury.
2. It is immoral to spend \$3 million to \$10 million on a patent suit.
3. Each party casts itself as in the right and its opponent as doing them wrong.
Answer
C. Each party casts itself as in the right and its opponent as doing them wrong.
18.
Which of the following is the definition of inequitable conduct?
1. Deceiving or misleading the patent office to grant a patent.
2. Deceiving or misleading a jury during opening arguments.
3. Deceiving or misleading the opposing party during the discovery phase.
Answer
A. Deceiving or misleading the patent office to grant a patent.
19.
What’s the standard for proving willful infringement, leading to enhanced damages?
1. Selling a product despite knowing that a patent exists that the product might be infringing.
2. Selling a product despite an objectively high likelihood that it infringed a valid patent and that this risk was known or should have been known to the infringer.
3. Deliberately not conducting a prior art search to determine if a patent exists that your product might be infringing.
Answer
B. Selling a product despite an objectively high likelihood that it infringed a valid patent and that this risk was known or should have been known to the infringer.
20.
What is the standard for imposing attorneys’ fees on the losing party to a patent suit?
1. Convincing evidence of bad faith or gross negligence by the losing party.
2. A case that “stands out from others” in the weakness of the plaintiff’s case or the unreasonable or abusive manner in which it was litigated.
Answer
B. A case that “stands out from others” in the weakness of the plaintiff’s case or the unreasonable or abusive manner in which it was litigated.
21.
What is often the most serious damage that a court can impose upon an infringer?
1. A very large award for monetary damages.
2. Pre- and post judgment interest payments on the damage award.
3. Injunctive relief barring further sales of the infringer’s products.
Answer
C. Injunctive relief barring further sales of the infringer’s products.
22.
Which of the following explain why patent infringement verdicts are almost always appealed?
1. The cost of an appeal is orders of magnitude less than the cost of the trial itself.
2. Legal issues such as claim construction are reviewed de novo - meaning, without regard to the previous trial’s rulings.
3. The U.S. Court for the Federal Circuit, the appeals court, affirms in full less than 60 percent of the patent cases it decides on the merits.
4. All of the above.
Answer
D. All of the above.
23.
As an alternative to litigation, mediation is different from arbitration in what way?
1. Mediations result in settlements only if both parties agree.
2. In arbitrations, the parties are bound by the decision of the arbitrator.
3. Both of these are accurate.
Answer
C. Both of these are accurate.
24.
Which of the following is the definition of a “patent troll”?
1. A patent owner who licenses their patents rather than makes or sells products.
2. A patent owner whose main source of revenue is patent litigation.
3. A patent owner whose main source of revenue is “nuisance settlements” for less than the cost of litigation.
Answer
C. A patent owner whose main source of revenue is “nuisance settlements” for less than the cost of litigation. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/02%3A_Patent_Enforcement/Chapter_2%3A_Assessment_Questions.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the theoretical and legal underpinnings of copyright.
• Appreciate the important differences between copyrights and patents.
A copyright is an intellectual property right granted by a government to the author of an original literary, dramatic, musical, artistic, or other eligible creative work that gives them the exclusive right to control how the work is published, reproduced, performed, or displayed—as well as whether or not derivative works (e.g., a movie version of a novel) may be produced.
In the United States, the legal foundation for copyright is set forth, along with that for patents, in Article 1, Section 8, Clause 8 of the U.S. Constitution. This clause gives Congress the authority 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.”i
Congress and the courts have interpreted the terms “authors” and “writings” very broadly so as to include the creators of a wide variety of artistic and intellectual works. Title 17 of the United States Code authorizes the grant of a copyright to the authors of “original works of authorship”—including literary works, dramatic works, choreographic works, graphic works, audiovisual works, sound recordings, and architectural works. In most cases, a copyright lasts for the life of the author plus 70 years.
How to Obtain a Copyright
In America, the copyright system is administered by the U.S. Copyright Office, which is part of the Library of Congress and maintains a registry of copyrighted works. Interestingly, registration is not required to obtain a copyright. It is automatically granted to an author at the moment of creation—i.e., as soon as the work is expressed in a tangible form that allows it to be seen or copied, such as being written on paper or on a computer, or recorded as video or audio. Registration is only required if a copyright holder wants to initiate a copyright infringement suit in federal court.
Copyrights vs. Patents
Unlike the case with patents, the United States never developed an examination system for determining whether or not a creative work merits copyright protection. That’s because while the validity of an invention can be evaluated fairly objectively based on its utility, novelty, and non- obviousness, the merit of any cultural work is a far more subjective affair, as demonstrated by the frequency with which publishers reject novels that later go on to become literary classics.
What the patent and copyright systems share, however, is the recognition that unless the inherent property rights of inventors and authors to their creations are protected, the wellsprings of creation and productivity would be negatively affected by the reduced incentive. Both systems also share the public policy goal of marshaling the benefits of individual creativity—whether technological, as in the case of inventions, or cultural, as in literary works—to the public good so that these promote the progress of the nation and the “general welfare” of its citizens.
How to promote that general welfare, however, was approached very differently by the Founders in the case of patents than it was with copyright.
The explicit intention of patent law, explained Supreme Court Justice Henry Baldwin inWhitney v. Emmett (1831), was “to benefit the inventor, in the belief that maximizing individual welfare leads to maximum social welfare.” Inventors, after all, created tools that enabled the new nation to free itself from dependency on foreign imports and develop industries of its own. Whatever incentives were needed to prod these technologically creative people to take on the challenge and succeed were well worth the bargain (see Chapter 1).
The Rights of Authors and the Public Interest
When it came to copyright, however, the rights of authors were thought to conflict with those of the public to a far greater extent. “Democratic values emphasized equal and widespread access to learning and the importance of information flows for maintaining political freedom, whereas strong copyrights impinged on the fullest attainment of these objectives,” notes Bowdoin College historian Zorina Khan, author of The Democratization of Invention: Patents and Copyright in American Economic Development, which won the Alice Hanson Jones prize for outstanding work in economic history in 2005.ii
As an example, a copyright owner’s right to prevent unauthorized use of their work may at times be constrained by the public’s First Amendment right of free speech—hence the doctrine of “fair use” (more on this later).
It was believed that a strategy of strong patent rights but weaker copyrights also better reflected the differing incentives that motivated inventors and authors. Inventors, many felt, were driven primarily by economic gain, whereas authors were often interested as much in the prospect of celebrity and reputation as they were in monetary reward.
Supreme Court Justice John McLean emphasized that this distinction between patents and copyrights exists in the structure of U.S. intellectual property law itself. In Wheaton v. Peters (1834), the first high court ruling on copyright, he wrote:
“It has been argued at the bar that as the promotion of the progress of science and the useful arts is here united in the same clause in the Constitution, the rights of authors and inventors were considered as standing on the same footing. But this, I think, is a non-sequitur … for when Congress came to execute this power by legislation, the subjects are kept distinct and very different provisions are made respecting them.”iii
To understand why the Founders gave greater weight to the public domain in copyright law than they did in patent law, it’s important to examine the origin and development of early copyright systems and their political and economic impact on society.
Footnotes
• iU.S. Constitution Arr. 1, § 8
• iiB. Zorina Khan, The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790O1920, Cambridge University Press, 2005.
• iiiWheaton v. Peters, 33 U.S. (8 Pet.) 591 (1834)Retrieved from http://supreme.justia.com/cases/fede.../591/case.html courtesy of B. Zorina Khan. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.01%3A_The_Basics_of_Copyright.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the role early copyright systems played in enforcing monopolies.
• Appreciate the degree to which authors’ rights were ignored at that time.
As was the case with patents, the granting of book privileges (now called copyrights) began in the Republic of Venice in the fifteenth century. Prior to that, printed books were considered part of the public domain and anyone could copy or reproduce them. But in 1492—the same year Columbus sailed the Santa Maria to the New World—a Milanese author named Donatus Bossius petitioned the sixth duke of Milan, Gian Galeazzo Sforza, for an exclusive privilege for his book, arguing that without such a privilege he would be unjustly deprived of the fruit of his effort. He was granted a ten-year privilege, and the practice soon spread throughout Europe.
The French copyright system was introduced in 1498. Exclusive rights to not only books but also translations, maps, type designs, engravings, and artwork were granted by the monarch for periods initially ranging from two to ten years. There were stipulations attached to such grants, sometimes including even price controls on the published works.
It is important to realize, however, that authorship was not required for the granting of early copyrights. In fact, the early copyright systems of Europe more often than not enabled printers and publishers to establish quite effective monopolies over the commerce in books, the arts, and other cultural works that limited the diffusion of culture in society. The owners of such privileges may have waxed poetic about “droit d’auteur” (authors’ rights), but this was often just a way of deflecting public criticism of their monopolistic power and superprofits.
Indeed, this was most glaringly revealed in the grant of exclusive privileges to French opera. According to a 1929 book by Henry Prunières,ivLouis XIV in 1669 granted a perpetual monopoly over all operatic performances in France to Jean-Baptiste Lully, the director of the Paris Opera. Lully also gained sole publication rights to opera librettos, and sold shares in the rights to printers. He then used his copyright privilege to limit the number of musicians who could perform outside the Paris Opera and to suppress competitors like the Comédie Francaise. In the end, Lully became fabulously rich and bequeathed his monopoly rights to his heirs.
Not exactly your starving artist asking merely to enjoy the fruits of his work.
Early copyright systems also quickly evolved into means of censorship and surveillance of the population’s reading habits. The 1566 Edict of Moulins in France, for example, required that any new book had to be approved and licensed by the Crown. Manuscripts first had to be read and approved by a censor before a permit was granted to print a book. The permit could be revoked if officials or influential citizens later complained about the book’s content.
Interestingly, a decree in 1777 enabled authors who did not sell off their rights to gain a copyright in perpetuity. But like the A.J. Liebling quote about freedom of the press belonging only to those with enough wealth to own one, so, too, were authors’ inalienable rights often just a lofty theory trumped by harsh economic reality. Because few authors had the capital required to print a book, they usually sold off their “exclusive rights” to commercial publishers.
Much the same situation prevailed in the English copyright system, where copyright law began as a monopoly grant to benefit favored guilds and as a means to censor public opinion on behalf of the Crown.
The Statute of Anne
In 1557, the Worshipful Company of Stationers was granted a royal privilege that enabled it to control the book trade for the next 150 years. Only in 1709 did a new copyright statute, theStatute of Anne, begin to erode the monopolistic power of the Stationers Company. It stipulated that a copyright could be obtained by anyone, and instead of a perpetual right, the term was limited to 14 years with the right to renew for one additional 14-year term. According to Professor John Feather of Loughborough University in Britain, the statute “wholly ignored the authors of books, and certainly was not intended to confer any additional rights on them.”v
Assessing early European copyright systems as a whole, Zorina Khan observes that they “resulted in ‘odious monopolies,’ higher prices and greater scarcity, large transfers [of money] to officials of the Crown and their allies, and pervasive censorship [while it also] disadvantaged smaller book producers, provincial publishers, and the academic and broader community.”vi
It wasn’t until 1774 in England, in the landmark case Donaldson v. Beckett, that a court ruled that authors have a fundamental right to their writings—at least until publication, after which the Statute of Anne still gave the rights to the publishers. The immediate claim in the case was whether Scottish bookseller Alexander Donaldson had acted as a pirate when he published an edition of James Thomson’s The Seasons, a work for which Thomas Beckett and other London booksellers claimed the copyright. But the larger principle at issue was whether copyright was a limited right granted by government under the Statute of Anne, or a common law right of publishers that existed in perpetuity despite the limitations of the statute.
The case would prove pivotal in deciding not only the future of publishing, but also of authors, in whose name the London publishers claimed to be acting. The court took the claim of authors’ rights further than the publishers ever intended, however. It reaffirmed the limited statutory nature of copyright and also recognized that authors—with the decline of patronage, authors were only then emerging as independent professionals writing for a mass market of book buyers—were the true originators and proprietors of the product of their own creative labors.
As Michel Foucault would put it nearly two centuries later,
“The coming into being of the notion of ‘author’ constitutes the privileged moment of individualization in the history of ideas, knowledge, literature, philosophy, and science.”
In the century after Donaldson v. Beckett, European copyright systems expanded to include sheet music, maps, design, sculpture, and even lectures. The doctrines of “work for hire” and “fair use” would emerge (more on these later), but the law would still remain largely arbitrary, confused, and frequently injurious to the public until late in the nineteenth century.
However, the process of transforming copyright from a scheme of monopoly privileges for publishers into a property right for the actual creators of cultural works had begun.
Footnotes
• ivHenry Prunières, “La vie illustre et libertine de Jean-Baptiste Lully,” Librairie Plon, Paris, 1929, courtesy of B. Zorina Khan.
• vJohn Feather, “Publishing, Piracy, and Politics: An Historical Study of Copyright in Britain,” Mansell, New York, 1994, courtesy of Khan.
• viOp. cit., Khan. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.02%3A_Early_Copyright_Systems.txt |
Learning Objectives
After completing this section, you will be able to
• See the origins of copyright law in the United States.
• Appreciate the importance the Founding Fathers attached to the public need for widespread access to learning and information.
Ever practical, the Founding Fathers sought to construct an intellectual property regime that above all else would encourage the growth of commerce and industry in order to ensure the survival of the young American nation during its precarious beginnings.
For patent law, this meant creating the maximum possible incentives to those whose ingenuity would spur the development of agriculture and domestic industry. As economist Jonathan Hughes once noted, entrepreneur-inventors like Eli Whitney, who developed a cotton gin in 1793 that increased agricultural production a hundredfold, were“the vital few” upon whom the nation depended for progress. That’s why early Supreme Court Justice Joseph Story argued that patent rights were “sacred,” and the just reward for their contributions to society.
But in copyright law, a different approach was taken—one that acknowledged authors’ rights but placed far greater emphasis on the public’s need for widespread access to learning and on the growth of markets. James Gilreath, the Library of Congress historian who in the late nineteenth century painstakingly reconstructed Thomas Jefferson’s massive library catalog burned by the British in 1814, explained the Founders’ view this way:
“The constitutional copyright provisions’ emphasis on the useful arts sought not to bolster a professional literary establishment of novelists, poets, and critics such as the one that existed in England, but rather to ensure that books with demonstrably practical benefits to society would be available to readers of the new Republic.”
This emphasis was certainly in tune with the realities of American book trade. Domestic publishers mainly produced newspapers, almanacs, and practical guides—reading material of useful value to a nation that needed to build an entire economy from scratch. Most important literary works, on the other hand, were imported from Britain and France.
As a result, even in colonial times, states that passed copyright laws did so only with explicit rules that ensured widespread public access to knowledge and information.
Take colonial Connecticut’s 1783 copyright law, for example. It certainly contained all the right rhetoric about authors’ natural rights:
“Whereas it is perfectly agreeable to the principles of natural equity and justice, that every author should be secured in receiving the profits that may arise from the sale of his works, and such security may encourage men of learning and genius to publish their writings; which may do honor to their country, and service to mankind."vii
But it also made it quite clear that copyrighted books had to be offered at reasonable prices or the state would issue a compulsory license enabling anyone to copy these at will. No one failed to get the point.
After the Constitutional Convention and the establishment of Congress, the first federal copyright statute was signed into law by President George Washington on May 31, 1790, less than two months after the first patent law was approved.
The law stipulated that “the author and authors of any map, chart, book or books already printed within these United States, being a citizen or citizens thereof, shall have the sole right and liberty of printing, reprinting, publishing and vending such map, chart, book or books” for a period of 14 years, with the right of renewal for another 14 years. The Founders’ belief that 28 years was the proper maximum copyright term stands in sharp contrast to today’s controversial maximum copyright term of life-plus-70 years, an issue we will discuss later in this chapter.
Anyone violating a copyright “shall forfeit all and every copy and all and every sheet to the author or proprietor who shall forthwith destroy the same.” What’s more, “offenders shall also forfeit and pay the sum of fifty cents for every sheet which shall be found in his or her possession.” As a final disincentive to infringers, the law allowed copyright owners to file suit “in any court of record in the United States within one year after the cause of action.”
Still, the law’s focus on the public interest was clear in the first five words of the text: “An Act for the Encouragement of Learning, by securing the Copies of Maps, Charts and Books, to the Authors and Proprietors of such Copies, during the Times therein mentioned.”
The failure in the text to distinguish between “authors” and “proprietors” (i.e., publishers, printers, and booksellers), of course, also suggested that Congress did not view copyright as an innate or moral right of authors. In fact, copyright was conditional upon the author or proprietor depositing a copy of the work in the district court and paying a fee of 60 cents.
Another sign that the emphasis of U.S. copyright law was to facilitate the diffusion of knowledge over the protection of authors’ inherent property rights was provided by this sentence:
“Nothing in this act shall be construed to extend to prohibit the importation or vending, reprinting or publishing within the United States, of any map, chart, book or books by any person not a citizen of the United States.”
In other words, America’s first copyright law explicitly authorized the piracy of foreign cultural works in order to promote widespread citizen access to the benefits of learning.
And that’s exactly what Americans did, unabashedly pirating European culture and resisting for a century all attempts to alter what Europeans called its “obnoxious laws.”
The first American to receive a U.S. copyright, one month after the Copyright Act was signed into law, was John Barry for his spelling book. The first woman granted a copyright was Mrs. Mercy Warren of Massachusetts for her Poems, Dramatic and Miscellaneous.
Over the next decade, half of all copyrights went to proprietors, proving yet again that the law’s concern was not chiefly with the rights of authors. Most of these were for practical books such as atlases, dictionaries, and textbooks, as one would expect in a society hungering for practical knowledge and lacking in homegrown literary works equal in sophistication to those of the Europeans.
The Pirates of Copyright
As late as 1835, 65 percent of science books, 92 percent of business texts, and 75 percent of law books published in the United States were written by Americans. But even then, a half century after independence, only a third of poetry and drama books published in America were written by Americans.viii
“A nation of artificers and innovators, both as consumers and producers, American citizens were confident of their global competitiveness in technology, and took an active role in international patent conventions,” explains Khan. “Although they excelled at pragmatic contrivances, Americans were advisedly less sanguine about their efforts in the realm of music, art, literature and drama.”
According to Ainsworth Spofford, the Librarian of Congress from 1864 to 1897, “a group of publishing houses in the [U.S.], which made a specialty of cheap books, vied with each other in the business of appropriating English and continental trash, and printed this under villainous covers, in type ugly enough to risk a serious increase of opthalmia among American readers.”ix
And not just “trash,” either. America gained a notorious reputation internationally for its piracy of English and European literary classics—a practice greatly encouraged by the protectionist levying of tariffs as high as 25 percent on imported books.
Put another way, America in those days was seen as a nation of technological innovators and cultural pirates.
Between 1790 and 1875, more than a hundred petitions were submitted to Congress to bring the United States in line with international copyright laws. All were defeated by publishers’ and printers’ lobbies. It wasn’t until 1891 that the Chace Act granted copyright protection to select foreign authors—but only if their work was published in the United States on or before the publication date in their own countries, and only if the actual printing was done here. The United States failed to qualify for admission to the Berne Convention on copyright until 1988, an astonishing 102 years after the convention.
Such piracy had its costs, however—and not just to foreign authors and publishers. According to Arthur Schlesinger, “So long as publishers … could reprint, or pirate, popular English authors without payment of royalty, and so long as readers could buy such volumes far cheaper than books written by Americans, native authorship was at a marked disadvantage.”x
Some believe this helps to explain why no great American novels were written in the early nineteenth century. Only in the mid-1800s, with the emergence of novelists like James Fenimore Cooper, Nathaniel Hawthorne, and Henry Wadsworth Longfellow did a change in the relative balance of authorship between Americans and foreigners begin to take place. More and more authors took up the pen and influenced American culture, including Harriet Beecher Stowe, who copyrighted Uncle Tom’s Cabin in 1851. Nonetheless, it wasn’t until the early twentieth century, after the United States began to comply with international copyright standards, that Americans became the majority of best-selling authors in the United States.xi
It would be far too simplistic, of course, to ascribe the late- blooming of American literature simply to weak copyright laws and the prevalence of cheap pirated foreign literature. There are organic reasons why a young nation, and a new culture, needs time to develop its own literary voices. But it is also true, as research worldwide has repeatedly demonstrated, that where weak intellectual property protections exist in developing nations (like today’s China or early nineteenth-century America), citizens have an excessive incentive to copy and insufficient incentive to invent and create for themselves.
Footnotes
• viiState of Connecticut. (1906). Copyright Laws Passed by the Original States: 1783-1786. In T. Solberg (Ed.),Copyright Enactments of the United States, 1783-1906 (2 ed., pg. 11). Retrieved from http://books.google.com/books?id=xNA...AIAAJ&oe=UTF-8
• viiiOp. cit., Khan.
• ixThe Question of Copyright,” compiled by George Haven Putnam, G.P. Putnam’s Sons, New York, 1896, courtesy of Zorina Khan.
• xArthur M. Schlesinger, The Rise of the City, 1878-1898, McMillan, New York, 1933.
• xiAlice Hackett and James Burke, Eighty Years of Best Sellers, 1895-1975, Bowker, New York, 1971. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.03%3A_Copyright_in_America.txt |
Learning Objectives
After completing this section, you will be able to
• Know what kinds of creative work are eligible for
• Grasp the broad definition of "authors" and "literary works."
Can I Copyright That?
Before reading this section, please watch the overview video covering the basics of copyright law—eligible works, the distinction between ideas and their expression, the rights granted to copyright owners, and is copyright term—life plus 70 years.
Title 17 of the United States Code Section 102 explicitly delineates eight categories of original works that are eligible for copyright.
This list, while broad, actually includes a far more extensive range of work than the average citizen might imagine. For example, copyrightable works also include software.
Copyrighting Software
Why is software copyrightable? It’s because an appellate ruling in the 1983 case of Apple v. Franklin held that software was a kind of “literary work” and therefore eligible for copyright.
The court noted that the Copyright Act defined the term “literary work” as follows:
“Literary works are works, other than audiovisual works, [that are] expressed in words, numbers, or other verbal or numerical symbols or indicia, regardless of the nature of the material objects, such as books, periodicals, manuscripts, phonorecords, film, tapes, disks, or cards, in which they are embodied.”xii
Based on this definition, the court determined that a computer software program “is an appropriate subject of copyright.”
Note, however, that copyright does not extend to the elements of works of authorship that are potentially patentable processes. And indeed, beginning in the 1990s, software companies began increasingly to patent those elements of their new software that could be described as patentable processes, precisely in order to secure the stronger protections of patent law.
In any event, software is but one example of how the courts have tended to interpret broadly the eight categories of eligible subject matter. Just as technology drove the expansion of eligible subject matter into ever new realms—e.g., first photographs and then motion pictures—the courts have also expanded the definitions of all eight categories of eligible subject matter to include maps, games, puzzles, toys, fabric design, and many other creations.
Ideas to Copyrightable Works
However, not everything is copyrightable—far from it. Just as patent law makes a sharp distinction between ideas and their application—i.e., you cannot patent an idea for a better mousetrap but you most certainly can patent a new, non-obvious, and useful apparatus that catches mice—so, too, does copyright law differentiate between ideas and their expression. You cannot copyright, for example, the idea of an epic space opera in which a mystical cadre of Jedi knights wielding laser swords battle galactic evil, but you can copyright the particular expression of that idea in the screenplay and motion picture Star Wars.
Because it is an abstract concept or idea, Einstein’s formula E = MC2 is also not copyrightable. It is true that Einstein was the first to derive the famous formula involving mass and energy, which at first blush seems to fit the requirement for creative authorship in a copyrightable work. But the formula was derived from observation of natural physical laws, and must remain in the public domain lest private intellectual property rights create a blockade that prevents scientists and mathematicians from continuing their research and teaching.
Also noncopyrightable are names, addresses, and other known facts that are not creatively compiled. That’s why a phone book cannot be copyrighted, whereas the creative compilation of facts in a Chinese-American phone directory listing “Bean Curd & Bean Sprout Shops” may be under certain conditions, as a judge ruled in the 1991 case Key v. Chinatown .
To be copyrightable, a creative work must not only be expressed in a tangible form that allows it to be seen or copied (i.e., put to paper or some other medium), but it must also be original. The requirement for originality in copyright has its parallel in the necessity for novelty in patents. But this parallel works only to a point, for a copyrighted work need not be novel in the strictest sense to be original.
As Arthur R. Miller and Michael H. Davis explain in their textbook on intellectual property for law students:
“The author’s ideas and themes may have appeared in earlier works, Indeed, much of the expression may have been produced before. But copyright will be available to [this] second author if his is a work of independent creation.”xiii
To reiterate, a copyrightable work must not only fit under one of the eight broad categories of eligible subject matter, but it must also be:
• Independently created.
• Expressed or fixed on a tangible medium that can be seen or copied.
• Creatively authored or compiled.
• Not a fact or abstract idea.
Footnotes
• xiiApple Computer, Inc. v. Franklin Computer Corp., 714 F.2d 1240 (3d Cir. 1983) Retrieved from http://bulk.resource.org/courts.gov/...0.82-1582.html.
• xiiiArthur R. Miller and Michael H. Davis,Intellectual Property: Patents, Trademarks, and Copyright in a Nutshell. (5th ed., p. 25). St. Paul MN: West Publishing Co., 2007. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.04%3A_Eligible_Works.txt |
Learning Objectives
After completing this section, you will be able to
• Discern the specific rights granted to copyright owners.
• Understand the term of those rights as well as in some cases their limitations.
Just as common law property rights grant owners’ exclusive powers of possession, use, and distribution, so, too, does copyright law provide for six roughly analogous exclusive rights:xiv
1. The right to reproduce the copyrighted work
2. The right to prepare derivative works
3. The right to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending
4. The right to perform the copyrighted work publicly
5. The right to display the copyrighted work publicly
6. The right to perform sound recordings publicly through a digital audio transmission.
These rights are exclusive to copyright owners—only they or those to whom they have legally assigned their rights can act upon them. Only the author of a copyrighted book, for example, can decide to make copies of (i.e., publish) the work and prepare derivatives of the book, such as a movie version of it. If any person other than the author and copyright owner were to make a movie based on the book, that person would infringe the copyright.
The term or time period of a copyright varies. For an individual, the term of a copyright is the life of the author plus 70 years after the author is deceased. For a work with two or more authors, the term expires 70 years after the last author’s death. Finally, for works that are “made for hire,” or anonymous or pseudonymous works, the copyright term lasts 95 years from the first publication or 120 years from the year of the work’s creation, whichever comes first.xv As examples, assume a musical artist writes a song that is published and performed under their name. The copyright will last 70 years beyond their death, and could conceivably be quite valuable to their heirs.
On the other hand, imagine that an anonymous Korean War soldier’s diary, dated “December 1951” is discovered in an antique shop in the year 2013 and published that same year. Ordinarily, the copyright for an anonymous work would last for 95 years from the date of first publication, expiring in the year 2108. But because the date of creation is known to be 1951, the copyright would expire in 2071, or 120 years after it was written.
As noted earlier and discussed later in Section 3.9 of this chapter, these lengthy terms for copyright are controversial and opposed even by many supporters of copyright.
Work for Hire
According to U.S. law, a work for hire is:
“a work prepared by an employee within the scope of their employment, or a work specially ordered or commissioned for use as a contribution to a collective work, as a part of a motion picture or other audiovisual work, as a translation, as a supplementary work, as a compilation, as an instructional text, as a test, as answer material for a test, or as an atlas, if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire.”xvi
Imagine that you are an employee of a company, and you are asked to write one section of a white paper on a subject of interest to the industry. Or let’s say you’re a contractor hired to perform that same task under a “work for hire” arrangement. You will not own the copyright to that section of the white paper when it is completed, nor can you publish or use it if you leave the company and go to work for someone else. Although it is your creation, it is owned by the employer, who often uses your work product as part of an integrated project involving other contributors. The copyright for this particular white paper will last for 95 years from the year of first publication, or for 120 years from the year of its creation, whichever expires first.
First-Sale Doctrine
It is important to note, however, that an author’s distribution rights (No. 3 above) are strictly limited by what is known as the first-sale doctrine, which terminates those distribution rights once he sells or distributes the work to someone else. For example, once the author of a copyrighted novel lets a publisher distribute copies of that novel to a bookstore, the author’s distribution rights to those copies are ended and the bookstore can do whatever it wants with them—sell them, rent them, give them away, or throw them in the dumpster. The bookstore owner cannot, however, make additional copies of the book because the first-sale doctrine does not limit a copyright owner’s reproduction right (the first right listed above).
The first-sale doctrine was first delineated in the 1908 Supreme Court case Bobbs-Merrill Co. v. Straus . The Bobbs-Merrill Co. distributed copies of a novel titled The Castaway to retailers with the proviso that these be sold for exactly one dollar. Printed right in the book itself, in fact, right after the title page, was the following notice:
“The price of this book at retail is \$1 net. No dealer is licensed to sell it at a less price, and a sale at a less price will be treated as an infringement of the copyright.”
Retailers, however, sold the book for less than a dollar and the Bobbs-Merrill Co. sued one of them. The high court found that once copies of the book were sold, the distribution rights of the author terminated as to those copies.xvii The ruling came to be known as the first-sale doctrine and was codified into law as 17 U.S.C., § 109. The statute distinctly draws the line at distribution rights, leaving all other rights to the copyright owner.
It’s the first-sale doctrine that explains why Amazon.com and eBay allow users to resell secondhand copies of printed books, music, and movies at prices of their own choosing—but only if those copies were legally obtained. It is still illegal to sell pirated works.
In 2011, however, a new case in the United States Court of Appeals for the Second Circuit— John Wiley & Sons, Inc. v. Supap Kirtsaeng —waived the first-sale doctrine in cases where the copies of the copyrighted work were manufactured abroad.xviii But in March of 2013, the U.S. Supreme Court overturned that ruling in a 6-to-3 decision that affirmed that Mr. Kirtsaeng’s rights after first sale trumped the publisher’s right to ban imports. He couldn’t make unauthorized copies of the book. But just as with secondhand books or Gucci bags bought at a flea market, if the books had been bought legally (regardless of whether they had been imported or sold originally in the United States), Mr. Kirtsaeng had a right to sell them.
The first-sale doctrine was also limited by Vernor v. Autodesk , when an appeals court in 2010 ruled that software was not subject to the first-sale doctrine because purchasers of software were actually only licensees and therefore could not resell the software to others.
Does the first-sale doctrine apply to digital music, such as your iTunes library? In a case involving the start-up company ReDigi, U.S. District Court Judge Richard J. Sullivan ruled on March 30, 2013, that a resale of digital music that involved creating a new copy on someone else’s computer while erasing the copy on your computer actually concerned the reproduction right, not the distribution right, and the first-sale doctrine therefore did not apply. (You could sell your hard drive that has your music files on it, but most people would not want to do that!) But this decision is likely only the first round in what many feel will ultimately be a successful effort to create legal markets for secondhand digital goods.
First-Sale vs. Moral Rights
The first-sale doctrine does not affect an author’s moral rights, which under U.S. copyright law are limited only to certain works of visual art but under European copyright statutes are more broadly applied to other kinds of copyrightable work. Derived from the French concept of droit d’auteur, these give authors the power to protect the integrity of their work as well as the right of attribution. xix Preserving the integrity of a work means that the author has the right to prevent its intentional distortion, mutilation, or modification by others. Authors also have the right to control the use of their name in relation to the work.
Both of these rights, however, have limitations. Under U.S. law, because moral rights are personal, they exist only for the life of the author. Only the author can enforce those rights; they cannot be transferred by the author to heirs or anyone else.
As noted at the beginning of this chapter, registration is not required in order to enjoy copyright protection. Once an author puts words to paper, paint to canvas, or software code into a digital file, it is immediately protected by copyright and nothing more is required.
Although the requirement of registration as a condition of federal copyright protection was discarded over a century ago, when Congress passed the Copyright Act of 1909, the requirement that proper copyright notice be affixed to copies of published works survived much longer. It was only dropped in 1989, when the United States joined the Berne Convention and had to amend its copyright law to comply with the terms of that convention. Notice and registration of copyright are now discretionary, but recommended. Registration of a copyright provides a legal record of copyright ownership in cases where infringement is alleged, and in fact is required before the author can even file suit for infringement.xx To register a published work, an author will usually need to submit two copies of the work to the U.S. Copyright Office. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.05%3A_Rights_and_Terms.txt |
Learning Objectives
After completing this section, you will be able to
• Discuss the specific requirements for proving copyright infringement.
• Understand how copyright is affecting a changing music industry.
What If Someone Infringes Your Copyright?
Before reading this section, please watch the overview video below covering what you can do if your novel, blog post, photograph, or song is used by another without permission, and what the famous “Blurred Lines” copyright trial means to you.
Derived from the common law of trespass, infringement of a copyright or any other intellectual property right occurs when a person violates the exclusive rights of its owner. The term gets its meaning from the word “fringe”—implying a boundary that cannot be crossed. As laid out in Sections 106 through 122 of Title 17 of the U.S. Code and subject to certain exclusions, infringement occurs when a person copies, distributes, performs, or displays all or part of a copyrighted work (or in the world of television, conducts a secondary transmission of a cable system without the express consent of the cable system owner). Copyright infringement requires proof of two things. First, it requires proof that the defendant actually copied from the plaintiff’s work. That makes it different than patent infringement, which can take place even if the defendant independently came up with the invention that was patented by the plaintiff. Proof of copying can be obtained either directly, by the defendant admitting the act, or, indirectly, by showing that he had access to the plaintiff’s work, and that there are similarities between the works that make independent creation unlikely. Second, infringement requires proof that the allegedly infringing work is substantially similar to the plaintiff’s work.xxi The second requirement is there to make clear that not all copying amounts to infringement. For example, copying of a general theme, such as a detective solving a murder mystery, would not be considered infringement.
There are two ways to demonstrate the similarity of an allegedly infringing work and the original copyrighted work. “Fragmented literal similarity” may be shown by demonstrating that the infringing work contains specific copied elements of the original work. For example, suppose that one travel writer wrote a guide to Florida that contained a chapter on Key West, and a second writer copied that chapter and included it in their otherwise independently researched and written guide to Florida. In that case, we could point to specific sentences and paragraphs in the two works that were identical, even if other sentences and paragraphs were not.
Or, to take another example, in today’s music scene, certain genres of music use pieces or “samples” of previous sound recordings that are then mixed into a new sound recording. Unless the artist doing the sampling licenses the sound recording (and maybe the underlying musical work as well), the sampling could be considered infringing.
Copyright Infringement in the Music Industry
Take Kanye West, for example. He was recently sued for sampling Sly Johnson’s song “Different Strokes” and using it in a new song called “The Joy” on Kanye’s and Jay-Z’s Watch the Throne Album. The case was settled out of court for an undisclosed amount.
The second type of similarity—called comprehensive nonliteral similarity—involves the borrowing of patterns without necessarily borrowing specific elements. In the case of a novel, for example, one author might infringe by copying the plot of another novel, even though he used different words to describe the action taking place. Similarly, a composer of a song might write lyrics and music that closely borrowed patterns from another song, even though he did not use the exact same words and notes.
Again, take Kanye West. He was also recently sued by Vincent Peters, a local Chicago artist, not for sampling his music but rather for employing substantially similar concepts and wording in Kanye’s megahit “Stronger.” The judge did not agree, finding that Kanye’s song had actually used concepts and phrasing that were “common ideas” and in the public domain—specifically, Friedrich Nietzsche’s phrase, “That which does not kill us makes us stronger.”xxii
But by far, the most significant copyright infringement case in recent years concerning music was the March 10, 2015, verdict against Robin Thicke and Pharrell Williams, the performer and primary songwriter-producer of the 2013 pop hit “Blurred Lines.” A federal jury ruled that Thicke and Williams committed copyright infringement by using elements of the 1977 Marvin Gaye classic R&B hit “Got to Give It Up.” The jury awarded Gaye’s family \$7.3 million—a very significant penalty—but the Gaye family announced that they will also seek an injunction against further radio and concert performances of the song, which will certainly give them leverage in negotiating future royalties and songwriting credit.
The case is significant, even beyond the outsize monetary award, because it challenges the growing practice in contemporary music production of incorporating elements, features, themes, and even the “feel” and “mood” of the work of other artists and genres.
Larry Iser, an intellectual property lawyer who has represented artists like Jackson Browne and David Byrne, criticized the verdict. “Although [Marvin] Gaye was the Prince of Soul,” Iser told the New York Times, “he didn’t own a copyright to the genre, and Thicke and Williams’ homage to the feel of Marvin Gaye is not infringing.”
Despite the critics, musicians and producers will likely be more cautious in the future. In addition to the “Blurred Lines” case, singers Sam Smith and Tom Petty reached a settlement in 2015 granting songwriting credit and royalties to Petty on Smith’s song “Stay With Me,” which bore some resemblance to Petty’s hit “I Won’t Back Down.”
Actual and Statutory Damages
As we see in the above case, infringing a copyrighted work can carry very significant penalties. The copyright owner has the right to recoup damages and lost profits from infringement. There are two kinds of damages—actual and statutory. The copyright owner may only receive one or the other form of damages.xxiii
The Recording Industry Association of America (RIAA), for example, was awarded major damages from Jammie Thomas in 2009 for her willful statutory infringement of 24 copyrighted songs that she had uploaded to the music sharing site Kazaa. Because the infringement was found to be willful, the court in its discretion raised the damages maximum from its usual \$30,000 per act of infringement to \$80,000 per infringement. That \$80,000, times 24 songs that were infringed, resulted in a damage award of \$1,920,000xxiv After several trials and appeals, however, the damages assessed against Thomas were reduced to \$222,000.
Take note, infringers—the risks can be very great, indeed.
Only the owners of registered copyrights may file for statutory damages. That’s another reason why it’s a good idea to register your copyright.
Sometimes, though, the copyright owner’s most important remedy for infringement will be an injunction that forces the infringer to stop illegal actions that cause continuing damage to their rights. The grounds for getting that injunction, however, have tightened in recent years and now require the plaintiff, or copyright owner, to provide substantial evidence of infringement that cannot be repaired without an injunction.
As the court of appeals for the ninth circuit put it in 2011:
“Our long-standing precedent finding a plaintiff entitled to a presumption of irreparable harm on a showing of likelihood of success on the merits in a copyright infringement case, as stated inElvis Presley v. Passport Video and relied on by the district court, has been effectively overruled. In other words, ‘Elvis has left the building.’ Accordingly, we hold that even in a copyright infringement case, the plaintiff must demonstrate a likelihood of irreparable harm as a prerequisite for injunctive relief, whether preliminary or permanent.”xxv
Individuals who infringe copyrighted material face not only restitution for damages and lost profits and impoundment and destruction of materials, but strict criminal penalties as well. To be subject to criminal penalties, the infringer must have willfully infringed the copyright. For those doing so for commercial advantage or private financial gain, the sentence may be up to five years for a first offense, and ten years for a second offense.xxvi
We have focused solely on the federal penalties for infringement. That’s because, with the passage of the 1976 Copyright Act, federal copyright law now preempts state laws. State laws governing breach of contract, violations of trust, trespassing, conversion, invasion of privacy, defamation, and deceptive trade practices still exist, however, and these may also be employed by a copyright owner seeking redress for other harms caused by infringing activity. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.06%3A_Infringement_and_Remedies.txt |
Learning Objectives
After completing this section, you will be able to
• Understand the nature of fair use and how it serves the public interest.
• Appreciate the continuing debate over just vagaries in what is considered fair use.
Is It Fair Use or Infringement?
Before reading this section, please watch the overview video below covering Fair Use is an enigma—indeed, no one even knows how many words of a copyrighted work one can legally copy as “fair use.” Here, at last, is everything you need to know about Fair Use.
Title 17 of the United States Code allows the copying and use of copyrighted material for specific purposes—including criticism, comment, news reporting, teaching (involving multiple copies for classroom use), scholarship, or research. The statute also describes fourfactors that draw on the precepts first discussed by Supreme Court Justice Story 150 years earlier to determine if the use of a copyrighted work is infringement or “fair use.”xxvii
Based on these factors, which are not meant to be all inclusive, a judge must determine if the use of copyrighted material is within the bounds of fair use. What makes that determination sometimes difficult is the challenge of weighing a variety of purposes—was the work used for criticism, comment, news reporting, teaching, scholarship, or research?—in concert with various factors (such as how much was used, and whether it was for commercial gain or not).
In the crucial 1973 Supreme Court case ofWilliams & Wilkins v. United States , for example, the divided justices affirmed a lower U.S. Court of Claims decision that the benefits of freely distributing photocopies of medical journal articles to nonprofit government research libraries outweighed the reduction of potential revenue to the publisher of those journals.xxviii
Parody
One of the purposes for which copyrighted work may at times be freely used is parody. As a federal court ruled in one 1993 case:
“The heart of any parodist’s claim to quote from existing material is the use of some elements of a prior author’s composition to create a new one that, at least in part, comments on that author’s work.”xxix
And the greater the “transformative” nature of the new work, the less likely it infringes the original work.
A case involving the Fox TV show Family Guyillustrates the point. In Bourne Co. v. Fox , the court found that a Family Guy episode in which the character Peter Griffin sang a revised version of the song “When You Wish Upon a Star” called “I Need a Jew” was a parody and thereby a fair use of the original material. The outrageous if not offensive visuals and words employed in the Family Guy parody were so substantially different in character and form from the original use of the song in the Walt Disney movie Pinocchio that no one could ever confuse the two or fail to realize that Fox’s use was a parody.
Transformative or Theft?
A very interesting case involving fair use was decided by the U.S. Court of Appeals for the Second Circuit on April 25, 2013. It overturned a 2011 district court ruling that artist Richard Prince had acted illegally by using another artist’s photographs to create a series of collages and paintings. Such borrowing of another’s work is considered fair use only if it is “transformative” in some substantial way, and the district judge held that it was not because the collages did not comment on the original work explicitly. The federal circuit disagreed, holding that explicit references to the original work are not required so long as the required “transformation” is manifested by “an entirely different aesthetic” in the secondary work.
According to the appeals court:
“Where [the original artist’s] serene and deliberately composed portrait and landscape photographs depict the natural beauty of the Rastafarians and their surrounding environs, Prince’s crude and jarring works are hectic and provocative.”
Fair Use for Public Good
The fair use clause also allows libraries and archives that are open to the public, or researchers in a specialized field, to use copyrighted materials for the purpose of preservation and security of the material or as a deposit for research. These libraries and archives can keep up to three copies of a copyrighted work, but a copyright notice must be included on each copy. Libraries and archives will not be held liable for “unsupervised use of reproducing equipment located on its premises” if there is a notice on the equipment that a copy may be subject to copyright law.xxx Any use of photocopied copyrighted materials must be specifically for private study, scholarship, or research, and any other use constitutes infringement. Photocopying copyrighted materials in a business setting is also infringing if used outside of research.
Academic institutions also are protected by specific rules regarding fair use, pursuant to an agreement between representatives of the publishing industry and of academic institutions negotiated in the 1970s. The photocopying of a copyrighted work for the classroom is permitted if it is limited to:
• A chapter from a book
• An article from a periodical or newspaper
• A short story, short essay, or short poem, whether or not from a collective work
• A chart, graph, diagram, drawing, cartoon, or picture from a book, periodical, or newspaper.
xxxi
But even in the above academic uses, limitations apply regarding the size of both the audience and the content to be copied. For example, teachers may photocopy works only for students enrolled in the class. The photocopied material must also pass brevity, spontaneity, and other tests. “Brevity” means no more than 250 words of a poem, 2,500 words of a prose work, or 10 percent or 1,000 words of an excerpt of a prose work may be used. In addition, the decision to photocopy the material must be spontaneous; the photocopied material must be used only for one course and one class term; no more than one poem, article, story, or essay—and no more than two excerpts—may be copied from the same author; and such bulk photocopying must be limited to nine instances per class during one term. xxxii
Finally, copyrighted works may not be photocopied and used in educational settings as a substitute for required texts, photocopies may not be mandatory, and you cannot charge for the photocopied work (although you may recoup the costs of photocopying).xxxiii | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.07%3A_The_Fair_Use_Defense.txt |
Learning Objectives
After completing this section, you will be able to
• See how copyright law has continually adapted to technological change.
• Note how digital entertainment industries in particular have been affected by changes in copyright law.
Throughout the more than 226-year history of copyright in the United States, technological innovation and changes in consumer behavior have continuously forced Congress and the courts to embrace new forms of copyrighted media and new ways of distributing and consuming it.
The Copyright Act of 1976
As noted earlier, the nineteenth century saw copyright expand to include a variety of new technologies, such as mechanical reproductions of musical compositions (player pianos and phonographs), photography, and eventually motion pictures. But those changes were small compared with the enormous advances of the twentieth century. The invention of radio, broadcast television, cable television, the video cassette recorder (VCR), personal computers, computer software and video games, digital audio recorders, compact discs, the digital video recorder (DVR), the Internet, iTunes media players, and now the streaming of music and movies all offered consumers new forms of creative content—and offered creators a new means of reproducing and distributing it. Each of these required an adjustment in U.S. copyright law.
Take the advent of cable television in the 1960s and 1970s. Early court cases like Fortnightly Corp. v. United Artists in 1968 andTeleprompter v. CBS in 1974 held that the rebroadcast of broadcast television shows over cable television systems did not constitute a “performance” and therefore did not infringe the copyright in those shows. The Copyright Act of 1976—the most significant revision of copyright law since 1909—remedied this failure to see cable broadcasts as performances and extended copyright protection to works performed over cable TV.
The Copyright Act of 1976 made several other major changes to the law. It also codified “fair use” into the statutes rather than simply the common law, granted statutory copyright protection as soon as a work was reduced to a concrete form rather than only when registered, and began to bring the United States into compliance with international copyright law rather than continue to stand apart from it.xxxiv
The Computer Software Rental Act of 1990
The next major copyright issue arose with the emergence of personal computer software in the 1980s. Software companies and independent developers lobbied Congress to curtail the illegal copying of copyrighted software. As a result, the Computer Software Rental Act of 1990 was passed, prohibiting the unauthorized rental, lease, or lending of a computer program for commercial gain. Individuals, however, could still make personal copies for their own use, and libraries were permitted to lend software.xxxv
The hope was that this would curb the rampant software piracy then costing U.S. firms roughly \$1 billion per year in lost sales and rentals. The law probably did slow piracy inside the United States. But by 2010, software piracy worldwide had grown into a \$10 billion a year business.
The Audio Home Recording Act of 1992
Hoping to prevent similar piracy in the emerging digital audio field, the Audio Home Recording Act of 1992 amended copyright law to require manufacturers and importers of digital audio recording devices to install technology to prevent the illegal copying of copyrighted music. It also mandated that royalties be paid to copyright owners for every device sold.
When it came to performance rights—one of the six exclusive rights of copyright owners—the last 150 years have witnessed major changes in the way musical performances are distributed and consumed. The American Society of Composers, Authors and Publishers (ASCAP) was formed in 1914 to develop a system whereby royalties could be obtained for composers whose songs were performed live—and later on, over the newly invented technology of radio. Today, 435,000 U.S. composers, songwriters, lyricists, and music publishers rely upon ASCAP to secure royalties for their work performed over TV, CD, and every new media that has come after radio.
The other three performing rights organizations are SESAC, formed in 1930; Broadcast Music, Inc. (BMI), formed in 1939; and SoundExchange, which in 2007 was granted the sole right by the Copyright Royalty Board to represent performers whose music airs on satellite radio (such as SIRIUS XM), Internet radio (like Pandora), cable TV music channels, and similar platforms for streaming sound recordings. The Recording Industry of America Association (RIAA), formed in 1952, represents record labels and music distributors and has played an important role in ensuring that their rights are respected even as new technologies for distributing recorded music have emerged.
The RIAA lobbied Congress to enact the No Electronic Theft Act of 1997, for example, which made it a criminal offense to reproduce or distribute music by electronic means (i.e., over the Internet). Nonetheless, by 2002, some 3.6 billion songs a month were still being downloaded illegally, thanks to music sharing sites like Napster, which had been launched in 1999 and at its peak facilitated the downloading (much of it illegal) of 80 million songs. Indeed, many college dormitory networks became overloaded with MP3 musical file transfers.
At the time, many Internet pundits, enthralled with the misquoted notion that “information wants to be free” online, insisted that downloading technology made it impossible for musicians and their labels to enforce their copyrights on the Internet. For its part, Napster claimed that they should not be held responsible for any illegal downloading committed by users.
But the RIAA and musicians brought suits for contributory infringement. In court cases like A & M Records. v. Napster and Metallica v. Napster , judges and juries repeatedly found Napster guilty of infringement and it was forced into bankruptcy in 2002.
Music piracy still exists, of course. But in place of Napster, music consumers now have legal music download sites such as Apple’s iTunes music store that sell digital music with permission from, and appropriate royalties to, their copyright owners. Surveys show that most consumers don’t really want to steal music. They just want convenient, low-cost online access to it. Most consumers also appear to recognize that if music creators cannot make a living from their work, they won’t be able to keep making music.
Meanwhile, digital rights management (DRM) technologies had been developed that have the potential to limit the piracy of copyrighted content. Companies in various content industries lobbied Congress to pass the Digital Millennium Copyright Act of 1998 (DMCA). This law made it a crime to disseminate technology or services that could circumvent DRM measures used to control access to copyrighted movies, music, and books. It also increased penalties for copyright infringement on the Internet.
But in an appropriate concession to online services that merely hosted user content, the DMCA limited the liability of online services for copyright infringement committed by their users, so long as they acted to remove the offending content once informed of it.
Viacom vs. YouTube
In 2007, however, Viacom filed suit against YouTube and its corporate parent Google for copyright infringement, claiming that the popular video-sharing site was committing “massive intentional copyright infringement” for not taking sufficient steps to prevent or remove some 160,000 unauthorized clips of Viacom’s entertainment programming posted by users. Google argued that the DMCA’s “safe harbor” provisions shielded them from liability for the actions of its users, and a district court judge ruled in favor of Google in 2010. But in April of 2012, a court of appeals vacated that decision and ruled that Viacom had presented enough evidence to warrant a trial. Viacom was seeking more than \$1 billion in damages from YouTube, but in March of 2014, the parties quietly settled the seven-year-old case.
A key factor in spurring the settlement is that Google has in the interim addressed the concerns of content owners like Viacom by creating a system that allows them to track their content when posted on YouTube and then request it be taken down or run with ads.
Extending Copyrights
The same year that saw passage of the DMCA also witnessed the passage of the Sonny Bono Copyright Term Extension Act, which added an additional 20 years to the term of copyright—extending it for most works to the life of the author plus 70 years after the author is deceased. Critics called it the “Mickey Mouse Protection Act” because it effectively extended the copyrights of many of the characters and content of the Walt Disney Company, which lobbied strongly for the bill. They argued that copyright law was historically designed to serve a public purpose and ought to defer to the public interest, as it has throughout U.S. history. As the New York Times put it:
“When Senator Hatch laments that George Gershwin’s ‘Rhapsody in Blue’ will soon ‘fall into the public domain,’ he makes the public domain sound like a dark abyss where songs go, never to be heard again. In fact, when a work enters the public domain it means the public can afford to use it freely, to give it new currency.”
Even a staunch defender of intellectual property rights like Professor Richard Epstein of the NYU School of Law—he was rated one of the top legal thinkers of modern times by the journalLegal Affairs—believes that the copyright term of life- plus-70s years is too long.
“My own view is that no commercial property right should ever be tied to life, and the extra 70 years is far too long,” he argues. “It has the potential to create an anti-commons that deprives the public of its rights to freely access cultural works. Copyrighted works should pass into the public domain after 28 years, which was the approach of the Founders.”
The debate over the Copyright Term Extension Act, not surprisingly, continues.
In the international sphere, meanwhile, the late twentieth century also saw the United States finally agree to the Berne Convention in 1988, joining the following year. The purpose of the convention is to ensure fair and reciprocal copyright protection for member nations. Although it did not create an international copyright per se, it did require the United States to amend its copyright law to comply with certain Berne provisions, such as a ban on registration as a condition of copyright. But overall, the convention facilitated the reciprocal cross-border protection of creative works while leaving most details of each nation’s copyright laws to member states.
One proposed bill that didn’t make it into law was the Consumer Broadband and Digital Television Promotion Act of 2002. It attempted to deal with continuing piracy of copyrighted works by requiring every medium and every device for the consumption of copyrighted works to implement digital rights management (DRM) technology. But the bill was considered too draconian—too 1984, if you will—and failed to pass.
To be sure, many companies have voluntarily implemented elements of DRM technology, to the chagrin of many consumers. Some electronic book readers (e-books) limit the ability of users to read books only on those devices, preventing interoperability between Kindle and iPad e-book readers, for example. Some music labels install software on their CDs to prevent copying of the music. And some Blu-ray and DVD movie players do not allow for the creation of transformative copies. In fact, iTunes, a very popular way to manage music and other media, used to employ a DRM system that limited the transfer of songs to five authorized computers.
Groups like the Free Software Foundation argue that “The motive for DRM schemes is to increase profits for those who impose them, but their profit is a side issue when millions of people’s freedom is at stake.” But their argument is undercut by the simple reality that if content creators can’t make a living from it, most will stop creating and take day jobs to pay the rent. This has always been the copyright bargain in America—protection for the rights of creators but only so long as it serves the public interest.
And enabling creators to keep creating is clearly in the public interest.
E-Books
A more legitimate concern regarding DRM is that, whatever its perceived benefits for publishers and distributors, it is holding back innovation and consumer rights in digital content industries. This is especially evident in the burgeoning e-book market, which exploded from barely 10 percent of U.S. book sales in 2011 to 30 percent of all book sales by 2013. But a growing number of e-book publishers have now concluded that unless they meet consumer demands to ease these DRM anti-piracy provisions, further growth could be constrained.
According to Microsoft’s Chief Intellectual Property Strategy Counsel Tom Rubin, a leading voice on this issue, that’s because DRM makes the e-book reader experience much less enjoyable and useful than that for printed books. According to Rubin:
“When I buy a printed book, I can choose where to buy it—whether from a small neighborhood bookstore, a large chain bookstore, a grocery store, drug store, other retail establishment, or an online retailer. I can even buy books at a steep discount by going to second-hand stores, garage sales, and flea markets. "You can't do that with an ebook. “Then after I buy a print book and bring it home, I can write notes in the margin, share those passages or even the whole book with friends and colleagues, and even photocopy a few pages for my book club. “You can’t do that with an ebook.”
Rubin says the fault here lies not in the technology, which already exists to enable these capabilities in e-books and also augment them with rich audio, video, and social media. Rather, it lies in the business arrangements underlying the publication and distribution of e-books.
The e-book you buy, for example, is often available from only one source—and usually only readable on one proprietary device. You can’t access it from any device you want, nor can you use the e-reader app of your choice. This balkanization of the market diverts resources from enhancing the user experience into defending the turf of incumbent players.
But it’s not just the balkanization of the market that hinders competition and innovation. Some publishers now believe that the digital rights management (DRM) controls they employ to prevent piracy are actually preventing many consumers from fully embracing e-books. After all, as many book buyers have angrily noted, you can’t even download the digital version of a print book that you’ve already purchased unless you pay a second time.
Publishing DRM Free
"The consumer ebook market is an emerging and changing one, and we want to offer customers as many choices as possible."
-Elsevier spokeswoman Suzanne BeDell
In response to consumer complaints, some publishers have dispensed with DRM controls.Harry Potter author J. K. Rowling has launched her own website, Pottermore.com, to sell her e-books DRM free, enabling readers to enjoy them on any device they choose. Interestingly, the piracy of Harry Potter books has declined by 25 percent since DRM was dropped in 2012.
Also in 2012, Tor Books, a major science fiction publisher owned by MacMillan, went DRM free as well, with no apparent harm to its sales—and to the delight of its customers.
Then there’s the big U.S. tech publisher O’Reilly, which has been DRM free since its inception. O’Reilly, which has one of the most loyal customer bases in publishing, signed a deal on April 16 of 2013 with Elsevier, the world’s largest publisher of scientific and health information, to distribute more than 1,200 titles DRM free. (It also distributes all Microsoft e-books DRM free.)
“The consumer ebook market is an emerging and changing one, and we want to offer customers as many choices as possible,” explained Elsevier spokeswoman Suzanne BeDell.
And finally, although the prestigious Harvard Business Press still sells its books on Amazon with DRM restrictions, it recently started selling books on its own site DRM free.
These early publisher moves to dispense with DRM restrictions parallel what happened in the digital music industry a decade ago. For the first few years after the launch of the iTunes music store in 2003, piracy-wary music publishers required Apple to sell its songs with DRM controls that limited the kind and number of devices consumers could play them on.
But on February 6, 2007, Apple CEO Steve Jobs wrote an open letter to the industry urging music publishers to let iTunes sell music DRM free:
“DRMs haven’t worked, and may never work, to halt music piracy. If such requirements were removed, the music industry might experience an influx of new companies willing to invest in new [music distribution systems].”
This, said Jobs, would obviously be “positive for the music companies.”
And sure enough, once publishers agreed to license digital music DRM free later that same year, the market exploded. In 2013, iTunes announced the sale of its twenty-fifth billionth song!
Ultimately, argues Rubin:
“Success [for ebook publishers] can only come with the satisfaction of legitimate consumer needs—most especially the need for an ebook experience that is every bit as good or better than that of their beloved printed books.”
Recent Copyright Laws
The debate over DRM in e-books is likely to be center stage in the copyright debate in coming years. In the meantime, it’s worth mentioning three other copyright-related laws that were passed during the last decade or so.
One, the Technology, Education, and Copyright Harmonization (TEACH) Act of 2002 enabled educators to use certain copyrighted performances and displays for educational purposes.xxxvi The bill was focused on the fast-growing arena of distance education, whose students number 12 million and are growing rapidly.
Also that year, the Small Webcaster Settlement Act of 2002 eased royalty burdens for small webcasters who don’t have the resources of the major content distributors.xxxvii
Finally, the Family Entertainment and Copyright Act of 2005 mandated fines and possible imprisonment for the unauthorized recording of motion pictures in theaters. It also enabled consumers to use new technologies to screen out or skip over some 14 different categories of objectionable content in movies played on DVD players and other devices.xxxviii | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.08%3A_Changes_in_Copyright_Law.txt |
Learning Objectives
After completing this section, you will be able to
• See how a changing music industry has been affected by copyright.
• Appreciate the challenges that continued technology advances may pose for copyright in the future.
One of the newest technology challenges facing copyright law concerns royalty rates for streaming music online. As it stands, royalty rates are much lower for music played over satellite and cable radio outlets like Sirius XM than they are for music streaming services like Pandora.
Music Streaming
Rates are set by the federal Copyright Royalty Board (CRB), a three-judge panel, but currently they apply a different rate for streaming music than they do for satellite and cable music. Sirius pays about 8 percent of its revenue to record companies and artists. Pandora, however, claims it must pay a rate per song streamed that amounts to 44 percent of revenue. So it pushed for the introduction in September 2012 of the Internet Radio Fairness Act, which would make the rates for Internet radio companies the same as those for satellite and cable radio.
This bill was opposed not only by many musical artists and their organizations, but by many copyright experts as well. In November of 2012, a who’s who of musicians and singers—including stars from Motown, rock and roll, country, rap, and jazz—published an open letter in Billboard magazine opposing Pandora’s plan to cut artists’ pay and make more money, as they put it in the letter, “on the backs of hard working musicians and singers.”
In November of 2013, Pandora quietly abandoned efforts to seek legislation that would help reduce the royalties paid to rights holders. Instead of pursuing legislation, Pandora said it will focus its efforts on lobbying the CRB.
In early December 2015, the music industry waited breathlessly for the CRB’s decision on royalty rates. Pandora had petitioned the CRB to reduce the current statutory rate of 14 cents per 100 songs to 11 cents per 100 songs starting in 2016. But music labels and artists represented by a royalty collection organization called SoundExchange wanted the statutory royalty rate raised to 25 cents per 100 songs—an 80 percent increase—and then by 1 cent every year after that until 2020. Collectively, music streaming services have a combined listenership of 100 million people and are the fastest-growing revenue source for artists and music labels.
On December 16, 2015, in a victory for record labels and artists, the CRB ruled that online radio firms will have to pay 17 cents per 100 plays of songs through 2020.
TV Streaming
Another new technology challenge to copyright involved television broadcasters and an upstart television service called Aereo that at one point rented dime-sized antennas for \$8 per month that act like long-range rabbit ears to people with digital video recorders, enabling them to watch and record over-the-air network channels like NBC or Fox without paying the much-larger fees for cable or satellite service.
TV broadcasters argued that Aereo violated their copyrights by rebroadcasting their TV signals. Aereo, however, claimed that it was the subscribers who were doing the transmitting, and that Aereo merely rented a tool that enabled people to watch a private performance—much like they do when they tape a TV show and watch it in their living room.
The case, which had the TV and technology industries on edge, was decided in their favor on June 25, 2014, by the U.S. Supreme Court, which ruled that Aereo had infringed the rights of copyright holders. Five months later, Aereo declared bankruptcy. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.09%3A_New_Technology_Challenges_to_Copyright.txt |
Learning Objectives
After completing this section, you will be able to
• Understand how alternative forms of copyright are emerging in today’s increasingly digital ecosystem.
Up to now, we have focused on traditional copyright situations in which an author usually pursues some sort of monetary gain in exchange for the use of their creative work as well as situations in which the author also wants to prevent any alteration of their work. But what if an author simply wants to get their work out before the broadest possible readership and monetary gain is not an issue? What if an author would welcome others adding to the original work? In these cases, there are new kinds of copyright licenses that may be employed by authors.
Creative Commons
The development of the Creative Commonsrepresents a voluntary private sector alternative to traditional copyright that coordinates the creation and consumption of content among a wide variety of individuals and institutions—all without a hint of government intervention. In doing so, Creative Commons captures a whole section of the market for which broad dissemination of content and not financial gain is key, which is something that could not be done as effectively by either traditional copyright or the public domain.
The Creative Commons License is currently available in six flavors:
All of these licenses require the work to be copyrighted because the Creative Commons license is based on copyright. Although Creative Commons licenses can provide authors with added opportunities to have their work distributed and used, these licenses do not allow authors to limit any of the rights otherwise available under copyright law, such as fair use.
Creative Commons licenses also cannot be revoked, which means that if copies of your work are distributed under a Creative Commons license, they will always be distributed that way. If, for example, you distribute your amazing new video under a Creative Commons license and it generates five million page views on YouTube—and then 20thCentury Fox offers you a seven-figure deal for exclusive rights to distribute your video—you will not be able to prevent everyone on the planet from continuing to distribute your video for free on the Internet.
Open Access
Another alternative copyright approach is called open access, founded by the Budapest Open Access Initiative in 2002. Open access encourages scholars to provide the fruits of their research online without expectation of payment.xxxix The aim here is to open up scholarly research far more widely than is currently the case, but open access adherents face a key challenge in the fact that many scholarly articles are published in expensive journals as “works made for hire.” This means that the rights belong to the journals, not the authors. But open access supporters are working with publishers to try to overcome this limitation and create more opportunities for scholarly research to be made more widely accessible at lower cost.
Finally, open source software licensing also offers an alternative to traditional copyright. An open source license for computer software allows the source code to be used, modified, and/or shared under certain defined terms and conditions set by the Open Source Initiative, an educational, advocacy, and stewardship organization formed in 1998. An open source license allows end users to modify the source code for their own purposes. Open source licensed software is mostly available free of charge, though this does not always have to be the case.
Footnotes
• xxxixChan, L., Cuplinskas, D., Eisen, M., Friend, F., Genova, Y., Guedon, J., Hagemann, M., Harnad, S., Johnson R., Kupryte, R., Manna, M., Rev I., Segbert, M., Souza, S., Suber, P., & Velterop J. (2002, February 24).Budapest Open Access Initiative. Retrieved from http://www.soros.org/openaccess/read.
3.11: Copyright in a Changing World
Learning Objectives
After completing this section, you will be able to
• Understand how copyright law is showing signs of strain today.
• Realize that it may very well need to adapt to an increasingly mobile world.
Comprehensive copyright reform may soon be on the horizon. On March 20, 2013, Register of Copyrights at the United States Copyright Office Maria A. Pallante testified before the House Judiciary Committee that the time had come for a comprehensive review and updating of the Copyright Act.
According to Pallante:
"The law is showing the strain of age and requires your attention. [People] increasingly are accessing content on mobile devices and fewer and fewer of them will need or desire the physical copies that were so central to the 19thand 20th century copyright laws."
The list of issues requiring attention is long, involving everything from copyright term and digital rights management restrictions on digital content to the legality of developing secondary resale markets for digital content as exist with traditional printed content.
The debates may be contentious, as they always are when intellectual property rights are involved. But U.S. copyright law has throughout our history demonstrated a remarkable ability to adapt to new economic, social, and technological realities, and there is no reason to doubt that it will continue to do so. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/3.10%3A_Alternative_Forms_of_Copyright.txt |
1.
A copyright gives authors, artists, dramatists, architects, and other artistic creators the exclusive right to control what?
1. How their work is published, reproduced, performed, or displayed.
2. The price at which their work is sold, performed, or displayed.
3. Whether or not the work becomes a classic on art, theater, or literature.
Answer
A. How their work is published, reproduced, performed, or displayed.
2.
Copyright is made possible by Article 1, Section 8, Clause 8 of the U.S. Constitution, which also gives Congress the authority to do what?
1. Declare war.
2. Grant patents.
3. Make all laws necessary and proper to enforce copyrights.
Answer
B. Grant patents.
3.
Congress and the courts have interpreted the terms “authors” and “writings” very broadly to include which of the following as eligible for copyright? (Choose all that apply)
1. Graphic works.
2. Novel, non-obvious and useful inventions.
3. Architectural works.
Answer
A. Graphic works and C. Architectural Works
4.
When is a work considered copyrighted?
1. Once it is officially registered with the U.S. Copyright Office.
2. Once the U.S. Copyright Office grants an official copyright.
3. Once it is expressed in a tangible form that allows it to be seen or copied.
Answer
C. Once it is expressed in a tangible form that allows it to be seen or copied.
5.
There is an extensive examination system for getting a patent approved. Why is there not a similar system in place for copyrights?
1. The merit of an artistic or literary work is a wholly subjective determination.
2. Merit has nothing to do with whether or not a creative work is copyrightable.
3. Patent examiners can all agree that an invention is novel, non-obvious and useful, but art critics may never all agree that any one painting is beautiful.
4. All of the above.
Answer
D. All of the above.
6.
Which two public policy goals are served by granting copyrights? (Choose all that apply)
1. By protecting the property rights of artists to their creations, the wellsprings of creation do not dry up for lack of incentive.
2. Copyrights ensure that artists and writers won’t be taken advantage of.
3. Cultural creativity serves the public good and promotes literacy and learning.
Answer
A. By protecting the property rights of artists to their creations, the wellsprings of creation do not dry up for lack of incentive. and C. Cultural creativity serves the public good and promotes literacy and learning.
7.
How were copyrights viewed very differently from patent rights in terms of the interests of the general public?
1. Copyrights were thought to be in less conflict with the public interest.
2. Copyrights were enforced with the same diligence as patent rights.
3. Patent rights were seen as more beneficial to the public than copyrights.
Answer
C. Patent rights were seen as more beneficial to the public than copyrights.
8.
The policy of strong patent rights and weaker copyrights also reflected what differences in the motivations of inventors compared with authors?
1. Authors were not generally interested in economic gain.
2. Authors were motivated only by the prospect of economic gain.
3. Both artists and inventors sought economic gain, but authors also tended to be rewarded by celebrity and reputational gain as well.
Answer
C. Both artists and inventors sought economic gain, but authors also tended to be rewarded by celebrity and reputational gain as well.
9.
Copyrights began to be formally issued in what part of Europe?
1. France in the sixteenth century.
2. England under Queen Anne.
3. The Republic of Venice in the fifteenth century.
Answer
C. The Republic of Venice in the fifteenth century.
10.
Initially, to whom were copyrights given?
1. Authors.
2. Artists.
3. Printers and publishers.
Answer
C. Printers and publishers.
11.
The copyright granted in 1669 to Jean-Baptiste Lully, director of the Paris Opera, gave him exclusive rights to? (Choose all that apply)
1. All operatic performances.
2. The publication of operatic librettos.
3. The number of musicians who could perform outside the Paris Opera.
4. Bequeath his copyright monopoly to his heirs.
5. All of the above.
Answer
E. All of the above.
12.
How did early copyrights evolve from business monopolies into instruments of censorship and surveillance?
1. Bookstores sent the authorities records of who purchased what books.
2. Books had to be read and approved by a censor before a permit was granted to print the book.
Answer
B. Books had to be read and approved by a censor before a permit was granted to print the book.
13.
What did the 1709 Statute of Anne do to copyright practices?
1. It required that copyrights be given to multiple printers, not just one monopoly.
2. It enabled copyrights to last as long as 150 years.
3. It enabled anyone to get a copyright lasting 14 years with the right to renew.
Answer
C. It enabled anyone to get a copyright lasting 14 years with the right to renew.
14.
In general, early European copyright systems achieved what results?
1. Created monopolies, high prices, censorship, and wealth for the Crown.
2. Guaranteed authors’ rights.
3. Prevented publishers and printers from exploiting authors and artists.
Answer
A. Created monopolies, high prices, censorship, and wealth for the Crown.
15.
What was the significance of the landmark Donaldson v. Beckett case in England?
1. It established that copyright was the common law right of publishers.
2. It treated copyright as a limited right of authors for the first time anywhere.
3. It gave Thomas Beckett the right to his own work in perpetuity.
Answer
B. It treated copyright as a limited right of authors for the first time anywhere.
16.
After Donaldson v. Beckett, copyrights were expanded to include which of the following? (Choose all that apply)
1. Sheet music, maps, design, and sculpture.
2. Lectures.
3. Inventions.
Answer
A. Sheet music, maps, design, and sculpture. and B. Lectures.
17.
At the time of America’s first copyright laws, publications in America were mostly focused on which of the following?
1. Literary works.
2. Practical guides, newspapers, and almanacs.
3. Poetry.
Answer
B. Practical guides, newspapers, and almanacs.
18.
Given America’s more utilitarian focus in publishing, what was the emphasis placed in the drafting of our first copyright laws?
1. To guarantee the rights of authors.
2. To guarantee the rights of publishers and printers.
3. To ensure widespread public access to knowledge and information.
Answer
C. To ensure widespread public access to knowledge and information.
19.
Copyrights for U.S. citizens last for what term?
1. 28 years.
2. 14 years, with the right of renewal.
3. Life-plus 70 years.
Answer
B. 14 years, with the right of renewal.
20.
The first U.S. copyright law was signed by George Washington when?
1. 1776.
2. 1783.
3. 1790.
Answer
C. 1790.
21.
How did America’s first copyright law treat the infringement of foreign cultural works?
1. It strongly prohibited copyright infringement whether domestic and foreign.
2. It explicitly allowed, even encouraged the piracy of foreign works.
Answer
B. It explicitly allowed, even encouraged the piracy of foreign works.
22.
America would resist all efforts to outlaw the piracy of foreign works for how long?
1. Until 1810.
2. Until the end of the Civil War in 1865.
3. Until 1891.
Answer
C. Until 1891.
23.
John Barry was the first American to receive a copyright. For which type of work did he receive the copyright?
1. A novel.
2. An almanac.
3. A spelling book.
4. A book of poems.
Answer
C. A spelling book.
24.
A half century after independence, what proportion of literary works published in America were written by Americans?
1. 33%
2. 65%
3. 92%
Answer
A. 33%
25.
What were some of the costs of America’s rampant piracy of foreign books?
1. The U.S. was regarded as an publishing outlaw by other countries.
2. American works cost a lot more than pirated foreign works.
3. Domestic American authorship was stunted and delayed as a result.
4. All of the above.
Answer
D. All of the above.
26.
When was Harriet Beacher Stowe’s Uncle Tom’s Cabin copyrighted?
1. 1837.
2. 1851.
3. 1861.
Answer
B. 1851.
27.
Research and historical experience demonstrate that, in the absence of intellectual property rights, nations are bound to face which of the following?
1. An excessive incentive to copy others.
2. An excessive incentive to invent or create for themselves.
3. An incentive to trade ideas and work freely.
Answer
A. An excessive incentive to copy others. and B. An excessive incentive to invent or create for themselves.
28.
When did U.S. authors finally become the majority of best-selling authors in the U.S.?
1. The mid-19th Century.
2. The early 20th century.
Answer
B. The early 20th century.
29.
Which of the following is NOT one of the eight broad categories of copyrightable work?
1. Literary works.
2. Musical works, including any accompanying words.
3. Dramatic works, including any accompanying music.
4. Pantomimes and choreographic works.
5. Creative Ideas.
6. Pictorial, graphic, and sculptural works.
7. Motion pictures and other audiovisual works.
8. Sound recordings.
9. Architectural works.
Answer
E. Creative Ideas.
30.
Why is computer software eligible for copyright?
1. It cannot be patented.
2. It is considered to be a literary work, which the Copyright Act defines as a work expressed in words, numbers, or other symbols that is creatively compiled.
3. It is able to display artistic or literary work on a TV or in an e-book.
Answer
B. It is considered to be a literary work, which the Copyright Act defines as a work expressed in words, numbers, or other symbols that is creatively compiled.
31.
What is the difference between ideas and their expression under copyright law.
1. You can’t copyright an idea for a movie, but you can patent it.
2. Ideas are just thoughts, not matter how creative. You can’t copyright thoughts.
3. You cannot copyright an idea for a space opera, but you can copyright Star Wars—the original expression of a space opera idea put to paper or film.
Answer
C. You cannot copyright an idea for a space opera, but you can copyright Star Wars—the original expression of a space opera idea put to paper or film.
32.
Which of the following may be copyrightable?
1. A mathematical formula.
2. Facts that you have discovered through research.
3. A compiled Chinese-American phone book that uses facts.
Answer
C. A compiled Chinese-American phone book that uses facts.
33.
Other than being one of the eight broad categories of creative content, which is NOT one of the other four things a copyrighted work must be.
1. Original.
2. Expressed or fixed on a tangible medium that can be seen or copied.
3. Authored or creatively compiled.
4. Not a fact or abstract idea.
5. Culturally worthwhile.
Answer
E. Culturally worthwhile.
34.
How many exclusive rights does a copyright owner have?
1. 5.
2. 6.
3. 8.
Answer
B. 6.
35.
If the copyright in a work lasts for 95 years from first publication, it is copyright for:
1. An individual.
2. A work of two or more authors.
3. A work for hire.
Answer
C. A work for hire.
36.
How long will Michael Jackson’s copyrights last? (Note: He died in 2009)
1. Until 2025.
2. Until 2079.
3. Until 2110.
Answer
B. Until 2079.
37.
What is the “first-sale” doctrine?
1. It states that copyright begins with the first sale of your manuscript to a publisher.
2. It gives you the right to protect the integrity of your work after publication.
3. It terminates your distribution rights after you (or your publisher) sell your work to a bookstore, art gallery, etc.
Answer
C. It terminates your distribution rights after you (or your publisher) sell your work to a bookstore, art gallery, etc.
38.
Registration used to be required for a copyright. When did that requirement end?
1. 1976, with the passage of the Copyright Act.
2. 1909, when Congress passed the Copyright Act of 1909.
3. 1989, after the United States joined the international Berne Convention.
Answer
C. 1989, after the United States joined the international Berne Convention.
39.
If attorneys could demonstrate in court that Kanye West “sampled” or used pieces of Sly Johnson’s song “Different Strokes” in a song called “The Joy,” this would be evidence of what kind of copyright infringement?
1. Comprehensive nonliteral similarity.
2. Fragmented literal similarity.
Answer
B. Fragmented literal similarity.
40.
In 2015, a federal jury found Robin Thicke and Pharrell Williams guilty of copyright infringement of soul singer Marvin Gaye’s “Got to Give It Up.” They found that their song “Blurred Lines” demonstrated what form of copyright infringement?
1. Comprehensive nonliteral similarity.
2. Fragmented literal similarity.
Answer
B. Fragmented literal similarity.
41.
In addition to the \$5.3 million jury award, why was the Thicke and Williams copyright infringement case considered to be so significant within the music industry?
1. It shows that you can’t get away with stealing other people’s work.
2. The verdict seemed ironic in light of Williams’s smash hit “Happy.”
3. It challenged the growing practice in music of incorporating elements, features, themes, and even the “feel” and “mood” of the work of other artists and genres.
Answer
C. It challenged the growing practice in music of incorporating elements, features, themes, and even the “feel” and “mood” of the work of other artists and genres.
42.
The jury’s decision also drew criticism from many copyright and music experts. Why?
1. The \$5.3 million award was thought to be outrageously large.
2. Critics said that although Marvin Gaye may have been the Prince of Soul, he didn’t own a copyright to the whole genre.
3. Not a single word, melody, or beat from Gaye’s song was actually copied.
Answer
B. Critics said that although Marvin Gaye may have been the Prince of Soul, he didn’t own a copyright to the whole genre.
43.
In what way has the Marvin Gaye case already made musicians and producers more cautious?
1. Singers are more willing to license the work of previous artists from whom they gain “look and feel” ideas and inspiration.
2. Sam Smith granted Tom Petty songwriting credit and royalties to Smith’s song “Stay With Me,” which bore a resemblance to Petty’s hit “I Won’t Back Down.”
3. Both of these are accurate.
Answer
C. Both of these are accurate.
44.
Which of the following are NOT one of the types of damages that copyright owners may receive if their work is infringed?
1. Actual.
2. Punitive.
3. Statutory.
Answer
B. Punitive.
45.
If someone willfully infringes your copyrighted work for commercial advantage or private financial gain, what may he or she also face?
1. Treble damages.
2. Criminal penalties of up to five years in prison for a first offense, and ten years for a second offense.
3. An order to publicly apologize for the infringement.
Answer
B. Criminal penalties of up to five years in prison for a first offense, and ten years for a second offense.
46.
Sometimes the copyright owner’s most important remedy for infringement will be an injunction. Why?
1. It immediately stops the infringer from continuing to make money from work that infringes your copyright.
2. It puts the infringer in jail where he cannot commit more infringement.
Answer
A. It immediately stops the infringer from continuing to make money from work that infringes your copyright.
47.
Fair use allows for the copying and use of copyrighted material for all EXCEPT which specific purpose?
1. Criticism and comment.
2. News reporting.
3. Teaching or research.
4. Political organizing.
Answer
D. Political organizing.
48.
One of the four factors considered in whether the copying or use of a copyrighted work is considered to be fair use is “the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes.” Which of the following would likely be considered fair use?
1. A profit-making magazine like Vanity Fair publishes a book review that quotes several thousand words of the copyrighted book being reviewed.
2. A nonprofit university distributes copies of two chapters of a copyrighted textbook to its students so they don’t have to buy the textbook itself.
Answer
A. A profit-making magazine like Vanity Fair publishes a book review that quotes several thousand words of the copyrighted book being reviewed.
49.
What major change in copyright law was NOT made in the Copyright Act of 1976?
1. It extended copyright to performances via cable television.
2. It prohibited the unauthorized rental or lease of computer software programs.
3. It codified fair use into the statutes.
Answer
B. It prohibited the unauthorized rental or lease of computer software programs.
50.
The Digital Millennium Copyright Act of 1998 made it a crime to circumvent digital rights management (DRM) measures that control access to digital music and ebooks as a means of preventing piracy. So why are so many listeners, readers, and book and music publishers voluntarily abandoning DRM measures?
1. It prevents people from sharing their digital music and e-books with friends and family, like they can with regular music CDs and printed books.
2. DRM measures alienate consumers and limit their choices.
3. The elimination of DRM measures will grow the market for digital books and music much more rapidly.
4. All of the above.
Answer
D. All of the above.
51.
Why was the Sonny Bono Copyright Term Extension Act of 1998 so controversial?
1. It put all of Sonny and Cher’s formerly copyrighted music into the public domain.
2. It reduced the copyright term to that favored by the Founding Fathers—28 years.
3. It extended copyright an additional 20 years to the life of the author plus 70 years.
Answer
C. It extended copyright an additional 20 years to the life of the author plus 70 years.
52.
On December 16, 2015, the Copyright Royalty Board changed the royalty rates paid by music services like Pandora. What change was made?
1. The board reduced the rate from 14 cents per 100 songs played to 11 cents.
2. The board raised the rate to 17 cents per 100 songs played.
3. The board raised the rate to 20 cents per 100 songs played.
Answer
B. The board raised the rate to 17 cents per 100 songs played.
53.
Which of the following alternative channels for licensing copyright never allows users to change, modify, or reuse original content?
1. Open source software licensing.
2. Open access publishing.
3. Creative Commons licenses.
Answer
B. Open access publishing.
54.
Changes to copyright law in the future are likely to focus on which issues?
1. Reducing or eliminating DRM.
2. Adjusting to new advances in digital technology.
3. Enabling and regulating a secondary market for digital content.
4. Shortening copyright term.
5. All of the above.
Answer
E. All of the above. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/03%3A_Copyright_Basics/Chapter_3%3A_Assessment_Questions.txt |
Learning Objectives
After completing this section, you will be able to
• Understand trademarks and their properties.
• Identify differences between trademarks and other intellectual property rights.
A trademark is an intellectual property right granted by a government to an individual, business, or legal entity that creates and uses a distinctive word, name, symbol, or device to distinguish its products or services from those from any other entity in the marketplace.
The original purpose of a trademark was to indicate the origin of goods and services. Trademarks thus protected the public by preventing mistakes, confusion, or deception by those who would “palm off” their goods as those of another. But it also served to protect the market and reputation (or goodwill) of the producers of goods. As modern markets evolved, trademarks also developed into guarantees of quality as well as potent marketing and advertising devices.
Trademarks as Branding
Consider, for example, the role that Nike’s “Swoosh” logo plays in its \$106 billion shoe, equipment, and apparel business. In 1971, Nike founder Phil Knight paid graphic design student Carolyn Davidson a mere \$35 to design the “Swoosh” logo for the fledgling new company. According to the Portland Oregoniannewspaper, when Knight saw her design, he reportedly told her, “I don’t love it, but maybe it will grow on me.” Nike attorneys nonetheless registered the logo with the U.S. Patent and Trademark Office (USPTO) on June 18, 1971.i
Today, this one logo is estimated to be worth as much as \$20 billion, and is recognized around the world as a symbol of Nike’s quality workmanship and design. Indeed, its vital role in protecting Nike’s market share and reputation explains why the company so strenuously protects its trademark rights from being infringed by counterfeiters. As for design student Carolyn Davidson, Phil Knight gave her Nike stock in 1983 that is today worth more than \$850,000.
Trademarks vs. Other Intellectual Property Rights
Trademarks share with other intellectual property rights the power to encourage and reward creative enterprise. Trademarks also share with patent rights and copyrights the public policy goal of marshaling the benefits of creative endeavor—in this case, the distinctive branding of one’s products and services from those of others—to the public good. They do this by protecting the consumer from deception and encouraging sellers to provide quality products.
But trademarks are different from other intellectual property rights in three key respects. In the first place, the legal foundation for U.S. trademark law comes not from rights expressly enumerated in the Constitution, as is the case with patent rights and copyrights. Rather, it lies in the Commerce Clause of the Constitution, which gives Congress the authority to regulate interstate commerce and enact whatever necessary and proper legislation is required to do that.
Trademarks are also different from other intellectual property rights in that they are not limited in duration. Patents and copyright are granted only for limited periods of time because society benefits by putting an invention or literary work into the public domain once the inventor or artistic creator has recouped the costs of innovation and been rewarded for the pioneering endeavor. Trademarks, however, never hinder the sales of other products or services, so they are granted in perpetuity so long as they are not abandoned by the trademark owner.
Trademarks Mean Business
Finally, trademarks exist only in conjunction with commercial activity. An inventor may receive a patent for a new invention and never employ or “practice” that invention in a business or research endeavor. Similarly, an author can receive a copyright for an original literary or artistic work and yet never publish, display, or sell it. A trademark, however, cannot exist by itself, apart from commercial activity.
Thus a trademark cannot be obtained by mere adoption. It can only be acquired through commercial use or in anticipation thereof—i.e., through the sale of goods and services.
Footnotes
• iAllen Brettman, “Creator of Nike’s Famed Swoosh Remembers Its Conception 40 Years Later,” the Oregonian, June 15, 2011. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.01%3A_Core_Concepts.txt |
Learning Objectives
After completing this section, you will be able to
• Discuss the origins of trademarks.
• Analyze examples of early forms of trademarks.
Bronze Age Origins
Scholars of antiquity give Early Bronze Age potters the credit for creating the world’s first trademarks by imprinting their works with distinctive markings. We assume that these marks were meant to indicate the origin of a particular work or the identity of its craftsman, but the historical record is not conclusive on this point. But an examination of the potters’ seals found on Corinthian artifacts dating to 2000 BC suggests this is a reasonable supposition. Trade and commerce between the tribes and early civilizations of that era were expanding rapidly, and in order to be mutually beneficial, trade requires a certain amount of trust in the provenance and quality of goods. These early potters’ trademarks seemed to have served that purpose by distinguishing the goods of quality craftsmen from those of unknown or uncertain sources.
Trademarks have always been inextricably bound up with commerce. And as commerce grew and developed over the centuries, so did the use of trademarks. Marks have been found, for example, on works ranging from Egyptian pots to the swords of Roman blacksmiths. But it was in the medieval period, with the emergence of powerful craft guilds, that trademark usage really expanded. Their marks identified a work as being made by a particular guild or member of that guild, and therefore continued the long tradition of identifying the origin of goods. But medieval trademarks also served other functions. They became a means by which guilds could control the quality of work of fellow guild members and, because of a trademark’s association with quality, ultimately, a source of competitive advantage in the market.ii Trademarks thus began to acquire something akin to the existential “moral rights” found in later copyright statutes—i.e., the right of a creator to defend the quality, originality, and “personality” of their work.
Trademark use in medieval times also acquired a public interest function. As Arthur R. Miller and Michael H. Davis note in Intellectual Property: Patents, Trademarks, and Copyright in a Nutshell, “Statutes dating back as early as the thirteenth century show that [trademark] was eventually recognized as having social consequence. These statutes were meant to protect the public by preventing the sale of unidentified goods whose quality could not be ascertained.”
One notable trademark from the time was that of Löwenbräu Brewery, which claims to have used its lion mark since its founding in 1383.iii
Early Trademark Cases
Scholars had until only recently attributed the first reported trademark case in Anglo-American law to be Southern v. How, which was decided in 1618. This despite the fact that the case involved not a trademark but the sale of counterfeit jewels.iv Its connection to trademark came from a reference by the presiding judge to an earlier, unnamed, and unreported case in 1584 involving a suit brought by a cloth maker against another cloth maker who had used his mark. That earlier clothier case, only recently discovered and now known as Sanforth’s Case, is now held to be the earliest reported trademark case in Anglo- American law. It establishes beyond a doubt that even 250 years before the Industrial Revolution, trademark infringement was viewed as a tort of deceit and a violation of the laws against unfair competition.v
To quote from a contemporary 1656 legal report:
“The action upon the case was brought in the [Court of] Common Pleas by a clothier, that whereupon he had gained great reputation for his making of his cloth … to his benefit and profit, and that he used to set his mark on his cloth whereby it should be known to be his cloth; and another clothier, observing it, used the same mark to his ill-made cloth [in order] to deceive him.”
In the more than four centuries since then, as commerce and industry have evolved into an \$80 trillion a year global marketplace unimaginable to the people of Sanforth’s Casetime, its verdict that trademark infringement is competition most unfair and demands redress still serves as the foundation and wellspring of worldwide trademark policies and statutes today.
Footnotes
• iiArthur R. Miller and Michael H. Davis,Intellectual Property: Patents, Trademarks, and Copyright in a Nutshell. (5th ed., p. 25). St. Paul MN: West Publishing Co., 2007.
• iiiGary Richardson, Brand Names Before the Industrial Revolution, National Bureau of Economic Research, NBER Working Paper No. 13930, April,2008.
• ivMcKenna, M. The Normative Foundations of Trademark Law(December 30, 2010). Notre Dame Law Review, Vol. 82, No. 5, p. 1839, 2007. Retrieved from SSRN: http://ssrn.com/abstract=889162.
• vKeith M. Stolte, How Early Did Anglo-American Trademark Law Begin? An Answer to Schechter’s Conundrum, Fordham Intellectual Property, Media and Entertainment Law Journal, Volume 8, Issue 2, 1997. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.02%3A_Early_Trademark_Systems.txt |
Learning Objectives
After completing this section, you will be able to
• Grasp the basics of trademark law.
• Analyze notable trademark cases.
As the young United States rapidly developed its commerce and industry in the late eighteenth and early nineteenth centuries, propelled in no small part by the nation’s unusually democratic and effective patent laws (see Chapter 1, “Section 1.5: What the U.S. Patent System Wrought”), the states developed increasingly sophisticated and complex trademark laws. Eventually, however, the transformation of America’s many local and regional markets into a single, unified, national economy propelled Congress to try to federalize trademark law despite the lack of any express constitutional authority to do so. So Congress passed the first national trademark laws in 1870 and 1876. But in a set of three court challenges consolidated into a single appeal before the U.S. Supreme Court in 1879, Justice Samuel Freeman Miller ruled for the majority that the Patent and Copyright Clauseof the Constitution gave Congress no explicit authority to regulate trademarks, and declared the 1870 and 1876 trademark laws unconstitutional.vi
The Commerce Clause and the Lanham Act of 1946
Two years later, Congress instead acted under the Commerce Clause of the Constitution to pass the Trade Mark Act of 1881. This first national trademark law, however, only regulated trademarks used in commerce with other nations and with Indian tribes. It wasn’t until 1905 that Congress passed another trademark statute regulating the use of marks within the United States.
Those two trademark laws were subsequently overhauled by the Lanham Act of 1946 , which remains the principal law of the land on trademarks in the United States to this day.vii It broadened national registration of trademarks, and also gave owners of unregistered marks access for the first time to the federal courts. The act also established remedies such as bars on the sale or importation of infringing products, and required the renewal of trademarks every ten years to weed out the registry trademarks that are no longer in commercial use (known as the “deadwood” prevision).viii
After 119 years in business, for example, the world-famous retailer Woolworth’s went bankrupt in 1997 and its trademark was no longer protected. The 83-year-old Hostess Twinkies brand, however, was acquired by two private equity firms for \$410 million because they see future profit in the iconic brand—and the customers who love it.
Requirements for a U.S. Trademark
The requirement that a trademark must be actively used or intended to be used in commercial activity in order to be protected by law has been a fundamental feature of U.S. trademark law since its inception. The Lanham Act specifically requires applicants to submit “a verified statement that the mark is in use in commerce, specifying the date of the applicant’s first use of the mark in commerce and those goods or services specified in the notice of allowance on or in connection with which the mark is used in commerce.”ix A trademark is presumed to have been abandoned when its owner ceases to use it for three or more years, after which anyone else can register and use the mark.
4.04: Four Types of Trademarks
Learning Objectives
After completing this section, you will be able to
• Identify the four types of trademarks.
• Compare differences between types of trademarks.
Can I Trademark That?
Before reading this section, please watch the overview video below covering the four types of trademarks and what they are used for, the subject matter of trademarks, and why trademarks are important—not just to their owners, but even more so, to the general public.
The term “trademark” is usually used to describe any of the four types of marks that can be registered with the U.S. Patent and Trademark Office. The two primary types of marks are trademarks and service marks. The two other marks—certification marks andcollective marks—occur much less frequently and must meet different requirements for registration.x
Trademarks
Trademarks identify products—i.e., physical goods and commodities—that are either manufactured, produced, grown, or that exist naturally. A trademark is a word, name, symbol, or device—or combination of these—used to identify and distinguish the source of that product. Examples of trademarks include the Nike “Swoosh” symbol, the arched “M” for McDonalds, and the apple symbol with a small curved bite taken out of it for Apple Computer.
Service Marks
Service marks are exactly the same in principle as trademarks except that these words, names, symbols, or devices identify and distinguish the source of a service. Examples of service marks include the sleek silver greyhound dog on Greyhound buses, and United Parcel Service’s brown shield emblazoned with the bold yellow letters “UPS.”
Certification Marks
A certification mark is any word, phrase, symbol, or design—or a combination of any of these—owned by one party that certifies the goods and services of others when they meet certain standards or requirements.xi A certification mark identifies either the nature of a product or service—for example, that it meets the quality standards needed to receive the “Good Housekeeping Seal of Approval”—or theorigin of products or services, as in the certification mark “Washington State” given to apples grown in that state.
Collective Marks
Collective marks come in one of two varieties: collective trademarks and service marks, and collective membership marks. A collective trade or service mark is any word, phrase, symbol, or design that is owned by a cooperative, association, collective group, or organization and is used by its members to indicate the source of goods or services.xii An example of a collective trademark is the “Girl Scouts” mark seen on cookies every February, or the designation “CPA” to identify the services provided by a Certified Public Accountant.
A collective membership mark, by contrast, is used to indicate that a person is a member of some organization, such as a trade union or an association like the Rotary Club, but is not used to identify the source of goods and services. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.03%3A_U.S._Trademark_Law.txt |
Learning Objectives
After completing this section, you will be able to
• Learn the subject matter of trademarks.
• Analyze characteristics of various forms of trademarks.
As discussed, there are four types of trademarks: trademarks, service marks, certification marks, and collective marks. But what does it mean to say that a trademark may be a “word [or phrase], name, symbol [or design], or device.” The answers may in some cases surprise you.
Words, Phrases, and Names
There is little confusion about what is meant by a trademarkable word, phrase, or name. The only point to remember here is that words, names, and phrases that are simply descriptive of the goods or services with which they are associated do not necessarily qualify for registration as a trademark.xiii They must be distinctive and indicate the origin of a product or service. What is meant by distinctive—and how distinctive they must be—will be discussed in the next section.
Symbols and Devices
Symbols and devices are where things start to get interesting in trademark law. The language of the Lanham Act does not specify what is meant by a “symbol” or a “device” that can be trademarked. The U.S. Supreme Court took careful note of that fact, ruling in 1995 that, “Since human beings might use as a ‘symbol’ or ‘device’ almost anything at all that is capable of carrying meaning, this language, read literally, is not restrictive.”xiv
In the United States, therefore, trademarks can include almost anything that carries distinctive meaning and identifies the origin of products and services. This includes slogans, letters, numbers, logos, three-dimensional designs—even colors, scents, and sounds that indicate the source of a good or service to consumers.xv
A trademarkable symbol can be a number. The number 5, for example, is a trademarked symbol of Chanel No. 5 perfume (No. 73788555). So is the number 31, which is the trademarked symbol of Baskin-Robbins 31 Flavors (No. 72172718).
No trademark can block the use of the numbers 5 or 31 in math. Nor have the courts allowed the trademarking of mere part numbers,xvimodel numbers,xvii or grades,xviii because these are not distinctive enough and do not indicate the origin of the goods in question. Regular gas, also known as “87 octane,” also cannot be trademarked because it doesn’t tell you whether that gas comes from Exxon, Shell, or BP.
Yet despite the above, one of the most iconic trademarked numbers is 501. Originally, the number 501 was simply the lot number Levi’s assigned to the famous copper-riveted waist overalls. But over time, 501 acquired meaning in the minds of consumers and came to be very strongly associated with Levi’s brand jeans. How otherwise un-trademarkable symbols (or words and designs) can acquire secondary (trademark) meaning will be discussed in the next section.
As for scents, the fundamental case for trademarking these came about when the USPTO denied Celia Clarke’s request in 1990 for a trademark for scented yarns and threads with a “fresh, floral fragrance reminiscent of Plumeria blossoms.” She appealed, and the Trademark Trial and Appeal Board overruled the examiner, granting her a trademark for the scent.
“[F]ragrance is not an inherent attribute or natural characteristic of applicant’s goods but is rather a feature supplied by applicant,” the board noted. “Moreover, applicant has emphasized this characteristic of her goods in advertising, promoting the scented feature of her goods. Applicant has demonstrated that customers, dealers and distributors of her scented yarns and threads have come to recognize applicant as the source of these goods. . . . In her advertisements and at craft fairs, applicant has promoted her products as having a scented nature. We believe that applicant has presented a prima facie case of distinctiveness of her fragrance mark.”xix
On the other hand, a trademark cannot be granted for any scent that serves a function other than identifying the product’s source. The scent of perfumes and air fresheners, therefore, cannot be registered, nor can the sulfurous smell that serves as a warning for natural gas leaks.
Still, there remains a good deal of uncertainty about when a scent is trademarkable and when it is not. Consider the world-famous Cinnabon smell—that sweet, sugary, cinnamon-infused scent that is absolutely unmistakable (if not also irresistible). But it is not trademarked because even though it is certainly distinctive, it cannot be easily distinguished from the smell of cinnamon buns made by any number of other bakeries.
Sounds can also be trademarked provided they indicate the source of the product or service with which they are associated, and indeed, there are approximately 700 trademarked sounds registered at the USPTO.xx These include Tarzan’s Yell, the THX theme heard at the beginning of a movie, MGM’s roaring lion, America Online’s “You’ve got mail” announcement, the sequence of chimes heard with the display of the NBC logo on TV, and, naturally, the sound of a duck quacking “Aflac!” for the American Family Life Assurance Company.
Designs and Trade Dress
A design, like a logo, can also be trademarked, provided it distinguishes the origin of the product or service from any other source or producer. In these trademarks, the logo must be unique and consist of more than simple stylization.
Bacardi for using a similar stylized “O” on its label for orange-flavored vodka. The court ruled against Geogri, however, because its design consisted merely of a stylized symbol that had not acquired a distinguishing (or secondary) meaning in the minds of consumers that enabled them to identify the producer.xxi
Examples of pure trademarked designs, without any associated words, include Nike’s “Swoosh” and Apple’s famous logo of an apple with a bite taken out of it.
This is why design trademarks often take a “design plus words” approach, as in the trademarked Lacoste logo featuring the word “Lacoste” above the famous green alligator.
Trade dress, on the other hand, refers to theoverall appearance of a product or service that indicates its source. Trade dress can include features such as size, shape, color or color combinations, texture, graphics, or even particular sales techniques. The key to claiming trade dress protection is that the attributes must be distinctive. For example, Taco Cabana has trademarked its distinctive and “festive eating atmosphere having interior dining and patio areas decorated with artifacts, bright colors, paintings and murals,” and won an infringement case against a competitor restaurant called Two Pesos. By creating a theme that was similar to Taco Cabana, Two Pesos created confusion in the minds of consumers.xxii
A design trademark may be one part of a product’s trade dress, but it is distinct from trade dress because it only covers the stylization of words, letters, numbers, or of a specific design like the Lacoste green alligator.
Imagine that an Apple competitor opened a retail store with the same colors, lighting, atmosphere, and overall look and feel as the Apple store but sold their own products. The goal would not be to stop the sale of the goods, which are not necessarily infringing any of Apple’s design trademarks or patents, but to stop the competitor from infringing the look and feel of the Apple store. In this case, Apple would file a trade dress suit.
Both design trademarks and trade dress are different from design patents. Although all three cover only nonfunctional designs and appearances, design patents strictly protect only the new and original ornamental design of an article of manufacture, and the actual drawing of a design patent limits what is protected. A design trademark, on the other hand, protects a particular word, name, symbol, or design used in commerce to distinguish a product’s source. And trade dress protects the overall appearance of the product and can include anything that gives a product or service meaning and distinguishes it from those of any other producer.
A design patent might protect the new and original ornamental design of a lamp, for example, so long as that appearance does not affect the lamp’s function. A design trademark would protect the words or symbols used on the lamp that identify it as coming from a particular producer. And trade dress protects the overall “look and feel” of the lamp.
Sometimes both forms of protection can be obtained, providing an extra advantage to the owner of these rights. Examples of products with both design trademarks and design patents include the Dustbuster vacuum cleaner, the Pepsi bottle, and the Honeywell round thermostat. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.05%3A_Subject_Matter_of_Trademarks.txt |
Learning Objectives
After completing this section, you will be able to
• Discover the elements of distinctiveness within trademarks.
• Identify the various kinds of marks used.
The fundamental and overriding requirement for a trademark is distinctiveness. The requirement for distinctiveness is analogous to the requirement for novelty in patent rights andoriginality in copyright. Without distinctiveness, there can be no trademark.
As Miller and Davis note, “Naturally, a trademark must be distinctive if it is to serve the function of identifying the origin of goods and thereby avoid confusion, deception, or mistake. If a trademark is to protect purchasers from confusion over what they are purchasing, then the trademark somehow must be recognizable, identifiable, and different from other marks.”xxiii
Some trade and service marks achieve distinction via their inherent nature—Nike’s curved “Swoosh” check mark suggesting speed and agility, for example.
But other marks gain distinctiveness as a result of marketing, eventually forming a powerful association over time in the minds of consumers. As an example, the term “Raisin Bran” is merely descriptive of the foods used in the cereal and would not be eligible for trademark registration had Kellogg Company not demonstrated through evidence of use (including sales, advertising expenditures, and consumer surveys) that the buying public had come to distinctively associate Raisin Bran with this particular Kellogg’s cereal.
The public’s distinct association of a trademark to a company is known as secondary meaning, and that is something that can only be established over time. An understanding of secondary meaning is crucial when discussing the spectrum of distinctiveness.
In Abercrombie & Fitch Co. v. Hunting World, Inc. in 1976, Judge Henry Jacob Friendly established five basic categories of marks along a spectrum of distinctiveness, ranging from “fanciful” marks that are inherently distinctive on one end and on the other end “generic” marks that are never distinctive and thus not eligible for trademark registration.xxiv
Fanciful Marks
Fanciful marks are invented words, symbols, or devices that have no relation to the good or service being sold and have no meaning other than to distinctly identify the product or service and distinguish it in the minds of consumers from those of any other vendor. “Xerox” is a good example of a fanciful mark, as are “Google” and “Kodak.” Fanciful marks are considered the strongest type of mark and are prima facie registrable with the USPTO.
Arbitrary Marks
Arbitrary marks are real words in common usage that have no descriptive relationship to the product or service being sold. Examples of arbitrary marks include “Apple” (for the computer company), “Oracle” (for the software company), and “Galaxy” (for the mobile phone). Arbitrary marks are also unreservedly eligible for trademark registration.
Suggestive Marks
Suggestive marks are marks that suggest or imply a quality or characteristic of the goods and services being sold. They require imagination, insight, or perception on the part of the consumer as to the nature of the article.xxv Examples include “iPad” for the tablet computer and “Coppertone” for the sunscreen lotion.
A suggestive mark is the minimum required for a mark to be unconditionally registrable absent a secondary meaning. Or in the words of Judge Friendly, “The validity of the mark ends wheresuggestion ends and description begins.”xxviFrom this point on along the spectrum of distinctiveness, things get a bit tricky.
Descriptive Marks
A descriptive mark explicitly describes the purpose, nature, or an attribute of a product or service and is, therefore, not eligible for trademark registration unless a secondary meaning or association has been developed in the public’s mind through usage.xxvii Ineligible descriptive marks include “Lightweight” and “Faster.” However, if a descriptive mark takes on a secondary meaning in the public mind—“Sharp” televisions, for example, or “Windows” for windowing software—then it can be eligible for trademark registration.
The bar against descriptive marks is designed to protect for public use common concepts and language that everyone needs to use. Imagine having to pay the coiner of the term “reverse mortgage” every time you wanted to describe such a financial arrangement. It would create a nightmare of social costs, which can be prevented simply by allowing the descriptive term to remain in the public domain. The bar against descriptive marks spotlights the overall social purpose of trademarks, which is to prevent fraud and confusion in the market while not conferring a monopoly on anyone.
Generic Marks
The last and least distinctive category of marks are generic marks that are simply the common name for the goods and services being sold. Examples of generic marks might be “Aspirin” for the analgesic, or the use of the word “Baskets” for a basket store without any accompanying logo or other design element to distinguish from a merely generic description of the items sold. A generic mark is never eligible for registration no matter how much evidence a mark owner offers that it has acquired a secondary meaning through advertising and marketing.
Ironically, a product or service can become so successful in the marketplace that the public begins to associate its trademark with an entire category of similar products and services. When this happens, a valid trademark can become a generic name and the trademark will be lost, as happened with both “Cellophane” and “Aspirin.” To prevent this from happening, companies like “Kleenex,” “Xerox,” and more recently “Google” have gone to great legal and advertising expense to prevent the generic misuse of their trademarks so these remain valid.
There are many companies that sell aspirin, but aspirin itself can no longer be trademarked.
Adobe, for example, sent emails to many web authors advising them to discontinue using the term “photoshopped” and instead say that their photos were “modified by Adobe Photoshop software.” Similarly, Xerox spent heavily on advertisements warning that “you cannot Xerox a document, but you can copy it on a Xerox brand copying machine.” | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.06%3A_The_Spectrum_of_Distinctiveness.txt |
Learning Objectives
After completing this section, you will be able to
• Identify the bars to trademark.
• Dissect criteria for trademark registration.
The Prior Use Bar
No one can register a trademark if it has been used by other parties prior to its use by the applicant. Indeed, if the applicant uses such a mark, he or she may be liable for trademark infringement.xxviii The only exception to the prior use bar is when the mark has been used in an entirely different market or field of business, as in the trademark “Progressive” granted to two companies, one a backpack manufacturer and the other an auto insurance company.
The Functionality Bar
To be trademarked, no word, symbol, design, device, scent, or sound may purely or primarily serve a functional purpose. Nor can it be trademarked if its absence in or on the product inflates its cost or reduces its quality.xxix
Thus as noted earlier, the scent of a perfume cannot be trademarked because the core requirement of a perfume is that it have a pleasant and distinctive smell.
The design of a chair presents an interesting dilemma, however. Does the design enable a person to sit—i.e., does it have a functional purpose? Or does the design distinctively mark an otherwise perfectly functional chair as coming from an identifiable producer?
This “chicken and egg” question has confronted many applicants, trademark examiners, judges, and juries over the years. The issue is usually decided by asking whether the appearance of a product or its components is inspired more by design or by function?
The issue is most easily decided when the functionality of an item resides in a specific part of the product, and the design elements are found in other parts of the product. A great example of this is the “A Christmas Story Leg Lamp” based on the classic 1983 film comedy. The functional part of the lamp is its electronics and light fixture sitting atop the base. The base, however, is in the shape of a woman’s stocking-clad leg, and is thus clearly a design feature that distinguishes the lamp from any other on the market, and it is trademarked (No. 77105065).
Subject Matter Bars
In addition to prior use and functionality, certain kinds of subject matter are generally not eligible for trademark registration. These are surnames, geographic marks, and ornamental, immoral, or offensive marks.xxx
Surnames or family names such as “Smith” and “Johnson” cannot be trademarked except under certain conditions. The USPTO assesses five factors in determining whether a surname is eligible for a trademark:
• Whether the surname is rare.
• Whether the term is the surname of anyone connected with the applicant.
• Whether the term has any recognized meaning other than as a surname.
• Whether it has the “look and feel” of a surname.
• Whether the stylization of lettering is distinctive enough to create a separate commercial impressionxxxi
“If the mark’s character as a surname predominates in terms of its ‘primary significance to the purchasing public,’ then it is prohibited,” write Miller and Davis.xxxii But over time, if the surname becomes associated in the public mind with the distinctive origin of products or services, then it may be eligible for a trademark, as is the case with “Sears” and “Macy’s.”
Geographic marks must also be evaluated for eligibility on the basis of several factors. If a geographic mark is simply descriptive, the following tests apply:
• The primary significance of the mark is a generally known geographic location.
• The goods or services originate in the place identified in the mark.
• Purchasers would be likely to believe that the goods or services originate in the geographic place identified in the mark.xxxiii
The test above determines whether there is a literal association to the name or not. For example, if an entrepreneur launches a company called “Los Angeles Shoes” to produce shoes in Los Angeles, the name would not pass the test for trademark eligibility because the primary significance of the mark is that it is a generally known location, the product is produced in the location stated in the mark, and consumers would believe the shoes were made in Los Angeles.
The goal of the bar against geographically descriptive marks, then, is to protect one party from seizing ownership of a geographic term that ought to remain in the public domain.
If a geographic mark is deceptively misdescriptive, however, the test is as follows:
• The primary significance of the mark is a generally known geographic location.
• The goods or services do not originate in the place identified in the mark.
• Purchasers would be likely to believe that the goods or services originate in the geographic place identified in the mark.
• The misrepresentation is a material factor in a significant portion of the relevant consumer’s decision to buy the goods or use the services.xxxiv
The goal of this test for geographically misdescriptive marks is to prevent the confusion and deception of the consumer. For example, if an entrepreneur launches a fashionable shoe business called “New York Shoes” but actually manufactures the shoes in China, he will not receive a trademark for the name because it will likely confuse or deceive consumers.
Sometimes, however, a geographic name may be trademarked, as was the case with the online retailing giant’s trademark “Amazon.” In this case, the geographic name “Amazon” is not indicative of the source of goods, nor are consumers under the impression that the goods sold by the retailer come from the Amazonian region of South America. In addition, the geographic nature of the name “Amazon” is not a significant factor in whether or not consumers decide to purchase books, clothing, electronics, or anything else from the company.
Nor can ornamental, immoral, or offensive marks be trademarked. Ornamental marks such as a “smiley face” logo are merely decorative and are too vague to distinguish the origin of a product or service. Immoral or offensive marks—e.g., an online dating service with a logo depicting two naked people having sex—also cannot be registered. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.07%3A_Bars_to_Trademark.txt |
Learning Objectives
After completing this section, you will be able to
• Identify the reasons for establishing trademark registration.
• Understand the process of trademark protection.
Establishing Your Trademark Protection
Before reading this section, please watch the overview video below covering the “spectrum of distinctiveness” and other fancy-sounding legal terms and what they really mean in the real world of commerce and consumerism.
As in the case with copyrights, trademarks do not necessarily have to be registered with the federal government, but doing so has benefits. The owners of unregistered trademarks have the exclusive right to use the mark concerning similar goods and services in the geographic area of actual use of the mark, the right to bring civil action against infringers, and protection against false advertising. Unregistered trademarks are usually identified by the “TM” symbol displayed on the product, package, or advertising used to promote them. Trademarks formally registered with the USPTO, however, receive additional benefits:
• A legal presumption of ownership of the mark and exclusive right to use the mark nationwide on or in connection with the goods/services listed in the registration.
• Public notice of claim of ownership of the mark.
• The ability to bring an action concerning the mark in federal court.
• The use of the U.S. registration as a basis to obtain registration in foreign countries.
• The ability to record the U.S. registration with the U.S. Customs and Border Protection (CBP) Service to prevent importation of infringing foreign goods.
• The right to use the federal registration symbol ®
• Listing in the United States Patent and Trademark Office’s online databases.xxxv
Because registration costs money, many small businesses choose to rely upon the common law protections afforded trademarks, especially when just starting up. A case in point was Google, which used an unregistered trademark for its first six years in operation. Only in 2006 did the company formally apply for a registered trademark for “Google.” It was registered in 2012.
But trademark protection can be vital to a small business, as one recent case amply demonstrates. Payam “Peter” Tabibian first registered the 1950s-style red, white, and yellow logo for his start-up Z-Burger chain in 2007, a few months before he opened his first restaurant the next year in a hip Washington neighborhood. As the New York Times reported, “his first restaurant was an immediate hit, attracting students from nearby American University. The place [later] drew public praise when it gave free food to federal workers who were furloughed from their jobs during government budget cutbacks.”
But Mr. Tabibian eventually fell out with his partners, who then tried to stop him from continuing to use his Z-Burger brand with his expanding chain of restaurants; they also demanded he transfer the trademarks to them.
But because Mr. Tabibian had done his homework and taken the time to properly register his trademarks, a federal judge ruled in August of 2015 that he was the legitimate owner of the trademarks and could continue to use them.
As James Gibson, law professor at the University of Richmond School of Law, told theNew York Times, the Z-Burger case shows why “it is very important early on to pick a trademark that’s going to work, and make sure ownership is sewn on. That’s particularly true if nobody knows who you are and you’re operating in a limited area. The federal trademark gives you a lot of nationwide rights.”
In order for your trademark to be eligible for registration with the USPTO, however, you must actually use it in conjunction with commercial activity—i.e., with the marketing and sale of products and services—or be about to use it within six months. Absent the selling of athletic shoes and other sports attire, Nike’s \$20 billion “Swoosh” logo would be nothing more than a worthless doodle.
When applying for trademark registration, the applicant must file an affidavit attesting to the date the mark was first used in commerce as well as a specimen showing how the mark was first used, whether in advertising or on the product in a store setting. It is imperative that the applicant identify the earliest provable date of first use in commerce, to lessen the likelihood that another party can claim prior use of that mark and invalidate the trademark.
The USPTO also offers an “intent-to-use” application, which allows an entity to apply for a trademark that is not yet used in commerce.
“If you have not yet used the mark but plan to do so in the future, you may file based on a good faith or bona fide intent to use the mark in commerce,” notes a USPTO publication. “A bona fide intent to use the mark is more than an idea, [but] less than market ready. For example, having a business plan, creating sample products, or performing other initial business activities may reflect a bona fide intent to use the mark.”xxxvi
The mark must then be put into use within six months of receiving a “notice of allowance” from the USPTO or the applicant risks having to pay extension fees or losing the mark entirely.
If the trademark is still in commercial use five years after registration, the owner is eligible to receive an additional protection known as “incontestability,” which immunizes the mark from many challenges, including challenges to validity, ownership, registration, and descriptiveness. (Incontestable marks can still be challenged on some grounds, such as genericism, functionality, and abandonment.) To receive incontestability status, a § 15 Declaration must be submitted to the USPTO.
Once incontestability is achieved, no one can contest the validity, ownership, or registration of the mark, nor can anyone contest the owner’s exclusive right to use the mark. An individual or a corporate entity can register a mark.
A trademark can be assigned to others in the event of purchase or acquisition by another entity.
The §15 Declaration must include:
1. The registration number and the date of registration.
2. The fee for each class of goods/services in the registration to which the Declaration pertains.
3. A statement that declares: -The mark has been in continuous use in commerce for a period of five years and is still in use in commerce -No final decision exists adverse to the owner’s claim of ownership of the mark for the goods/services, or to the owner’s right to register the mark or to keep the same on the register -No pending proceeding exists involving the claimed rights in the USPTO or in the courts
4. A signed and dated affidavit or declaration under 37 C.F.R. §2.20xxxvii
There are other reasons why an owner might assign trademarks to another party, including a business name change, a security agreement, a license, a lien, as collateral for a loan, or as a result of a bankruptcy procedure. Ford used its trademarks as collateral for a \$23.5 billion loan. Ford was still able to use its trademarks, but if the company had defaulted on the loan, the trademarks would have been assigned to the lender.xxxviii
Just like tangible assets, trademarks and other intellectual property such as patents and copyrights often have enormous value. In fact, some sources estimate that in contrast to 40 years ago, when plant, equipment, and other tangible assets comprised 80 percent of the market value of most public companies, today it is intangible assets like intellectual property, business methods, and know-how that make up roughly 80 percent of the value of public companies.xxxix
Trademarks can also be licensed to others. In 2012, licensed trademarks generated \$5.45 billion for North American owners, reported the Licensing Industry Merchandisers’ Association. That same year, the top 150 global brand licensors earned \$230 billion in sales of trademarked products, with the Walt Disney Company alone accounting for nearly \$40 billion in sales.
Abandonment of a mark results in loss of ownership and the associated rights of the mark. For a mark to be considered abandoned, it must be discontinued from active use in commerce with no intent to resume the commercial use of the mark. Evidence of nonuse for three consecutive years is usually considered to be sufficient proof of abandonment. Upon abandonment, the trademark owner loses the right to prevent others from infringing the mark. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.08%3A_Establishing_Trademark_Protection.txt |
Learning Objectives
After completing this section, you will be able to
• Identify the factors involved in trademark infringement.
• Understand the basis for determining similarity.
Trademark Infringement and Remedies
Before reading this section, please watch the overview video below covering similarity, market confusion, vicarious infringement, and getting back what’s yours.
The purpose of trademarks is to enable consumers to distinguish the source of products and services as well as help businesses defend the quality and reputation of those goods. Trademarks benefit society by protecting consumers and businesses alike, and by preventing confusion in the marketplace. This principle lies at the heart of the trademark system.
It is also the basis on which the courts rule on claims of trademark infringement. The most common way that trademark infringement causes confusion is through similarity. In the words of the Lanham Act, no trademark may be registered “which so resembles” another name or mark that it will be likely “to cause confusion, or to cause mistake, or to deceive.”xl
To determine similarity, the mark must be evaluated as a whole rather than through its individual components. This is important because there are only a limited number of parts—words, names, shapes, symbols, or devices—that can be used separately or together to create a unique and distinctive trademark that indicates the origin of goods.
The courts generally look at five key factors to determine if a defendant’s use of your mark is likely to cause confusion among consumers.
The two most important are:
• The similarity in the overall impression created by the two marks (including the marks’ look, phonetic similarities, and underlying meanings)
• The similarities of the goods and services involved.
But the court also looks at three other factors:
• The strength of your mark.
• Any evidence of actual confusion by consumers.
• The intent of the defendant in adopting its mark.
The basis for determining similarity, again, is not an assessment of the similarity between each component of two trademarks but of their totality as seen and experienced by the consumer. And the key test for similarity isresemblance, not sameness. In short, two marks do not have to be exact mirror images of each other to be legally similar. According to a 2003 decision by the U.S. Court of Appeals for the Federal Circuit, “Similarity is not a binary factor but is a matter of degree."xli Each and every attribute of a mark need not be replicated exactly by those of another mark to be deemed similar. But the more one mark’s attributes are similar to those of another, the greater the likelihood that there is legal similarity between the marks as a whole.
The social networking site LinkedIn, for example, sports a logo made up of the joined words “Linked” and “in” displayed in a white font with the “in” component surrounded by a blue colored square with rounded edges. If a new networking site for professionals was launched that featured a logo with the same words except that the “in” component was surrounded by a red colored square, there would likely be enough similarity between the two logos to justify a case for infringement. The colors of one component of the logo may be different, but when the concept, wording, font style, and design are considered as a whole, any judge or jury would probably find the similarity between the marks so substantial as to constitute infringement.
But similarity is not the only basis for assessing infringement. The question is also whether any similarity between marks is likely to cause confusion in the minds of consumers. This takes into account such factors as the similarity of the goods and services on which the two marks are being used. If a company that made metal chains called itself “LinkedIn,” that would less likely cause consumers to believe that the chains came from the same source as the social networking site, because the manufacture of chains is a very different line of business than running a social networking site.
An entity can be guilty of contributory infringement if it intentionally encourages the infringement of a valid mark by a third party. One can also be liable for contributory infringement if one continues to produce or distribute a product with knowledge that the beneficiary is infringing a mark. As the Supreme Court held in the 1982 case Inwood Labs., Inc. v. Ives Labs., Inc. , “If a manufacturer or distributor intentionally induces another to infringe a trademark, or if it continues to supply its product to one whom it knows or has reason to know is engaging in trademark infringement, the manufacturer or distributor is contributorily responsible for any harm done as a result of the deceit.”xlii
If a manufacturer or distributor intentionally induces another to infringe a trademark, or if it continues to supply its product to one whom it knows or has reason to know is engaging in trademark infringement, the manufacturer or distributor is contributorily responsible for any harm done as a result of the deceit.”xliii
-Inwood Labs., Inc. v. Ives Labs., Inc.
Another type of infringement is vicarious infringement. The definition of vicarious infringement is somewhat convoluted, but Cornell University’s Legal Information Institute describes it thusly:
“A person may be held liable for the infringing acts committed by another if he or she had the right and ability to control the infringing activities and had a direct financial interest in such activities. The existence of direct infringement is required to establish a claim of vicarious infringement; however, it is not necessary for the alleged infringer to have intent or knowledge of the infringement.”xliv
Vicarious infringement most often occurs on Internet sites that allow outside parties to post or upload files. One such example was Sega Enters., Ltd. v. MAPHIA ., in which third parties uploaded unauthorized games that displayed the Sega mark to the Maphia site with the knowledge and consent of—and to the profit of—Maphia owners.
Finally, there is a form of harm calledtrademark dilution, which is described by the International Trademark Association as “the weakening of a famous mark’s ability to identify and distinguish goods or services, regardless of competition in the marketplace or the likelihood of confusion. Dilution typically occurs as the result of blurring or tarnishment of the famous mark. . . . The concept of dilution developed from the idea that because some marks are so well-known and famous, they deserve an extra level of protection beyond the likelihood-of-confusion analysis. Dilution theory seeks to prevent the coexistence of a mark that is sufficiently similar to a famous mark, regardless of the goods and/or services associated with the allegedly diluting mark.”
The Federal Trademark Dilution Act of 1995 and the Federal Dilution Revision Act of 2006 created a federal cause of action for trademark dilution that is separate from infringement. Generally speaking, an owner of a trademark eligible for dilution protection can prevent another company from using that mark no matter how dissimilar the goods and services of the two companies are. That makes dilution protection potentially broader in scope than infringement protection. After the 2006 revision, however, only marks that are “widely recognized by the general consuming public of the United States” are eligible for dilution protection, which means that only a very small percentage of trademarks used in the United States—undoubtedly less than 1 percent—qualify for that protection. Google has protection against dilution. Your local dry cleaner does not. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.09%3A_Trademark_Infringement.txt |
Learning Objectives
After completing this section, you will be able to
• Explain remedies for trademark infringement.
• Discuss effects of infringement.
Remedies for trademark infringement are similar to those available to owners of other intellectual property, including the possibility of receiving monetary damages for lost profits and injunctive relief. But even more so than is the case with patent and copyright owners, trademark owners almost invariably insist on injunctive (e.g. prohibiting continued sales) to cure the infringement. That’s because when a trademark is infringed, the biggest loss to the owner is not necessarily revenue but the potential damage to the reputation of the brand in the minds of consumers.
Imagine, for example, that a manufacturer in Bangladesh started shipping substandard athletic shoes with the Nike “Swoosh” on them into the U.S. market. The loss of revenue resulting from U.S. customers mistakenly buying the Bangladeshi manufacturer’s counterfeit shoes might not amount even to a rounding error on Nike’s books. But if customers began to lose trust in the “Swoosh” symbol as a reliable indicator of Nike’s quality design and manufacturing, the damage to Nike’s brand and future profits could be significant. The company would want to secure an immediate injunction against the importation of the offending shoes and thereby stop the ongoing damage to its trademark and brand.
Incidentally, in cases where the products being imported are not patented or copyrighted, the courts may only require the importer to stop use of the mark, but allow for the continued importation of the product.xlv
In addition to injunctive relief, monetary damages may also be awarded in trademark infringement cases. Monetary damages are primarily aimed at compensating trademark owners for lost profits due to the infringing activity, and may be trebled if the infringement is deemed intentional. The courts may base an award on any or all of the following measures:
• The defendant’s profits, either as an indicator of the plaintiff’s loss or under an unjust enrichment theory.
• Actual business damages and losses suffered by the mark owner as a result of the infringement, including lost profits and the cost of notifying customers.
• Punitive damages to punish the infringer (available in state courts only)
• Reasonable attorneys’ fees incurred by the mark owner to prosecute the case.
4.11: Fair Use of Trademarks
Learning Objectives
After completing this section, you will be able to
• Discuss fair use of trademarks.
• Identify examples of fair use cases.
Not every use of a trademark is infringement.
Individuals and entities may be permitted the fair use of another’s trademark under two conditions. These are known as nominative fair use and classic fair use.
Nominative fair use covers many occasions on which a party other than the trademark owner is using the mark another party to refer to genuine goods or services. An example of nominative fair use is when an auto repair shop advertises that it repairs BMWs and Hondas. It is using the mark “Honda” to refer to cars genuinely produced by the Honda Motor Company, and simply asserting that it is able to conduct repairs on those cars. Another example of nominative fair use is use of a competitor’s trademark in comparative advertising. When Verizon advertises that it has better coverage than AT&T, it is making nominative fair use of AT&T’s mark because it is actually referring to AT&T’s services.
Under nominative fair use, the entity using the trademark is permitted to use only so much of the mark as is necessary to identify the good or service to which it is referring, and cannot imply any sponsorship or endorsement by the mark holder (unless, of course, the repair shop really is a BMW- or Honda- approved repair facility). Another example is the use of another’s trademark for the purpose of a product review.
Classic fair use occurs when a trademark is used in good faith for its primary meaning, and no consumer confusion is likely to occur. Classic fair uses typically involve marks that are descriptive. For example, even though Kellogg’s has gained secondary meaning for the mark “All Bran,” another cereal manufacturer might be able to describe its cereal as “all bran,” if indeed it consists entirely of the hard outer layers of cereal grains.
Although fair use of trademarks is in many ways similar to the fair use of copyrights, there are differences. Under copyright law, you can use a copyright for the purpose of parody. You can also use trademarks for the purpose of parody, but whoever does so must be very careful to avoid confusion in the marketplace and diluting or tarnishing the trademark in question. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/4.10%3A_Trademark_Remedies.txt |
1.
What is the purpose of the intellectual property right we call a trademark?
1. To protect the inventions of businesses.
2. To indicate the origin of goods or services.
3. To reward businesses for their creative works.
Answer
B. To indicate the origin of goods or services.
2.
Which of the following is NOT true of trademarks?
1. They protect the public by preventing confusion or deception about the source of goods and services.
2. They protect the market reputation and goodwill of the producers of goods.
3. They are granted at the moment of creation.
4. They are excellent marketing and advertising tools.
Answer
C. They are granted at the moment of creation.
3.
How much did Nike pay a graphic designer in 1971 to produce its swoosh logo now estimated to be worth as much as \$20 billion?
1. \$850,000.
2. \$25,000.
3. \$35.
Answer
C. \$35.
4.
What value do trademarks provide society?
1. They encourage and reward creative enterprise.
2. They marshal the benefits of this creativity to the public good.
3. They protect the consumer from deception.
4. All of the above.
Answer
D. All of the above.
5.
What is the legal foundation for federal trademark law?
1. The Commerce Clause of the U.S. Constitution.
2. Article 1, Section 8 of the U.S. Constitution.
3. State laws.
Answer
A. The Commerce Clause of the U.S. Constitution.
6.
How are trademarks different from patents and copyrights?
1. They are not limited in duration.
2. They do not hinder the sale of similar products and services by others.
3. They cannot be obtained by mere adoption, but only through commercial use.
4. All of the above are true statements.
Answer
D. All of the above are true statements.
7.
Why did trademarks not emerge until the start of widespread trade in the Bronze Age?
1. There was no government agency to register trademarks before that time.
2. That was when written records of trademarks could be printed.
3. Widespread trade requires a certain level of public trust in the provenance and quality of goods, which trademarks helped to build.
Answer
C. Widespread trade requires a certain level of public trust in the provenance and quality of goods, which trademarks helped to build.
8.
Besides indicating the source of a good or service, how did trademarks change with the emergence of guilds in the Middle Ages?
1. The guilds issued trademarks only to their own members.
2. They became a means by which guilds could ensure the quality of work done by guild members.
3. The guilds started charging money to issue a trademark.
Answer
B. They became a means by which guilds could ensure the quality of work done by guild members.
9.
What is one of the oldest trademarks still in existence?
1. The Royal Dutch Tulip Company.
2. Wedgewood China.
3. Löwenbräu Brewery.
Answer
C. Löwenbräu Brewery.
10.
What is the significance of an old lawsuit known as Sanforth’s Case?
1. It proves that 250 years before the Industrial Revolution, trademark infringement was viewed as deceit and a violation of laws against unfair competition.
2. It is the first trademark infringement case known to be recorded.
3. It serves as the foundation for modern trademark laws and policies.
4. All of the above.
Answer
D. All of the above.
11.
What caused U.S. trademark laws to evolve from a patchwork of state laws into a unitary federal trademark system?
1. The Industrial Revolution transformed America’s many local and regional markets into a unified national economy.
2. Producers of goods and services began to grow into national entities.
3. State laws often conflicted with each other.
4. All of the above.
Answer
D. All of the above.
12.
Why were the first two national trademark laws ruled unconstitutional by the Supreme Court?
1. The court ruled that they infringed on non-trademark owners’ first amendment rights to free speech.
2. The court ruled in 1879 that the patent and copyright clauses of the Constitution gave Congress no authority to regulate trademarks.
3. The court ruled that they were too vaguely written.
Answer
B. The court ruled in 1879 that the patent and copyright clauses of the Constitution gave Congress no authority to regulate trademarks.
13.
What was the chief weakness of the Trade Mark Act of 1881?
1. It only regulated the trademarks used in commerce with other nations and with Indian tribes.
2. It only allowed for the registration but not the enforcement of trademarks.
3. It derived its authority from the Commerce Clause of the U.S. Constitution.
Answer
A. It only regulated the trademarks used in commerce with other nations and with Indian tribes.
14.
The Lanham Act is the principal federal law on trademarks in the United States. Which of the following was NOT a feature of trademark law enacted by the act?
1. It broadened the national system of trademark registration.
2. It set the trademark renewal period.
3. It required registration of trademarks before owners could gain access to the federal courts for redress.
4. It established remedies in the case of infringement.
Answer
C. It required registration of trademarks before owners could gain access to the federal courts for redress.
15.
When does federal law create a presumption of trademark abandonment?
1. When its owner ceases to use it in commerce.
2. When its owner ceases to employ it throughout the national territory of the United States.
3. When its owner ceases to use the trademark in commerce for three or more years.
Answer
C. When its owner ceases to use the trademark in commerce for three or more years.
16.
Of the four individual types of marks, what does a trademark identify?
1. Services provided to either consumers or other businesses.
2. Physical goods or commodities that are manufactured, produced, grown, or that exist naturally.
3. Both of the above.
Answer
B. Physical goods or commodities that are manufactured, produced, grown, or that exist naturally.
17.
A collective mark identifies a trademark owned by a member of a certain organization. True or False?
1. True.
2. False.
Answer
A. True.
18.
A certification mark indicates what?
1. The certified or verified origin of a product or service.
2. A product or service that meets certain standards or requirements.
Answer
A. The certified or verified origin of a product or service.
19.
A trademark may be a word (or phrase), name, symbol, or device. Which of these do the following trademarks represent?
1. Chanel handbags.
2. The MGM lion’s roar.
3. Tiffany’s blue color.
4. The power-on chime in Apple’s Mac computers.
Answer
A. Name (Chanel)
B. Device (a sound)
C. Device(the distinctive blue color)
D. Device (a sound)
20.
Why has no company been able to gain trademark protection for “87 Octane” as a brand of gasoline?
1. It’s a number.
2. It’s not trade dress.
3. It doesn’t indicate the origin of the gas—whether Exxon, Shell, or another company.
Answer
C. It doesn’t indicate the origin of the gas—whether Exxon, Shell, or another company.
21.
What’s the difference between a design protected as a trademark and trade dress?
1. A trademark-protected design consists of a discrete symbol or logo on the product or service, whereas trade dress is its overall “look and feel.”
2. A trademarked trade dress covers a product or service’s overall features like its size, shape, and color combinations rather than a particular symbol or design.
3. Both of these.
Answer
C. Both of these.
22.
In what way are trademarked designs and trade dress similar to design patents?
1. All three protect the unique look of a company’s products from being infringed.
2. All three protect only the nonfunctional elements of the product’s appearance.
3. Both of these.
Answer
C. Both of these.
23.
What is the trademark world’s corollary to novelty in patents?
1. Non-obviousness.
2. Distinctiveness.
3. Originality.
Answer
B. Distinctiveness.
24.
Of the following five categories of marks—fanciful, arbitrary, suggestive, descriptive, and generic—which one of them can never be protected as a trademark?
1. Descriptive.
2. Generic.
3. Fanciful.
Answer
B. Generic.
25.
Which kind of mark is owned by the following companies?
1. Apple.
2. Xerox.
3. Coppertone.
4. Windows.
Answer
A. Arbitrary. “Apple” is an example of a real word in common usage that has absolutely no relationship to the product or service being sold.
B. Fanciful. “Xerox” is a completely invented word that has no meaning except to indicate the source of a copier manufacturer. Fanciful marks are the strongest type of mark you can have.
C. Suggestive. The word “iPad” suggests or implies a quality or characteristic of the good being sold and is distinctive to its manufacturer (Apple).
D. Suggestive. Again, “Coppertone” suggests the quality or color of the tan you’ll get, while indicating which company is selling it.
E. Descriptive. “Windows” is one of the rare marks that describe the nature of a distinctive product (computer software) from a unique manufacturer.
26.
Why was the store Toys “R” Us able to gain trademark protection for its name, even though “toys” is a generic word used by thousands of toy stores nationwide?
1. Because Toys “R” Us was the first to use the name “toys” and thus has priority.
2. Because Toys “R” Us was the first to use the name nationwide.
3. Because of the fanciful spelling of its name.
Answer
C. Because of the fanciful spelling of its name.
27.
Why did “Cellophane” and “Aspirin” lose their trademarks
1. The original companies making these products went out of business.
2. The public came to associate the name with an entire category of similar products.
Answer
B. The public came to associate the name with an entire category of similar products.
28.
What are some of the bars to getting a trademark?
1. The prior use bar.
2. The functionality bar.
3. Subject matter bars.
4. All of the above.
Answer
D. All of the above.
29.
If geographic marks that are deceptively misdescriptive are ineligible for trademark protection, then why was Amazon able to gain trademark protection for its name, which refers to a geographic area of South America?
1. The name “Amazon” is not indicative of the geographic source of the retailer’s goods, nor do consumers think those goods come from the Amazonian region.
2. The name “Amazon” is not a factor in whether or not consumers decide to purchase books, clothing, electronics, or anything else from the company.
3. Amazon’s brand stands for low prices and great customer service, not for anything of a geographic nature.
4. All of the above.
Answer
D. All of the above.
30.
As with copyrights, trademarks do not have to be registered with the federal government, but doing so gives their owners all of the following additional rights EXCEPT for which one?
1. The exclusive right to use the mark in their geographic area of business.
2. The ability to seek assistance from the U.S. Customs and Border Protection Service in preventing the importation of infringing foreign goods.
3. The exclusive right to use the mark nationwide.
4. The right to use the federal registration symbol ® instead of the ™ symbol.
Answer
A. The exclusive right to use the mark in their geographic area of business.
31.
You can’t file a trademark registration application unless you are currently engaged in business.
1. True.
2. False.
Answer
B. False.
32.
Which of the following explains why a trademark owner may assign it to another?
1. A business name change.
2. A bankruptcy proceeding.
3. As collateral for a loan.
4. All of the above.
Answer
D. All of the above.
33.
How does trademark infringement harm consumers?
1. By confusing consumers about the source of goods or services.
2. By allowing others to “palm off” lower-quality knockoffs in place of the high-quality goods they are seeking to buy.
3. By damaging trust between consumers and providers of goods and services.
4. All of the above.
Answer
D. All of the above.
34.
How is the “similarity” between two marks in a trademark infringement case determined?
1. By examining each individual component of a mark and seeing if another mark uses individual components that are similar.
2. By examining the totality of the two marks as seen and experienced by the consumer in the context of the goods or services on which they are used and seeing if they are similar enough to cause confusion or deception.
Answer
B. By examining the totality of the two marks as seen and experienced by the consumer in the context of the goods or services on which they are used and seeing if they are similar enough to cause confusion or deception.
35.
What is trademark dilution as opposed to trademark infringement?
1. Dilution occurs when a mark famous to the general American public is blurred or tarnished by a similar mark, regardless of whether that mark is used on similar goods or services.
2. Dilution occurs when a trademark grows weaker in the minds of consumers as a result of its owner not advertising or featuring it prominently enough on products.
Answer
A. Dilution occurs when a mark famous to the general American public is blurred or tarnished by a similar mark, regardless of whether that mark is used on similar goods or services.
36.
Which of the following is true about trademark remedies?
1. Damages can be significantly increased if trademark infringement is deemed willful.
2. Courts frequently use injunctions based on trademark law to stop the importation of products that once carried infringing marks even after those marks have been removed.
3. Federal trademark law also provides for punitive damages for trademark infringement.
Answer
A. Damages can be significantly increased if trademark infringement is deemed willful.
37.
A party may be permitted the fair use of another’s trademark under two conditions, known as nominative fair use and classic fair use. Which of the following is an example of nominative fair use?
1. When a business compares its products with those of a competitor, with no intent to confuse customers as to the source of the competitor’s goods.
2. When a trademark of another is used to refer to that other’s goods or services in legitimate connection with one’s own, such as a notice on the packaging of a small company’s graphic design program that it can run on the Microsoft Windows operating system.
3. Both of the above are correct.
Answer
B. When a trademark of another is used to refer to that other’s goods or services in legitimate connection with one’s own, such as a notice on the packaging of a small company’s graphic design program that it can run on the Microsoft Windows operating system. | textbooks/biz/Civil_Law/Introduction_to_Intellectual_Property_(OpenStax)/04%3A_Trademark_Basics/Chapter_4%3A_Assessment_Questions.txt |
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