CONSUMER PROTECTION

Pursuant to the common law doctrine of caveat emptor, the buyer could not recover from the seller for defects on the property that rendered the property unfit for ordinary purposes. Caveat emptor is Latin for let the buyer beware. Both Congress and state legislatures have enacted consumer protection laws intended to limit abuses inherent in the common law approach that would have the buyer beware. A person violating the provisions of a consumer protection statute is generally liable even though there was no intention to violate the law. Liability also exists even though the breach was a single occurrence rather than a pattern of repeated conduct

Proof of Consumer Status

A consumer claiming that there has been a violation of the consumer protection statute has the burden of proving that the statutory definition of consumer has been satisfied. The word consumer refers to individuals or households that use goods and services generated within the economy.

Action by Consumer

Some consumer protection statutes provide that a consumer who is harmed by a violation of the statutes may sue the business or organization that acted improperly. The consumer may sue to recover a specified penalty or may bring an action on behalf of consumers as a class. Consumer protection statutes are often designed to rely on private litigation as an aid to enforcement of the statutory provisions. In such an action, a consumer must show that the defendant engaged in misconduct of the kind prohibited by the applicable consumer protection statute.

Advertising

Consumer protection statutes commonly prohibit fraudulent advertising. Most advertising regulations are entrusted to an administrative agency, such as the Federal Trade Commission (FTC). The FTC is authorized to issue orders to stop false or misleading advertising. Statutes prohibiting false advertising are liberally interpreted. A business is liable for false advertising when it advertises a reduced price sale of a particular item, but that item is out of stock at the time the sale begins. It is no defense to the store that the pre-sale demand was greater than usual.

Under consumer protection statutes, deception rather than fraud, is the significant element. There can be a breach of a consumer protection statute even though there is no proof that the wrongdoer intended to defraud or deceive anyone. Instead of basing the law in terms of fault of the actor, the law is concerned with the problem of the buyer who is likely to be misled. The good faith of an advertiser or the absence of intent to deceive is immaterial. The purpose of false advertising legislation is to protect the consumer rather than to examine the advertiser’s motives.

The FTC requires that an advertiser maintain a file containing the data claimed to support an advertising statement as to safety, performance, efficacy, quality, or comparative price of an advertised product. The FTC can require the advertiser to produce this material, If it is in the interest of the consumer, the FTC can make this information public, except to the extent that it contains trade secrets or material that is privileged.

Corrective Advertising

When an enterprise has made false and deceptive statements in advertising, the Federal Trade Commission may require that new advertising be made in which the former statements are contradicted and the truth stated. This corrective advertising required by the Federal Trade Commission is also called retractive advertising.

Seals of Approval

Many commodities are sold or advertised with a sticker or tag stating that the article has been approved or is guaranteed by some association or organization. Ordinarily, when a product is sold in such a way, it will in fact have been approved by some testing laboratory and will probably have proven adequate to meet ordinary consumer needs. Selling with a seal of approval of a third person makes, in effect, a guarantee that the product has been so approved. A seller is liable if the product was, in fact, not approved.

Labeling

Closely related to the regulation of advertising is the regulation of labeling products. Various federal statutes are designed to give the consumer accurate information about the product, while others require warnings about dangers of use or misuse. Consumer protection regulations prohibit the use in the labeling of products with such terms as jumbo or giant which tend to exaggerate and mislead.

Selling Methods

Consumer protection statutes prohibit the use of improper and deceptive selling methods. These statutes are liberally construed to protect consumers from improper practices.

Deceptive Practices

Consumer protection statutes and deceptive trade practice acts are violated when the statements or the business methods of the defendant are deceptive. It is not necessary to prove that the defendant was guilty of fraud. It is immaterial that the defendant who misrepresented the facts did not intentionally do so.

 Disclosure of Transaction Terms

Contract on Two Sides

To be sure that the consumer sees disclosures required by federal law, special provision is made for the case when the terms of the transaction are printed on both the front and back of a sheet or contract. In such a situation, both sides of the sheet must carry the warning: NOTICE: see other side for important information.  Also, the page must be signed at the end of the second side.

Particular Sales and Leases

The Motor Vehicle Information and Cost Savings Act requires a dealer to disclose to the buyer various elements in the cost of an automobile. The act prohibits selling an automobile without informing the buyer that the odometer has been reset below the true mileage. A buyer who is caused actual loss by odometer fraud may recover from the seller three times the actual loss or $1,500, whichever is greater. There is a breach of this statute when the seller has knowledge that the odometer has turned at 100,000 miles but the seller then states that the mileage is 20,000 miles instead of 120,000. The Consumer Leasing Act of 1976 requires that persons leasing automobiles and other durable goods to consumers make a full disclosure to the consumer of the details of the transaction.

Although the statute imposes liability only when the seller knowingly violates the statute, it is not necessary to prove actual knowledge. For example, an experienced auto dealer cannot claim lack of knowledge that the odometer was false when that conclusion was reasonably apparent from the condition of the car.

Referral Sales

The technique of giving the buyer a price reduction for customers referred to the seller is theoretically lawful. In effect, it is merely paying the buyer a commission for the promotion of other sales. In actual practice, however, the referral sales technique is often accompanied by fraud or by exorbitant pricing. Therefore, consumer protection laws condemn referral selling in various ways. As a result, the referral system of selling has been condemned as unconscionable under the Uniform Commercial Code (UCC), and is expressly prohibited by the Uniform Consumer Credit Code (UCCC) which has been adopted by a number of states.

Contract with Consumers

Contracts with consumers are affected by consumer protection legislation in various ways.

Form of Contract

Consumer protection laws commonly regulate the form of the contract, requiring that payments under the contract to be itemized and allocation to such items as principal, interest, and insurance are to be clearly indicated; Generally, certain portions of the contract or all of the contract must be printed in type of a certain size, and a copy must be furnished to the buyer. Such statutory requirements are more demanding than the statute of frauds section of the UCC. It is frequently provided that the copy furnished the consumer must be completely filled in.

Contract Terms

Consumer protection legislation does not ordinarily affect the right of the parties to make a contract on whatever terms they choose. It is customary, however, to prohibit the use of certain clauses that are believed to unconscionable to the debtor or that have too great a potential for abuse by a creditor.

Acceleration Clauses

An acceleration clause is a contractual provision which allows the holder to declare the remaining balance due and payable immediately upon the occurrence of a default in the obligation. Parties to a credit transaction may agree that payment should be made in installments but that if there is a default with respect to any installment, the creditor may declare the entire balance due at once. This cancels or destroys the schedule for payments by making the entire balance immediately due. Such acceleration of the debt can cause the debtor great hardship. Because of this, some statutes limit or prohibit the use of acceleration clauses.

Price Gouging

Some consumer protection statutes are aimed at preventing price gouging with respect to goods or services for which the demand is abnormally greater than the supply. The New York statute provides: During any abnormal disruption of the market for consumer goods and services vital and necessary for the health, safety, and welfare of consumers, resulting from stress of weather, convulsion of nature, failure or short age of electric power or other source of energy . . . no merchant shall sell or offer to sell any such consumer goods or services for an amount which represents an unconscionably excessive price. Consumer goods and services are defined as “those used, bought, or rendered primarily for personal, family, or household purposes.” Such a statute protects, for example, purchasers of electric generators for home use during a hurricane-caused blackout.

Credit Cards

The credit card permits the cardholder to buy on the credit or reputation of the issuer of the card.

Unsolicited Credit Cards

The unsolicited distribution of credit cards to persons who have not applied for them is prohibited.

Surcharge Prohibited

According to some consumer protection statutes, a seller cannot add any charge to the purchase price because the buyer uses a credit card instead of paying with cash or a check.

Unauthorized Fee

A card holder is normally not liable for more than $50 for the unauthorized use of a credit card.

 Payments

Consumer legislation may provide that when a consumer makes a payment on an

open charge account, the payment must be applied toward payment of the earliest charges. The result is that, should there be a default at a later date, any right of repossession of the creditor is limited to the later, unpaid items.

Product Safety

The health and well-being of consumers is protected by a variety of statutes and rules of laws. Most states have laws governing the manufacture of various products and establishing product safety standards. The federal Consumer Product Safety Act provides for research and the setting of uniform standards for products in order to reduce health hazards. This act also establishes civil and criminal penalties for the distribution of unsafe products. It also recognizes the right of a person to sue for money damages and to obtain an injunction against the distribution of unsafe products.  The Act also creates a Consumer Product Safety Commission to administer it.

The federal Anti-Tampering Act makes it a federal crime to tamper with consumer products.

Credit, Collection and Billing Methods

The Equal Credit Opportunity Act (ECOA) was passed in order to make sure that consumer credit was awarded based on an applicant’s credit worthiness rather than the applicant’s age, sex, color, religion, or national origin.  For example, a lender cannot consider the following when making a loan: race; marital status; receipt of public assistance income; receipt of alimony or child support; or future plans for children. Spouses have rights to individual credit application and consideration. The other spouse’s income does not have to be disclosed unless the applicant is relying on that income to qualify for credit.

The penalties for violating the ECOA are the actual damages and the possibility of punitive damages of up to $10,000.  If there is a pattern or practice of violations, a class action may be filed which can result in damages up to $500,000 or 1% of the net assets of the defendant, whichever is less.

The Truth-in-Lending Act (TILA) is part of the Federal Consumer Credit Protection Act.  The purpose of the TILA is to make full disclosure to debtors of what they are being charged for the credit they are receiving. The Act merely asks lenders to be honest to the debtors and not cover up what they are paying for the credit.  Regulation Z is a federal regulation prepared by the Federal Reserve Board to carry out the details of the Act.

TILA applies to consumer credit transactions.  Consumer credit is credit for personal or household use and not commercial use.  TILA applies to both open end and closed end transactions.  Examples of open -end transactions are credit cards, lines of credit, and revolving charge accounts.  Closed-end transactions involve a fixed amount to be paid back over a period of time such as a note or a retail installment contract.  Open-end disclosure requirements include: finance charges (including interest), the dates that bills will be sent and what, if any, security interest is being taken.  Bills must contain the following information:

  • balance from last statement;
  • payments and credits;
  • new charges made since last statement;
  • finance charges on unpaid balance;
  • the billing period covered by the bill;
  • the time period in which payment can be made in order to avoid a finance charge (e.g., 30 days); and
  • information regarding billing errors — what to do and where to inquire about billing errors.

When an organization solicits consumer to use its credit card, the solicitation must include the following disclosures:

  • fees for issuing the card;
  • APR for the card;
  • minimum or fixed finance charges;
  • any transaction charges;
  • grace periods (if any);
  • how the daily balance is computed;
  • when payments will be due;
  • what the late payment will be; and
  • any charges that will be assessed for going over the credit limit.

Disclosures regarding closed-end credit must include:

  • amount being financed;
  • finance charges
  • annual percentage rate;
  • number of payments and when due;
  • total cost of financing (price of goods plus all finance charges);
  • any penalties for prepayment or late payment;
  • any security interest or lien in the goods sold or used as collateral; and
  • any credit insurance cost.

In advertisements that include part of the credit terms, all the credit terms must be disclosed.  If payments are disclosed, the creditor must disclose the annual percentage rate (APR), the down payment, and the number of payments.

Regulation Z gives a three-day cooling-off period for certain credit contracts.  This cooling-off period applies in a credit situation when the debtor’s home is given as security for the loan or a home solicitation sale is involved. The Home Equity Loan Consumer Protection Act of 1988 applies to home equity loans and provides for additional disclosures, e.g., that the debtor can lose his home in the event of a default.

The penalties for violation of the TILA include an amount equal to two times the amount of the finance charges with a minimum recovery of $100 and a maximum recovery of $1000 plus any punitive damages.  In a class action law suit the maximum amount of damages is $500,000 or 1% of the creditor’s net worth, whichever is less.

The Fair Credit Billing Act requires monthly statements on open-end credit transactions.  The bill must contain an address for the debtor to write in order to report errors in the bill.  Any such notification must be sent within 60 days of the bill’s receipt. The creditor then has thirty days in which to acknowledge the notification and ninety days to take action.  The debtor does not have to pay the protested amount during this period of time.  Once the matter is resolved, the debtor must pay the correct amount owed.  If the creditor does not comply with the time limits of the Act the debtor does not have to pay the disputed amount, even if it is correct.

The Fair Credit Reporting Act regulates the use of information on a consumer’s personal and financial condition.  The most typical transaction which this Act would cover would be where a person applies for a personal loan or other consumer credit.  Consumer credit is credit for personal, family, or household use, and not for business or commercial transactions.  Also, this Act can apply when a person applies for a job or even a policy of insurance when certain investigations are made of the applicant.

The purpose of the Act is to insure that consumer information obtained and used is done in such a way as to insure its confidentiality, accuracy, relevancy and proper utilization.  Under the Act, consumer reports are communications in any form by which furnishes informa­tion on consumers to potential creditors, insurers or employers.

Upon request, a credit bureau must tell a consumer the names and addresses of persons to whom it has made a credit report on that consumer during the previous six months.  It also must tell, when requested, what employers were given such a report during the previous two years.

Some information obtained by credit reporting bureaus is based on statements made by persons, such as neighbors who were interviewed by the bureau’s investigator.  Needless to say, these statements are not always correct and are sometimes the result of gossip.  In any event, such statements may go on the records of the bureau without further verification and may be furnished to a client of the bureau who will regard the statements as accurate.  A person has the limited right to request an agency to disclose the nature and substance of the information possessed by the bureau to see if the information is accurate.  If the person claims that the information of the bureau is erroneous, the bureau must take steps within a reasonable time to determine the accuracy of the disputed items.  If no correction is made, the debtor can write a 100 word statement of clarification which will be included in future credit reports, even it the agency disagrees with clarification.

The FCRA requires that a credit reporting agency follow reasonable procedures to assure accuracy of the information it gathers.  Adverse information obtained by investigation cannot be given to a client after three months unless it is verified to determine that it is still valid.

Credit reporting bureaus are not permitted to disclose information to persons not having a legitimate use for this information.  It is a federal crime to obtain or to furnish a credit report for an improper purpose. Under the FCRA, agencies can only disclose information to the following:

  • a debtor who asks for his own report;
  • a creditor who has the debtor’s signed application for credit;
  • a potential employer; and
  • a court pursuant to a subpoena.

The Consumer Leasing Act is an amendment to TILA and provides disclosure protection for consumers who lease goods.  Basically, these disclosures fall into three categories:

  • how much is paid by the consumer over the life of the lease;
  • how much, if any, is owed by the consumer at the end of the lease; and
  • whether or not the lease can be terminated.

The Fair Debt Collection Practices Act (FDCPA) prohibits harassment or abuse in collecting a debt such as threatening violence, use of obscene or profane language, publishing lists of debtors who refuse to pay debts, or even harassing a debtor by repeatedly calling the debtor on the phone.  Also, certain false or misleading representa­tions are forbidden, such as representing that the debt collector is associated with the state or federal government, or stating that the debtor will go to jail if he does not pay the debt. This Act also sets out strict rules regarding communicating with the debtor.

The FDCPA applies only to those who regularly engage in the business of collecting debts for others — primarily to collection agencies.  The Act does not apply when a creditor attempts to collect debts owed to it by directly contacting the debtors.  It applies only to the collection of consumer debts and does not apply to the collection of commercial debts.  Consumer debts are debts for personal, home, or family purposes.

When a collector contacts a debtor, if the debtor asks for verification of the debt, the collector must provide this verification in writing.  The debtor must include the amount of the debt, the name of the creditor, and the debtor’s right to dispute the debt.

The collector is restricted in the type of contact he can make with the debtor.  He can’t contact the debtor before 8:00 a.m. or after 9:00 p.m.  He can contact the debtor at home, but cannot contact the debtor at the debtor’s club or church or at a school meeting of some sort.  The debtor cannot be contacted at work if his employer objects.  If the debtor tells the creditor the name of his attorney, any future contacts must be made with the attorney and not with the debtor.  The debtor can call off the collection contacts at any time.  The collector would then have to use other collection means like filing suit.

The Act prohibits contacting other people about the debtor’s debts, with the exception of the debtor’s spouse and parents.  Another exception is that third parties can be contacted in order to get the debtor’s address, phone number and place of employment.  Contact with the debtor by postcard is prohibited because someone other than the debtor may see the contents of the postcard.

When a collection agency violates the Act, it is liable to the debtor for damages, and it is no defense that the debtor in fact owed the money that the agency was seeking to collect.  Debtors can collect up to $1,000 in actual damages in addition to actual damages.  Also the Federal Trade Commission can get a cease and desist order to stop any unlawful practices.

If a creditor files a civil suit for the debt and gets a judgment, he will have to execute on that judgment unless the defendant voluntarily pays the judgment.  One way of execution is garnishment where a judgment creditor serves a writ of garnishment on the debtor’s employer.  The employer is then required to withhold part of the debtor’s wages for payment to the creditor in satisfaction of the judgment.  The Consumer Credit Protection Act limits the amount that can be garnished to 25% of the debtor’s net wages.  A judgment creditor can also garnish a debtor’s bank account or an account receivable due to the debtor.  Basically, any debt due to the debtor can be garnished.

Privacy and Information Law

Protect Your Online Information and Avoid Being Scammed

OnGuardOnline.gov provides practical tips from the federal government and the technology industry to help you be on guard against Internet fraud, secure your computer, and protect your personal information. The Federal Trade Commission (FTC) maintains OnGuardOnline.gov. Much of the following information in this section came from the  OnGuardOnline.gov website.

Protect your personal information.

To an identity thief, your personal information can provide instant access to your financial accounts, your credit record, and other assets. Anyone can be a victim of identity theft. There are almost 10 million victims every year. Some cases start when online data is stolen. You can go to www.ftc.gov/idtheft to learn what to do if your identity is stolen.

When it comes to crimes like identity theft, you can’t entirely control whether you will become a victim. But following these tips can help minimize your risk while you’re online:

If you’re asked for your personal information (e.g., your name, email or home address, phone number, account numbers, or Social Security number) find out how it’s going to be used and how it will be protected before you share it. If you have children, teach them to not give out your last name, your home address, or your phone number on the Internet.

If you get an email or pop-up message asking for personal information, do not reply or click on the link in the message. The safest course of action is not to respond to requests for your personal or financial information. If you believe there may be a need for such information by a company with whom you have an account or placed an order, contact that company directly in a way you know to be genuine. In any case, do not send your personal information via email because email is not a secure transmission method.

If you are shopping online, do not provide your personal or financial information through a company’s website until you have checked for indicators that the site is secure, like a lock icon on the browser’s status bar or a website URL that begins “https:” (the “s” stands for “secure”). Unfortunately, no indicator is foolproof; some scammers have forged security icons.

Read website privacy policies. They should explain what personal information the website collects, how the information is used, and whether it is provided to third parties. The privacy policy also should tell you whether you have the right to see what information the website has about you and what security measures the company takes to protect your information. If you do not see a privacy policy, or can not understand it, consider doing business elsewhere.

Know with whom you’re dealing.       

It is remarkably simple for online scammers to impersonate a legitimate business, so you need to know whom you’re dealing with. If you’re shopping online, check out the seller before you buy. A legitimate business or individual seller should give you a physical address and a working telephone number at which they can be contacted in case you have problems.

Phishing is the act of sending an e-mail to a user falsely claiming to be an established legitimate enterprise in an attempt to scam the user into surrendering private information that will be used for identity theft. The e-mail directs the user to visit a website where they are asked to update personal information, such as passwords and credit card, social security, and bank account numbers, that the legitimate organization already has. The Web site, however, is bogus and set up only to steal the user’s information.

For example, in 2003 there was a phishing scam in which users received e-mails supposedly from eBay claiming that the user’s account was about to be suspended unless he clicked on the provided link and updated the credit card information that the genuine eBay already had. Because it is relatively simple to make a website look like a legitimate organizations site by mimicking the HTML Code, the scam counted on people being tricked into thinking they were actually being contacted by eBay and were subsequently going to eBay’s site to update their account information. By spamming large groups of people, the “phisher” counted on the e-mail being read by a percentage of people who actually had listed credit card numbers with eBay legitimately.

Phishers send spam or pop-up messages claiming to be from a business or organization that you might deal with, for example, an Internet service provider (ISP), bank, online payment service, or even a government agency. Again, the message usually says that you need to “update” or “validate” your account information. It might threaten some dire consequence if you do not respond. The message directs you to a website that looks just like a legitimate organization’s, but is not. The purpose of the bogus site is to trick you into divulging your personal information so the operators can steal your identity and run up bills or commit crimes in your name. Do not take the bait. Never reply to or click on links in email or pop-ups that ask for personal information. Legitimate companies do not ask for this information via email. If you are directed to a website to update your information, verify that the site is legitimate by calling the company directly, using contact information from your account statements.

Every day, millions of computer users share files online. File-sharing can give people access to a wealth of information, including music, games, and software. You download special software that connects your computer to an informal network of other computers running the same software. Millions of users could be connected to each other through this software at one time. Often the software is free and easily accessible. But file-sharing can have a number of risks. If you do not check the proper settings, you could allow access not just to the files you intend to share, but also to other information on your hard drive, like your tax returns, email messages, medical records, photos, or other personal documents. If you decide to use file-sharing software, set it up very carefully. Take the time to read the End User Licensing Agreement to be sure you understand and are willing to tolerate the side effects of any free downloads.

Many free downloads come with potentially undesirable side effects. Spyware is software installed without your knowledge or consent that adversely affects your ability to use your computer, sometimes by monitoring or controlling how you use it. To avoid spyware, resist the urge to install any software unless you know exactly what it is. Your anti-virus software may include anti-spyware capability that you can activate, but if it does not, you can install separate anti-spyware software, and then use it regularly to scan for and delete any spyware programs that may sneak onto your computer.

Use anti-spyware software, as well as a firewall, and update them all regularly.

Firewalls help keep hackers from using your computer to send out your personal information without your permission. While anti-virus software scans incoming email and files, a firewall is like a guard, watching for outside attempts to access your system and blocking communications to and from sources you don’t permit. Some operating systems and hardware devices come with a built-in firewall that may be shipped in the “off” mode. Make sure you turn it on. For your firewall to be effective, it needs to be set up properly and updated regularly.

If your operating system does not include a firewall, get a separate software firewall that runs in the background while you work, or install a hardware firewall — an external device that includes firewall software.

Be sure to set up your operating system and Web browser software properly, and update them regularly.                                                                                        

Hackers also take advantage of Web browsers (like Internet Explorer or Netscape) and operating system software (like Windows or Linux) that are unsecured. Lessen your risk by changing the settings in your browser or operating system and increasing your online security. Check the “Tools” or “Options” menus for built-in security features. If you need help understanding your choices, use your “Help” function.

Your operating system also may offer free software patches that close holes in the system that hackers could exploit. In fact, some common operating systems can be set to automatically retrieve and install patches for you. If your system does not do this, bookmark the website for your system’s manufacturer so you can regularly visit and update your system with defenses against the latest attacks. Updating can be as simple as one click. Your email software may help you avoid viruses by giving you the ability to filter certain types of spam.

If you are not using your computer for an extended period, turn it off or unplug it from the phone or cable line. When it’s off, the computer doesn’t send or receive information from the Internet and isn’t vulnerable to hackers.

  • Protect your passwords. Keep your passwords in a secure place, and out of plain view. Don’t share your passwords on the Internet, over email, or on the phone. Your Internet Service Provider (ISP) should never ask for your password. In addition, hackers may try to figure out your passwords to gain access to your computer. You can make it tougher for them by:       
  • Using passwords that have at least eight characters and include numbers or             symbols.
  • Avoiding common words: some hackers use programs that can try every word in       the dictionary.
  • Not using your personal information, your login name, or adjacent keys on the           keyboard as passwords.
  • Changing your passwords regularly (at a minimum, every 90 days).
  • Not using the same password for each online account you access.

Internet fraud

If a scammer takes advantage of you through an Internet auction, when you’re shopping online, or in any other way, report it to the Federal Trade Commission, at ftc.gov. The FTC enters Internet, identity theft, and other fraud-related complaints into Consumer Sentinel, a secure, online database available to hundreds of civil and criminal law enforcement agencies in the U.S. and abroad.

Deceptive Spam If you get deceptive spam, including email phishing for your information, forward it to spam@uce.gov. Be sure to include the full header of the email, including all routing information. You also may report phishing email to reportphishing@antiphishing.org. The Anti-Phishing Working Group, a consortium of ISPs, security vendors, financial institutions and law enforcement agencies, uses these reports to fight phishing.

Divulged Personal Information                                                                                       

If you believe you have mistakenly given your personal information to a fraudster, file a complaint at ftc.gov, and then visit the Federal Trade Commission’s Identity Theft website at www.ftc.gov/idtheft to learn how to minimize your risk of damage from a potential theft of your identity.

 

Intellectual Property Law

Intellectual property is an area of law that deals with protecting the rights of those who create original works. It covers everything from original plays and novels to inventions and company identification marks. It can be a play, a novel, a product invention, a marketing plan, a logo or many other things The purpose of intellectual property laws are to encourage new technologies, artistic expressions and inventions while promoting economic growth.

Trademarks and Service Marks: A “trademark” is a word, design or combination used by an individual or a business to identify its goods or services. In some cases a trademark can also be a sensory mark–a sound, a color or a smell. While marks identifying services rather than goods are technically referred to a “service marks” we will use the term trademarks to include service marks. Trademarks protect names used to identify goods (or services) and their source of origin. The law protects trademarks in part because trademarked items tend to carry with them certain quality assurances – one would expect an automobile carrying the Rolls Royce trademark to be far superior to most other automobiles. You may use any kind of name or symbol as a trademark to identify your product.

A mark is any word, name, symbol, or design that identifies a product or service.  A trademark identifies a product (for example, Coca‑Cola).  A service mark identifies a service (for example, Holiday Inn). A mark may be registered with the United States Patent and Trademark Office (USPTO) if the mark distinguishes a person’s product or service from products or services of competitors.  Registration of a mark on the Principal Register of the USPTO entitles a person the exclusive use of the mark. Registration can also be accomplished with a State (usually with the Secretary of State of a particular state).  However, State registration does not provide as much protection as Federal registration. Before a mark can be registered, it must be used by the “owner,” and it must distinguish goods or services from others.  The owner of a mark cannot register it with the United States Patent and Trademark Office unless the mark is used in interstate commerce.

Generic terms that merely describe a class of products cannot be registered.  For example, the term motor oil or the word airline would not be accepted for registration.  Descriptive or geographical terms cannot be registered unless they have acquired a secondary meaning.  A mark acquires a secondary meaning when, through long usage, the public identifies the mark with a particular product.  For example, Best Western Motels involves a mark which has a secondary meaning.

One can be an owner of a trademark or service mark, whether or not it is registered.  This is common law protection.  Registration is proof of ownership and makes ownership rights easier to enforce.  The basic question in lawsuits over marks is whether or not the general public is likely to be confused as to the origin of the service or product.

If the owner of a mark permits widespread use of the mark to describe a general class of products, the exclusive right to the mark may be lost.  Two examples are cellophane and aspirin.

Trade dress is the total appearance of a product, including its packaging, label, shape, and size.  Trade dress may also include physical structures associated with a particular product or service, such as the “golden arches” of McDonald’s.  Trade dress may qualify as a protected trademark or service mark if it is distinctive and identifies the source of a specific product or service.

Copyrights: A “copyright” offers protection for original works of authorship. Copyright protection affords the author of a copyrighted work with specific rights that the author can give or sell to others or keep for him/herself. The concept of copyright protection in the United States is set forth in the original U.S. Constitution which allows Congress to pass laws that promote and encourage the process of the useful arts.

The word copyright can be defined as a property right in an original work of authorship (such as a literary, musical, artistic, photographic, or film work) fixed in any tangible medium of expression, giving the holder the exclusive right to reproduce, adapt, distribute, perform, and display the work. Copyright protection may be received regarding a wide range of creative, intellectual, or artistic forms or works. These include poems, plays, and other literary works, movies, choreographic works (dances, ballets, etc.), musical compositions, audio recordings, paintings, drawings, sculptures, photographs, radio and television broadcasts. The creator of the work has a limited monopoly on the work and can, with some exceptions, prohibit others from copying or displaying the work.  The United States copyright law is contained in Chapters 1 through 8 and 10 through 12 of Title 17 of the United States Code.

Works published after 1922, but before 1978 are protected for 95 years from the date of publication. If the work was created, but not published, before 1978, the copyright lasts for the life of the author plus 70 years. However, even if the author died over 70 years ago, the copyright in an unpublished work lasts until December 31, 2002. And if such a work is published before December 31, 2002, the copyright will last until December 31, 2047.

All works published in the United States before 1923 are in the public domain. The term public domain refers to creative materials that are not protected by intellectual property laws such as copyright, trademark or patent laws. The public owns these works, not an individual author or artist. Anyone can use a public domain work without obtaining permission, but no one can ever own it.  Once a copyright expires, it is in the public domain and no longer has protection.  Works created by the federal government are also in the public domain.

A copyright is obtained simply by creating the work.  It comes into existence automatically on the date it is created.  However, in order to get federal protection of a copyright, the creator of the work has to file two copies of the work with the Copyright Office in Washington, D.C.

Copyright law is designed to create an incentive for creativity by allowing the author to profit from his work. The Act tries to balance this need to protect the author with the public’s need for free and open discussion. A copyright owner has the exclusive right to:

  1. Reproduce the work;
  2. Prepare derivative works, such as a script from the original work (e.g., movie script for Book The Rainmaker);
  3. Distribute copies or recordings of the work; and
  4. Publicly display the work in the case of paintings, sculptures and photographs.

The Copyright Act contains several exemptions that allow a person or institution to use or copy a copyrighted work without the owner’s permission.  Three commonly used exemptions are:

  • the fair use doctrine which allows copying for such purposes such as teaching;
  • the right of libraries to make limited copies; and
  • certain performances and displays for teaching or religious purposes.

The fair use doctrine allows reasonable use of copyrighted works (without requiring the author’s permission) for teaching, research, and news reporting.  The Federal Act states: “[T]he fair use of a copyrighted work, including such use by reproduction in copies . . . for purposes such as criticism, comment, news reporting, teaching (including multiple copies for classroom use), scholarship, or research, is not an infringement of copyright.”

There are four important factors that must be looked at when determining whether or not the fair use doctrine applies:

  • the purpose of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes;
  • the nature of the copyrighted work;
  • the amount of the portion used in relation to the copyrighted work as a whole; and
  • the effect of the use on the potential market for or value of the copyrighted work.

If a work is a “work made for hire,” this means that a person was hired specifically to create the copyrighted work.  The employer of the creator of the work can register the copyright and is entitled to protection.

Patents: A “patent” is a grant of a property right by the Government to an inventor. The United States Constitution gives Congress the right to provide for patent protection in legislation in order to encourage useful inventions. The patent itself provides a detailed description of the invention, and how it is used or how to make it. Thus, if you obtain a patent you cannot keep the matter secret, which is the province of Trade Secret Law. A patent enables the owner to exclude others from making, using or selling the invention for the life of the patent.

Federal statutes give an inventor the exclusive right to use, sell, and market his invention. The types of things that can be patented are things that are new, useful, and not obvious to those in the business to which the invention relates.  An invention also may be a process, a new chemical or even a new type of plant.

Patents are granted by the U.S. Patent and Trademark Office in Washington, D.C. There are three types of patents:

  1. Utility Patents: These are granted for most new products or processes and are valid for 20 years;
  1. Design Patents: These are granted for new and original designs for manufactured goods and are good for 20 years; and
  1. Plant Patents: These are granted for developing a new type of plant.

The difference between a design patent and a utility patent is that a design patent protects the ornamental design, configuration, improved decorative appearance, or shape of an invention. This patent is appropriate when the basic product already exists in the marketplace and is not being improved upon in function but only in style. For example, designer eyeglass frames, the original Coca-Cola bottles, and “Pet Rocks” would have all been protected with design patents. A U.S. design patent generally lasts for 14 years.

A utility patent protects any new invention or functional improvements on existing inventions. This can be to a product, machine, a process, or even composition of matter. Examples of a utility patent would include a better carburetor, a new type of self-fastening diaper or a new recipe. The life of a U.S. utility patent lasts 20 years from the date of filing assuming the patent is granted, but the owner of the patent must pay maintenance fees to the United States Patent and Trademark Office (USPTO) to keep a utility patent from expiring.

A plant patent may be issued for a new and distinct, invented or discovered asexually reproduced plant including cultivated mutants, hybrids, and newly found seedlings, other than a plant found in an uncultivated state. A plant patent permits its owner to exclude others from making, using, or selling the plant for a period of up to twenty years from the date of patent application filing.  Plant patents are not subject to the payment of maintenance fees.

Before a patent is granted the applicant must submit his idea to a patent examiner in the patent office who will make a determination as the whether or not the invention is new and not obvious to a person of ordinary skill in the area in which the invention is related.  The examiner’s decision can be appealed to the Board of Patent Appeals or the Court of Appeals for D.C. circuit.

The owner of a patent is required to mark the word patent on the item patented and also put the patent number on the item.  Failure to do this can prevent the patent holder from recovering damages is an infringement case.

Employers sometimes require employees to sign an agreement to assign any right to an invention of the employee to the employer.  The invention must be related to the employer’s business, or this assignment would possibly be void as a violation of public policy.

Trade Secrets: A formula, process, or information that is secret, and gives its owner a business advantage may be protected under State laws concerning trade secrets.  Trade secrets, basically, are any formula, device, or information that is used in a business, and is of such a nature that it gives the owner an advantage over competitors who do not have the information. Customer lists may be protected unless they can be easily developed from public information. Trade secrets are protected under State law rather than Federal law.  This protection may be by virtue of common law or statutory law, such as the Uniform Trade Secrets Act.

When a trade secret is made public, it loses its protection as a trade secret unless it is disclosed in a restrictive manner to persons who know of its confidential nature.

Generally, computer programs may be copyrighted.  The Computer Software Copyright Act protects copyrighted programs from infringement.  In some cases, computer programs may be patented.  However, since patents are public record, there is a danger that the program might be copied by someone.  Trade secrets laws are sometimes used to protect computer programs.

Sometimes creators of software will require users to sign a licensing agreement which provides greater protection than the copyright laws.  Sample restrictions include limited reverse engineering, which is a method of learning the structure of a program and limiting the renting of the program of third parties in order to prevent unauthorized copying.

Remedies for Violation of Property Rights

When property is harmed, taken, or destroyed, the most common remedy is an action for monetary damages.  The property itself may be recovered if unlawfully taken.  Wrongful use of a copyright, trademark, service mark, or patent can result in injunctive action, as well as a suit for damages.  If an infringement is intentional, profits resulting from the infringement may also be obtained.

Infringement of a trademark or service mark occurs when a person uses or copies the trademark or service mark of another person without the person’s permission (e.g., putting Nike label on shoes and selling them).

An Overview of Contract Law

Introduction
A contract is a binding agreement between two or more parties. This agreement creates one or more obligations. Each party to a contract is legally bound to do, or to refrain from doing, certain acts. The essence of a contract is that by mutual agreement, parties create obligations that can be legally enforced.

The elements of a contract are:
• an agreement;
• between competent parties;
• based upon the genuine assent of the parties;
• supported by consideration;
• made for a lawful objective; and
• in the form required by law.

A voidable contract is an agreement that would be binding and enforceable except the circumstances surrounding its execution, or the fact that one of the parties lacks capacity, makes the contract voidable at the option of one of the parties. For example, a person who has been forced to sign an agreement may avoid being bound by the agreement.

A void agreement is an agreement which is without legal effect. For example, an agreement which deals with the performance of an illegal act is void. A gambling contract in many states is void.

An executed contract is a contract that has been completely performed. Nothing remains to be done by either party. For example, if you go into a furniture store and agree with the salesman to pay $400.00 for a chair and then pay the salesman cash and take delivery of the furniture, the contract has been completely executed.

In an executory contract, something remains to be done by one or both of the parties. For example, if a contract is executed between a seller and a buyer regarding the purchase of land, and both parties agree that the sale will be consummated after the buyer obtains his loan and the seller gives a certificate of title (showing no defects), the contract is enforceable, but it is said to be executory.

An option contract is a contract that gives the right to one party to enter into a second contract with the other party at a later date. One of the most common forms of option contracts deals with the sale of real estate. In this contract, the prospective buyer will be granted an option to purchase the property within a specified period of time. The prospective buyer will pay the seller a sum of money since the seller is, in effect, taking the property off the market during the option period. If the prospective buyer exercises his option during that time, a second contract is entered into regarding the sale of the property. If the option period expires, then neither party has any obligation to the other.

Agreement
One of the essential elements of a contract is an agreement. An agreement shows that the parties have bound themselves to act or refrain from acting in a manner specified by the contract. It is essential to a contract that there be an offer and, while the offer is still in existence, it is accepted without qualification. An offer expresses the willingness of the offeror to enter into a contract agreement regarding a particular subject.

To constitute an offer, the offeror must intend to create a legal obligation, or he must appear to a reasonable person to intend to create a legal obliga¬tion. This intent can be shown by conduct. For example, when one party signs a written contract and sends it to the other party, this action is an offer to enter into a contract on the terms of the writing. Again, the offeror must intend to create a legal obligation. No contract comes into being when an offer is made jokingly, or under any other circumstances under which a reasonable person would not regard such an offer as an intent to enter into a binding agreement.

Hypothetical: Richard discusses selling a farm to Lucy. After a 40-minute discussion of the first draft of a contract, Richard signs a second draft stating: “I hereby agree to sell to Lucy the Richard Family Farm for $50,000 with title satisfactory to buyer.” Lucy agrees to purchase the farm on these terms. Thereafter, Richard refuses to transfer title to Lucy claiming that he had made the contract as a joke and there was no contract. Was Richard correct? No. There was a binding contract because it would appear to a reasonable person that there was a serious transaction in which the parties made an agreement with contractual intent. The long discussion on the first draft and the execution of a second draft contradicted any claim that the transaction was not serious. The agreement was therefore binding; that is, a contract existed.

Hypothetical: The Smith Music Company advertised a television set at $22.50 in the Sunday paper. Ehrlich ordered a set, but the company refused to deliver it on the grounds that the price in the newspaper was a mistake. Was the Company liable? No. The newspaper ad was merely an invitation to the public to make offers. It was not an offer that could be accepted by placing an order with the company. Consequently, a purported “acceptance” by a customer did not result in a binding contract, but was merely an offer that did not become a contract until accepted by the advertiser.

An invitation to negotiate is not an offer. Newspaper advertisements, price quotations, and catalog prices are ordinarily just invitations to negotiate and cannot be accepted in a contractually-binding manner. No seller has an unlimited supply of any commodity and therefore cannot possibly be deemed to have intended to make a contract with everyone who sees the advertisement or seeks to accept the price offered.

Assuming that an offer is made with intent to be bound, it still is not a legal offer unless it is communicated to the offeree. This offer may be communicated by the offeror or at his direction. If the offeree hears about the offer indirectly, through the grapevine so to speak, he cannot accept the offer until it is communicated to him by the offeror or at the offeror’s direction.

An offer can be withdrawn before acceptance and therefore prevent a contract from arising. If an offer is withdrawn or terminated, an attempted acceptance after the termination has no legal effect. Ordinarily, an offer may be revoked at any time by the offeror prior to acceptance. All that is required is the showing by the offeror of his intent to revoke the offer and communication of this intent to the offeree.

Offers may be terminated in any one of the following ways:
• Revocation of the offer by the offeror;
• A counteroffer by offeree;
• A rejection of the offer by offeree;
• Lapse of a sufficient amount of time;
• Death or disability of either party; or
• Performance of the contract becomes illegal after the offer is made.

The general rule is that the revocation is effective only when it is made known to the offeree. Until it is communicated to the offeree, directly or indirectly, the offeree has reason to believe that there still is an offer that may be accepted. The offeree may rely on this belief.

If the offeror seeks to revoke the offer, but the offeree accepts the offer before notice of the revocation, a valid contract is created. Say, for example, Smith promises to sell 100 widgets to Jones. Smith then changes his mind. Smith mails a letter of revocation to Jones. Jones, in the meantime, sends a fax to Smith accepting the offer before Jones receives Smith’s letter. There is a binding contract.

If Smith makes an offer to Jones to sell Jones a car for $10,000.00, and Jones replies the he will purchase it for $7,500.00, the original offer is terminated. Jones in effect is refusing the original offer and making a counteroffer. The original offer of $10,000.00 cannot be accepted. A new offer of $10,000.00 can later be made, but the original offer is no longer effective.

A conditional acceptance is also a counteroffer. For example, if Jones accepts the $10,000.00 price, but adds a term by stating that new tires must be put on the car, this is a conditional acceptance and therefore a counteroffer.

A rejection also terminates an offer. A rejection is an offeree’s communication that an offer is unacceptable.

When an offer states that it will be open until a particular date, the offer terminates on that date if it has not yet been accepted. This is particularly true when the offeror declares that the offer shall be void after the expiration of a specific time. If the time passes, and the offeree then attempts to accept the offer, this is in effect a counteroffer from the offeree and can be accepted or rejected by the offeror.

If the offer does not specify a time, it will terminate after a reasonable time has passed. What constitutes a reasonable time depends on the circumstances of each case. For example, if the commodity to be sold or purchased is a perishable commodity, such as food, the reasonable time would be shorter than if the commodity to be sold is machinery.

If the performance of the contract becomes illegal after the offer is made, the offer is deemed to be terminated. For example, if there is an offer made to sell alcoholic beverages to a store, but a city ordinance is passed prohibiting the sale of alcoholic beverages before the offer is accepted, the offer is terminated.

If the offeror does not otherwise specify, a mailed accep¬tance takes effect when the acceptance is properly mailed. This is known as the “Mailbox Rule.” If the offeror specifies that an acceptance shall not be effective until received, the Mailbox Rule would not apply and there is no acceptance until acceptance is received.

Hypothetical: Thompson owns 100 acres of land. Morrison mails an offer to Thompson to buy his land. Thompson agrees to this offer and mails back a contract signed by him. While this letter was in transit, Thompson orally notifies Morrison that his acceptance is revoked. Is Thompson bound by a contract? Yes, since the acceptance was effective when mailed. Subsequent revocation had no effect.

Improperly mailing an acceptance can destroy the acceptance. Improper mailing can cause the acceptance to take effect only when received.

Competent Parties
The law generally presumes that everyone has the capacity to contract. However if a party does lack capacity, then the contract is voidable and the party without capacity, or his representative, may avoid the contract.

Parties to an agreement must have contractual capacity before the agreement will be binding on both parties. Contractual capacity is the ability to understand that a contract is being made and to understand its general nature. The fact that a person does not fully understand the full meaning and all ramifications of a contract does not mean that the person lacks contractual capacity.

Some classes of persons, such as people under the age of 18 in most states, are deemed by law to lack contractual capacity. With some exceptions, a contract made by a minor is voidable. The minor, in other words, may avoid the legal liability under a contract. Upon reaching the age of majority, a minor may affirm or ratify the contract and therefore make it contractually binding on him. Any expression of the minor’s intention to avoid the contract will void the contract. A minor can only avoid a contract during his minority status and only for a reasonable time after he reaches the age of majority. After a reasonable period of time, the contract is deemed to be ratified and cannot be avoided.

Parents of a minor are not liable regarding the contracts made by the minor merely because they are the parents of the minor. However, if a minor makes a contract and a parent signs along with the minor as a co-signer, the parent can be held liable.

A person who is mentally incompetent (NCM) lacks the capacity to make a contract. The cause of the mental incompetency is immaterial. It can be the result of a mental illness, excessive use of drugs or alcohol, a stroke, etc. If the person does not have the mental capacity to understand that a contract is being made or the general nature of the contract, the person lacks contractual capacity. A person who is mentally incompetent may ordinarily avoid a contract in the same manner as a minor. If the person later becomes competent, he can ratify or avoid the contract at that time.

Consent
The third element necessary to form a contract is the consent or understanding of the parties regarding the proposed contract. The consent or assent of a party to an agreement must be genuine and voluntary. This assent will not be genuine or voluntary in certain cases of mistake, deception or undue pressure. If the apparent agreement does not reflect the true intention of the parties, it is possible to have the agreement set aside.

The agreement of parties may be affected by the fact that one or both of them made a mistake. A unilateral mistake is a mistake made by one party to the agreement. A mistake that is unknown to the other party usually does not affect the enforceability of the agreement. A unilateral mistake regarding a fact does not affect the contract. For example, if a customer orders a water-resistant coat thinking that this means waterproof, the customer cannot get out of the contract unless the sale was made with some sort of misrepresenta¬tion as to the meaning of those words.

Failure to read a document before signing it can still cause the signer to be liable under the terms of the document. For example, suppose the president of ABC Corporation signs a promissory note in two places without reading it. In one place he signed as president of the corporation. However, in the other place, he signed under a statement that stated that if the corporation defaulted on the loan, the president would personally pay for the debt. In such a situation, the president could be held personally liable due to his negligence in not reading the document.

Even if a person is unable to read or understand the terms of the agreement, he is still bound by the terms of the agreement since he should have tried to obtain an explanation of the agreement. The exception to this rule is that if the other party knows, or has reason to know, that the signer cannot read or has a limited education. Some Courts would hold in such a situation that the other contracting party should have read the document to signer or explained the terms to him

If a party relies on the explanation of another party as to the contents of the agreement, the contract may be avoided under two circumstances:
the party was justified in relying on the explanation of the other party; and
the explanation was fraudulent.

The party making the explanatory statements does not have to be a lawyer, but can be any person who handles this type of agreement on a regular basis and therefore has a greater knowledge of the content than the other person. This rule is applicable to a situation where the agreement is on a preprinted form, and the person who explains the agreement handles these types of forms on a regular basis.

If both parties to an agreement make the same mistake regarding a key factual matter, the agreement is void. For example, a contract is void if both parties mistakenly believe that the contract can be performed when, in fact, it is impossible to perform it. Suppose Smith promises over lunch to sell Jones an antique Mercedes in Smith’s garage. Assume both parties believe the automobile is in Smith’s garage. However, the car had been destroyed by fire an hour before the agreement and Smith had not learned of this. Since this fact was unknown to both parties, there is a mutual mistake as to the possibility of performing the contract. The agreement is therefore void.

When parties to an agreement make a mistake as to the legal effect of the contract, the contract is still binding. For example, suppose Smith sold Jones a vacant lot and Jones planned to build an office on the lot. Both Smith and Jones assume that this would be a lawful use of the property. However, if after pur¬chasing the property and applying for a building permit, Jones is told that the property is zoned for residential use, the contract is still binding. However, if the contract had represented that the property could be used for the building of an office, it could be rescinded by Jones.

When one party to a contract knows of a fact that has a bearing on the transaction, the failure to disclose this information to the other party is called nondisclosure. Generally, the law does not attach any significance to nondisclosure. The theory is that it is preferable that the party lacking the knowledge ask questions of the party with the knowledge rather than imposing some sort of duty on the party with the knowledge to volunteer the information. Thus, generally, an agreement of the parties is not affected by the fact that one party did not disclose information to the other party. This is the general rule. Ordinarily there is no duty on a party to a contract to volunteer information to the other party. The nondisclosure of information that is not asked for by a party does not hurt the validity of the contract. For example, Jones wants to buy Smith’s house. Jones, prior to signing the contract, makes an inspection of the house and sees several cracks in the roof and walls. He assumes that these cracks are just the result of the house settling. Smith makes no disclosure one way or another about the cracks. Jones buys the house and later discovers that the house has severe foundation problems. He sues Smith for the damages incurred in repairing the foundation problems. Under the general rule, Smith would be under no duty to disclose the foundation problems to Jones. Of course, one way to avoid any question whatsoever is to state in the contract that the buyer has inspected the premises and is purchasing the premises in their as is and present condition.

There are some exceptions to this general rule of no liability for failure to disclose. In some instances, the failure to disclose information that was not requested can be regarded as fraudulent, giving the party harmed by the nondisclosure the same remedies as if a known false statement were intentionally made. These exceptions fall generally into one of four categories:
• Unknown defect or condition;
• Confidential relationship;
• Fine print; and
• Active concealment.

There is developing in the law a duty for one party who knows of a defect or a harmful condition to disclose this information to the other party if the defect or harmful condition is obviously unknown to the other party and is of a nature that the other party would be unlikely to discover or inquire about the defect or condition. Many manufacturers and distributors of asbestos products are being, and have been, sued for selling these products without disclosing the information that asbestos products can cause cancer.

Courts may find an intent to conceal when a printed contract contains clauses in such fine print that it is reasonable to believe that the other party will not take the time to read the provisions. Of course, no relief will be granted to the party reading the contract if the fine print is not material. In other words, if the provisions in fine print are such that the party reading the contract would have entered into the contract in any event, the provisions in the fine print would not cause the contract to be invalid.

Active concealment can cause a contract to be invalid or result in liability to the concealing party. This is more than a failure to volunteer information. Active concealment consists of hiding information from the other party by concealment. For example, using the Smith and Jones house transaction as an example, if Smith had painted over the cracks in the wall and the ceiling in order to hide the foundation problem, he would be guilty of active concealment and the contract could possibly be rescinded, or Jones could possibly recover damages from Smith in the amount of the foundation repair costs.

Fraud consists of five elements:
• The making of a false statement;
• With knowledge that the statement is false or with reckless disregard as to whether or not the state¬ment is false or true;
• With the intent that the listener rely on the statement;
• With the result that the listener relies on the statement; and
• With the consequence that the listener is harmed.

An essential element in proving fraud is to prove that one relied on the statement which is alleged to be fraudulent. If the alleged victim had the same knowledge of the true facts as the alleged wrongdoer, no fraud is present. If the victim should have known the facts or if a reasonable person would have known that the statement was not true, there is no fraud. If false statements are made after a contract has been signed, it is obvious that there was no reliance on the false statements and therefore there is no fraud.

Hypothetical: Smith offers to sell Jones a car and represents that the car has never been in a wreck. Jones, who has worked on cars for many years, notices some dents underneath the car that could only have been made a wreck. Jones buys the car anyway. Even if Smith knew this statement was false and was trying to deceive Jones, there is no fraud since Jones did not rely on Smith’s representation.

Ordinarily, a statement of opinion cannot be the basis for fraud liability. The theory is that a person hearing the statement should recognize it as merely the speaker’s personal viewpoint.

A statement of the law that is false is ordinarily treated in the same manner as an opinion and cannot be treated as fraud. The theory behind this is that the listener has an opportunity of discovering what the law is. However, if the speaker has an expert’s knowledge of the law or claims to have such a knowledge, the statement can be the basis for fraud liability. Of course, an obvious example of this would be a statement of law made by a lawyer to a non-lawyer which the lawyer knew was false. The other elements of fraud would also have to be present.

Lester purchased a used automobile from Moore Motors. He asked the seller if the car had ever been in a wreck. The Moore salesperson had never seen the car before that morning and knew nothing of its history, but quickly answered Lester’s question by stating: “No. It has never been in a wreck.” In fact, the auto had been seriously damaged in a wreck and, although repaired, was worth much less than the value it would have had if there had not been any wreck. When Lester learned the truth, he sued Moore Motors and the salesperson for damages for fraud. They raised the defense that the salesperson did not know that the statement was false and had not intended to deceive Lester. Did the conduct of the salesperson constitute fraud? Yes. The salesperson making the statement that there were no prior wrecks did not know whether that statement was true or false. Nevertheless, the salesperson made the statement as though it were true and as though he knew it were true. This constituted reckless indifference as to whether the statement was true. The reckless indifference as to the truth of a statement satisfies the mental state element of fraud. The salesperson was therefore guilty of fraud.

An agreement may be set aside if it was not in fact entered into voluntarily by both of the parties. If either party entered into it because of undue influence or physical or economic duress, it may be set aside.

Undue influence arises in a situation where a confidential type relationship exists and one party has such influence over the other party that the other party’s free will is dominated to the benefit of the influencing party. Confidential relationships which may result in undue influence can be such things as the relationship of an elderly parent and an adult child, a physician and patient, an attorney and client, or any other relationship of trust and confidence in which one party exercises a control or influence over another. Because of the possibility that a person in such a confidential relationship may dominate the will of another and take unfair advantage, if such a confidential relationship exists, the law presumes that undue influence has occurred if the dominating party obtains any benefit from a contract made with the person alleged to be dominated. The contract is then voidable and may be set aside unless it can be proven that no such domination took place.

Hypothetical: Smith, upon reaching the age of 75 and being in ill health, decided to move in with his oldest adult son. He lived with his oldest adult son for several years prior to his death. Upon his death, it was discovered that he deeded all of his property to his oldest son. The younger son contested the deed, stating that his older brother exercised undue influence over their father in getting him to give all of his property to the oldest son. A presumption of undue influence would arise which would have to be overcome by the oldest son. One way to overcome this would be to show that the father consulted a disinterested third party, preferably an attorney, without the older son being present, and was counseled by the third party. This is not absolute proof of the lack of undue influence, but it is a very important element.

Persuasion and argument are not in themselves undue influence. An essential element of undue influence is that the person making the contract does not exercise his free will. Unless there is a confidential relationship, such as that between a parent and child, Courts are most likely to take the attitude that the person who claims to have been dominated was merely persuaded.

An agreement made under duress may be set aside if the duress took the free will of the person seeking to avoid the contract away. In a duress situation, a party enters a contract to avoid a threatened danger. This threat may be a threat of physical harm to person or to the property of someone (physical duress) or it may be a threat of severe financial loss (economic duress).

A person makes a contract under duress when there is violence or the threat of violence to the extent that the person is deprived of his free will and makes the contract to avoid harm. The threatened harm may be directed at a relative of the contracting party as well as against the contracting party. If a contract is made under duress, the agreement is voidable.

Consideration
Another of the elements needed to make an agreement binding is consideration. Even though there has been an offer and an acceptance, an agreement may not be enforceable if there is no consideration.

Consideration is what the promisor demands and receives as the price for the promise. Remember, the promisor is the person making the promise, and the promisee is the person to whom the promise is made. Consideration consists of something that the promisor is not otherwise entitled to. It is not necessary to use the word “consideration” in a contract.

Consideration is the price paid for the promise. When thinking of consideration, think in terms of legal value as opposed to economic value. While economic value (e.g., money) is the most common form of consideration, consideration does not have to involve money. In order for a contract to be enforceable, each party to the contract must change his or her legal position in some way.

Ordinarily, Courts do not consider the adequacy of the consideration given for a promise. Suppose Smith agreed to provide janitorial service to Acme for six months at $400.00 per month. After three months, Smith decided that $400.00 was not enough money, and he sought to get out of his contract, stating that the consideration for the services was inadequate. Is there a binding contract? The contract is binding since, again, the law is not normally concerned with the value or quantity of consideration that the promisor demands and receives for the promise. The employment contract was binding even if the compensation to be paid was in fact low.

Lawful Objective
The fourth element of a contract is that it must be made for a lawful objective. Courts will not enforce contracts that are illegal or violate public policy. Such contracts are considered void. If the illegal agreement has not been performed, neither party can sue the other for damages or to require performance of the agreement. If the agreement has been performed, neither party can sue the other for damages or have the agreement set aside. For example, a gambling contract would be illegal in many states.

Hypothetical: Knight did not have a real estate license nor did he claim to. However, Johnson asked Knight to find a buyer for Johnson’s car wash in exchange for Johnson paying Knight a 15% commission if Knight could find a buyer. Knight obtained a buyer and was paid one-half of the commission. Johnson refused to pay any more commission. Knight sued Johnson for the remaining commission. The Court ruled in favor of Johnson as to the unpaid commission since the licensing statute was violated by Knight acting as a broker without a license. The agreement to pay him commission was therefore void and could not be enforced. Johnson also claimed that Knight should not be entitled to keep the commission he had received. The Court held that although Knight had no right to the commission, he had been paid and the Court would not aid either party to the illegal contract. Therefore, Johnson could not recover from Knight the commission that had already been paid.

In most cases, parties to an illegal agreement are denied remedies of any nature. A Court will not require parties to perform an illegal agreement, and a Court will not award damages because a party fails to perform.

An agreement which calls for the commission of a crime is illegal and therefore void. For example, a person could not enforce an agreement with another party to burn a house down. Also, an agreement that calls for the commission of a civil wrong (such as a tort) is illegal and void. For example, an agreement to slander a third party is void. An agreement to infringe another’s trademark or copyright is also void.

Ordinarily, a Court will not consider whether a contract is fair or unfair, wise or foolish. However, in some instances, Courts will hold that a contract will not be enforced because it is too harsh or oppressive to one of the parties. For example, a clause in a contract which provides that a party will pay a large penalty if he breaks the contract may be unenforceable, depending upon the circumstances. Another example would be a situation where one party agreed that the other party would not be liable for the consequences of gross negligence. This type of agreement would usually be void as against public policy.

A provision in a contract or a contract which a Court believes gives too much of an advantage over a consumer can be held to be void as unconscionable. This situation would arise when one party has a gross disproportionate bargaining power over another party, such as an inexperienced or financially weaker party. If the terms of an agreement in such a circumstance were deemed to be grossly unfair, the contract could be held to be void as uncon¬scion¬able and therefore contrary to public policy. Unconscion¬ability means that the actions of a party to a contract are so outrageous and oppressive as to shock the conscience of the Court and invalidate a clause or provision of the contract or the whole contract itself.

The fact that a contract is a bad bargain does not make it unconscionable. Unconscionability is to be determined in light of the circumstances existing at the time when the contract was made. The fact that later events show that the contract was unwise or undesirable does not make it unconscionable. For example, if the market price of goods sold pursuant to a contract increased dramatically, this increase in market value as compared to the sales price does not make the contract unconscionable. The concept of unconscionability is frequently used by Courts to protect consumers.

Agreements that may harm the public welfare are contrary to public policy and are not binding. An agreement may not violate a statute, but it still may be so offensive to society that Courts will rule that to enforce it would be contrary to public policy.

An agreement which would require a person to lose some sort of statutory protection would be in violation of public policy. For example, state insurance statutes frequently provide that policies of a certain type (e.g., medical) must contain certain benefits. An insurance policy which fails to supply such benefits would violate public policy as declared in the statute.

Any agreement intended to obstruct the process of law is void as being contrary to public policy. For example, in a medical malpractice case, if I offered to pay my expert witness, a physician, $10,000.00 for testifying in any event, and $25,000.00 if I win the case, would be void. The danger here is that a witness might lie in order to help win the case.

Most states provide that gambling contracts are illegal. Lotteries which involve the element of a prize, chance, and consideration are also held to be held illegal. Of course, a state may allow a lottery run by the state or may legalize gambling in general, such as in Nevada. In some states, bingo games, lotteries, and raffles are legal if the proceeds go to charity.

Giveaway plans and games are lawful as long as it is not necessary to buy anything or give anything of value in order to participate. If participation is free, the element of considera-tion is not present and therefore there is no lottery.

Statutes frequently require that a person obtain a license or certificate before practicing certain professions such as law or medicine, or before carrying on a particular business such as that of a real estate broker or stock broker. If the license is required to protect the public from unqualified persons, such as an unlicensed physician, the contract made by the unlicensed person is void. In a North Carolina case, a statute required that contractors be licensed. An unlicensed contractor made a contract to make repairs. The Court held that the contractor could not recover from the owner either the price agreed to in their contract or the reasonable value of the services actually performed since the contractor was unlicensed.

If a license is strictly a revenue raiser, such as a privilege license to conduct business from a store at a particular location, it would be rare for an agreement made in violation of the licensing statute to be held invalid. Someone operating a store without a permit would not have all of its sales declared void, but he might be fined for failure to obtain the appropriate license.

Proper Form
The fifth element of a contract is that it must be in the form required by law. Do all contracts have to be in writing? No – oral contracts can be just as valid and enforceable as written contracts. How¬ever, the law requires that certain contracts must be in writing in order to be enforceable by a Court. The state statutes that require certain contracts to be in writing are called statutes of fraud. Statutes of fraud require that either the contract itself be in writing and signed by both parties or there must be a sufficient memorandum of the agreement signed by the party being sued for breach of contract.

The statute of frauds normally does not apply if it is possible under the terms of the agreement to perform the contract within one year. If no time for performance is specified in the oral agreement and the performance will not necessarily take more than one year, the statute of frauds would not apply.

McLarty claimed that he and Wright made an oral contract to start a business under the name of DeKalb Textile Mill, Inc., to incorporate the business, and to divide the stock equally. The alleged contract was not performed. McLarty sued Wright for breach of contract. Wright raised the defense of the statute of frauds, asserting that it was not specified that the contract should be performed within one year of making. Was this defense valid? No. The contract could have been performed within one year of making. A writing was therefore not required. It is not necessary that the contract state expressly that it is to be performed within one year in order to avoid the statute of frauds applicable to contracts that cannot be performed within one year. The statute does not apply if the contract contemplated performance within one year or if in fact it could be performed within one year.

An agreement that cannot be performed within one year after the agreement is made must be in writing in most states to be enforceable. Hypothetical: Armored Motor Service made an oral contract to supply First Federal Savings with courier service. The contract was to run for two years. First Federal failed to make the payments required by the contract and was sued by Armored Motor. First Federal raised the defense that the oral contract could not be enforced because of the statute of frauds. The Court held in favor of First Federal. One key element was that the contract was to run two years.

Contracts involving the sale of land must be evidenced by a writing. This would include deeds and mortgages, as well as the contract between the buyer and the seller setting forth the terms of the sale. This statute applies only to the agreement between the owner and purchaser of the real property. It does not apply to collateral agreements such as between a real estate agent and one of the parties to the sales contract regarding the real estate agent’s commission.

Another type of contract that must be in writing is the promise to answer for the debt of another person. For example, an oral promise by the president of Acme Company to pay the debt owed by Acme to Trustmark would not be enforceable.

A promise by the executor or administrator of an estate to use personal funds to pay a debt of the estate must be in writing. An executor of a deceased person’s estate has a duty to pay the debts of the person from the person’s estate. If the executor promises to pay a debt of the decedent from his personal funds, this must be in writing. However, if the executor makes a contract on behalf of the estate, like hiring an attorney to represent the estate, this type of agreement could be enforceable even if it is not in writing.

A promise made in consideration of marriage must be in writing. An example of this would be a prenuptial agreement.

If a contract provides for the sale of goods with a price of $500.00 or more, this type of contract must ordinarily be in writing.

The statute of frauds requires a writing to evidence the contracts which it states must be in writing. This does not neces¬sarily have to be a formal contract signed by both parties. It can be a letter signed by only one party setting forth the terms of the oral agreement. However, the writing, whether it be a letter or memorandum, must be signed by the person “to be charged.” This means it must be signed by the person against whom you are seeking to enforce the contract. The writing must contain all of the material terms of the contract so that a Court can determine what has been agreed to. A letter from the seller of real estate to a potential buyer which did not adequately describe the property involved in the sale would not be enforceable. The description of the land must be adequate in order to allow the Court to know exactly what land is being referred to.

The letter, memorandum, or other writing may consist of more than one writing if there is a sufficient link between them. For example, two or three letters from a seller of land to the potential buyer describing the terms would satisfy the statute of frauds even if one of the letters alone would not be sufficient. It is not necessary that the writing be made with the intent to create a writing to satisfy the statute of frauds. A letter or memorandum signed by a seller of land to the potential buyer could satisfy the statute of frauds even if the seller did not intend for this letter to be used against him should he renege on his agreement.

In dealing with the statute of frauds, the first question is whether the contract is one that has to be in writing. The second question is whether or not there is a sufficient writing that can be enforced. With the parol evidence rule, there is already a written contract, and the question is whether evidence outside of the written contract is admissible in Court. If a contract is in dispute, often a question arises as to whether or not the writing evidencing the contract represents all that the parties agreed to. The general rule is that spoken words (i.e., parol evidence) will not be allowed to modify or contradict the terms of the written contract that is complete on its face. Exceptions to this rule are made in cases of fraud, accident, or mistake, and it can be shown that the writing is therefore not the complete or true contract.

The parol evidence rule prevents a party from avoiding liability on a written contract by presenting evidence that the writing does not mean what it says. This rule is based on the theory that either there was never an oral agreement involved, or, if there were, the parties abandoned their oral agreement when they executed the written contract. The reason for the rule is to give stability to written contracts and to prevent someone claiming that there were oral terms that never found their way into the written agreement.

Parol evidence will be allowed when:
• the writing is incomplete;
• the writing is ambiguous;
• the writing is not a true statement of the agreement of the parties because of fraud,
• accident or mistake; or
• the existence, subsequent modification, or ille¬gality of a contract is in question.

If the written contract is obviously incomplete or if the parties admit that it is incomplete, Courts will allow evidence as to what was orally agreed to, in addition to what was agreed upon in writing. If the terms of the contract are ambiguous, parol evidence will be allowed to explain the contract so as to make it not ambiguous. For example, if a written contract might have two different meanings, parol evidence may be admitted to clarify what the contract really means. The fact that the parties disagree as to the meaning of the contract does not mean that it is ambiguous.

A contract which looks complete on its face may have omitted a provision that should have been included. Parol evidence may be admitted to show that this provision was omitted due to a mistake or because of fraud of the party drawing up the contract. Parol evidence is, of course, admissible to prove fraud. For example, if the seller of property fraudulently represented that the land was zoned to permit commercial use, and the land in fact was not zoned for commercial use, this evidence can be admitted in seeking to avoid the contract.

Interpretation of Contracts
If there is a dispute as to the interpretation of a contract, Courts seek to enforce the intent of the parties to the contract. The intent which will be enforced is what a reasonable person would believe that the parties intended. The intent that will be enforced is the intent as it reasonably appears to a third person (the judge or jury).

Hypothetical: A contract was made for the sale of a farm. The contract stated that the buyer’s deposit would be returned “if for any reason the farm cannot be sold.” The seller later stated that she had changed her mind and would not sell, and she offered to return the deposit. The buyer refused to take the deposit back and brought suit to enforce the contract. The seller defended on the ground that the “any reason” provision extended to anything, including the seller’s changing her mind. Was the buyer entitled to recover? Yes. The condition of “cannot be sold” referred to some condition or circumstance independent of the parties.

In interpreting contracts, ordinary words are to be inter¬preted according to their ordinary meaning. Trade terms and technical terms are to be interpreted according to their trade or technical meaning. Software, when referring to a computer, doesn’t mean something that is soft, but it means the actual program.

The way parties have used terms in their prior relationships can also be used to determine what the parties meant by the words they used in a contract.

The provisions of a contract must be construed as a whole. Provi¬sions are not to be read out of context and interpreted out of context.

If an occurrence or a nonoccur¬rence of an event has an effect on the existence of a contract, the event is called a condition. A condition precedent is the occurrence of an event that precedes the existence of an obligation to perform or the existence of a contract. For example, in a fire insurance policy, there is no obligation on the insurance company to make a payment until there is a fire loss. The occurrence of such a loss is therefore a condition precedent to the duty of the insurer to make payment.

The parties may agree that the contract will terminate if a particular event occurs or does not occur. Such a provision is called a condition subsequent. For example, in a contract for the purchase of land, the contract may contain a condition subsequent that cancels the contract if the buyer is not able to obtain a zoning permit to use a building for a particular purpose. The contract may state something to the effect that this contract is contingent upon buyer being able to have the property rezoned from residential to commercial within 90 days from the date of the agreement.

Sometimes the provisions of a contract are contradictory. In such a situation, a Court will try to reconcile the provisions and eliminate the conflict. However, if this cannot be done, the Court will declare that there is no contract. For example, I make a contract to sell 100 acres of land to John. One paragraph of the contract states that the purchase price is $100,000.00. Another paragraph states that the purchase price is $1,100.00 per acre, which would produce a total price of $110,000.00. Which amount would be binding? Neither amount would be binding if the conflict in the terms could not be reconciled by parol evidence.

In some cases, a conflict can be solved by considering the form of the conflicting terms. If a contract is partly printed or typewritten and partly handwritten, the handwritten part would prevail if it conflicted with the typewritten or printed part. If there is a conflict between the printed part and a typewritten part, the typewritten part would prevail. If there is a conflict between an amount or quantity expressed both in words and figures, as on a check, the amount or quantity expressed in words prevails. For example, if a check is written for $1,000.00, yet the check states it is for One Hundred and 00/100 Dollars, the words would prevail over the figures.

A contract is ambiguous when it is uncertain what the intent of the parties was and the contract is capable of more than one reasonable interpretation. Sometimes ambiguous terms can be explained by the admission of parol evidence. Also, Courts abide by the rule that an ambiguous contract is interpreted against the party who drafted it. In other words, the party who did not draft the contract will be given the benefit of the doubt so to speak. Also, sometimes the background or circumstances surrounding the contract can eliminate ambiguity. For example, in a Minnesota case, suit was brought in Minnesota on a Canadian policy of insurance. The question arose as to whether the dollar limit of the policy referred to Canadian dollars or American dollars. The Court concluded that Canadian dollars were intended since the insurer and the insured were both Canadian corporations, the policy was entered into in Canada, and over the years premiums had been paid in Canadian dollars, and a prior claim on the policy had been settled by using Canadian dollars.

In every contract there exists an implied covenant of good faith and fair dealing. For example, when a contract to purchase a house is made subject to the condition that the buyer can obtain financing, the buyer must make a reasonable good faith effort to obtain the financing or be held in breach of the contract. The implied duty to act in good faith means an honest, good faith effort to satisfy the condition of the contract.

As a general rule, a party is bound by a contract even if it proves to be a bad bargain. However, if a Court is called upon to interpret a contract, if possible, the Court will interpret it in such a way as to avoid hardship when the hardship would hurt the weaker of the two parties to the contract.

When a contract has contacts with more than one state, it is a contract in interstate commerce, and it is necessary to determine which state’s law governs the contract. The rules that govern that decision are called the law of conflicts of law. The parties may specify the jurisdiction whose law is to govern. If that jurisdic¬tion bears a reasonable relationship to the contract, the choice will be given effect by the Court.

Assuming there is no choice of law in the contract, most states apply the “center of gravity” rule. Under this rule, the Court will choose to follow the law of the state which has the most significant relationship to the parties, the contract, and its performance. The Courts consider the place the contract was made, where the negotiations occurred, where the performance was made, the location of the subject matter of the contract (e.g., land location), the residence of the parties, and the states of incorporation and
principal place of business if a corporation is involved.

Suppose a contract requires performance to the satisfaction of the other party. The courts are divided as to:
• Whether the promisor must perform the contract to the satisfaction of the promisee; or
• Whether it is SUFFICIENT that the performance would satisfy a reasonable person under the circumstances.

When personal taste is an important element, the courts generally hold that the performance is not sufficient unless the promise is actually satisfied. However, in most instances, the courts require that the dissatisfaction be shown to be in good faith and not just to avoid paying for the work that has been done. Personal satisfaction is generally required when a person promises to make clothes or paint a portrait to the satisfaction of the other party

When a building contract requires the contractor to perform the contract to the “satisfaction” of the owner, the owner generally is required to pay if a reasonable person would be satisfied with the work of the contractor.

It is common to guarantee the performance of a contract. For example, a builder may guarantee for one year that certain work will be satisfactory. Such a guarantee may be made by a third person. For example, a surety company may guarantee to the owner that a contractor will perform a contract. In such a case, the obligation of the surety is in addition to the liability of the contractor, but the contractor is also still liable. However, a plaintiff cannot recover twice. He can recover only the amount of the liability.
• Part from contractor and part from surety
• or all from surety,
• but not all from surety and all (again) from contractor.

A contract may be discharged pursuant to a provision in the contract or by a subsequent agreement. For example, there may be a discharge by the terms of the original contract when it says it will end on a certain date. There may be a mutual cancellation when both parties agree to end their contract. There may be a mutual rescission when both parties agree to annul the contract and return to their original positions as if the contract had never been made. This would require returning any consideration (e.g., money) that had changed hands.

Other examples of discharge by agreement are:
• accord and satisfaction
• a release
• a waiver.

The parties may agree to a different performance. This is called an accord. When the accord is performed, this is called an accord and satisfaction. The original obligation is discharged.

In order for there to be an accord and satisfaction, there must be
• a bona fide dispute;
• an agreement to settle the dispute; and
• the performance of the agreement.

An example would be settlement of a lawsuit for breach of contract. The parties might settle for less than the amount called for under the contract.

Circumstances beyond the control of the contracting parties may discharge the contract. Impossibility of performance refers to external conditions as opposed to someone’s personal inability to perform the contract. For example, the fact that a debtor does not have the money to pay a debt, and therefore cannot pay the debt, does not discharge the debt. This is not a case of impossibility.

What if a seller cannot obtain the goods he needs from any supplier to meet his contractual obligation to sell the goods to a buyer? This will not discharge the seller’s obligation unless the inability to obtain the goods was a condition subsequent to the contract.

When the parties expressly refer to particular subject matter in a contract, the contract is discharged if the subject matter is destroyed through no fault of either party. When a contract calls for the sale of a wheat crop growing on a specific parcel of land, the contract is discharged if the crop is destroyed.

A contract is discharged when its performance is made illegal by a subsequent change in the law. For example, suppose there is a contract to construct a non-fire¬proof building at a particular place. Prior to beginning construction, a zoning law is passed which prohibits such a building in this area. The contract would be discharged. However, a change of law that merely increases the cost of one of the parties is not a “change of law” that discharges the contract.

When the contract calls for the payment of money, the death of either party does not affect the obligation. The estate (executor) of the person who was to pay the money is responsible to make payment. Likewise, the estate (executor) of the person who was to collect the money can collect it.

In every contract, there is an implied covenant of good faith and fair dealing. One party to a contact is under an obligation to do nothing that would interfere with the performance of the other party. If one party makes the other party’s performance impossible, the obligation to perform is discharged. For example regarding a contract between a contractor and a subcontractor, if the contractor refuses to allow the subcontrac¬tor access to the property where the subcontractor is to do the work, the contract is discharged as to the subcontractor. The subcontractor would have a cause of action against the contractor, but the contractor would not have a cause of action against the subcontractor.

If the conduct of the other contracting party does not make performance impossible, but only more difficult or expensive, or causes a delay, the contract may not be discharged, but the injured party will be entitled to damages for any loss he incurred. In our example, if the contractor eventually allowed the subcontractor on the work site, the contract would not necessarily be discharged, but the subcontractor could get damages for any loss he incurred.

Acts of God, such as tornadoes, lightning, and floods, usually do not terminate a contract, even though they make performance difficult. Weather conditions constitute a risk that is assumed by a contracting party in the absence of a contrary agreement. Extra expense because of weather conditions is a risk that the contractor assumes in the absence of an express provision for additional compensation in such case.

Modern contracts commonly contain a “weather” clause, which either expressly grants an extension for delays caused by weather condi¬tions or expressly denies the right to any extension of time or additional compensation because of weather condition difficulties.

Breach and Remedies
A breach of contract is a failure to perform the contract in the manner called for by the contract. A party is entitled to contractual remedies if the other party breaches a contract.

An anticipatory repudiation occurs when one of the parties to a contract makes it clear that performance will not be carried out as required by the contract when the time for performance arrives. This can be done by words or conduct. An example of such conduct would be to sell goods covered by a contract to another party. An anticipatory repudiation may be treated as a breach of contract prior to the time performance is actually due.

A breach does not always result in a lawsuit or mean the end of a contract. One party may be willing to waive or ignore the breach. A waiver can be by words or by conduct. Accepting a late payment on a note would be an example of a waiver by conduct. It is possible to make a waiver by silence. For example, failure to object to the manner of performance in a timely manner would be a waiver by silence.

A party who waives a breach gives up the right to damages or remedies regarding such breach, and cannot use the breach as a reason for not performing the contract.

A party retains the right to recover damages caused by another party’s breach if the party expressly reserves the right to damages at the time the party accepts a defective performance. The reservation of right should be, but does not have to be, in writing.

A buyer and seller enter into a contract regarding the purchase and sale of machinery. The buyer of the machinery may need the it badly and accept defective machinery, but reserves his right to sue for any damages suffered. In this situation, the buyer is not waiving his right to sue for the breach if the defective machinery causes damages.

If a party makes an anticipatory repudiation, the other party has the following options:
• Do nothing – wait until the time for performance, and then sue if performance is not made;
• Treat the repudiation as a definite breach and sue immediately; or
• Treat the repudiation as an offer to cancel the contract, and accept the offer, thereby terminating the contract.

A contracting party may be entitled to damages if the other party breaches a contract. Generally, damages are the sum of money necessary to put a party in the same or equivalent financial posi¬tion as the party would have been had the contract been performed. A party may recover compensatory damages for any actual loss that the party can prove with reasonable certainty. Compensatory damages include direct damages and consequential damages. An example of direct damages would be in a situation where the plaintiff has paid $10,000.00 for a truck, but the defendant refuses to deliver the truck. The direct damages would be $10,000.00.

Consequential damages would arise in a situation where the failure to deliver the truck harmed the business of the plaintiff since the plaintiff lost a delivery contract. In this situation, the plaintiff could possibly get consequential damages for loss of the delivery contract.

Punitive damages are designed to punish. A Court uses punitive damages to make an example of a defendant in order to keep others from doing a similar wrong. Punitive damages are rare in a breach of contract case except bad faith insurance claims. Consumer protection laws sometimes permit consumers to recover punitive damages for breach of certain types of contracts.

A non-breaching party has a duty to mitigate damages. In other words, a non-breaching party has the duty to take reasonable steps to minimize damages. The failure to mitigate damages may cause the victim to only be allowed to recover damages that would have resulted if mitigated. In our truck example, say the truck was purchased and was to be delivered on January 5, to allow the buyer to do a hauling job for $500.00. Delivery was late. The hauling contract was lost. However, the buyer could have rented a truck for $150.00. However, he failed to do this. Therefore, his damages would only be $150.00.

An appropriate remedy for a breach may be rescission of the contract. This places the parties in the position they would have been had the contract never been entered into. For example, money is returned to the buyer and the buyer returns the merchandise to the seller. If performance has been involved, the performing party may get the reasonable value of his performance under an unjust enrichment theory. Suppose that pursuant to a contract for the sale of land, a buyer has taken possession and made substantial improvements. If the contract is rescinded, the buyer will return the land and the seller will return the money. However, the seller must pay the buyer the reasonable value of the improvements.

Specific performance is an action to compel a party who breached a contract to perform the contract as promised. The subject matter of the contract must be unique, or an action for damages would be the proper remedy. Actions for specific performance are usually allowed with regard to:
• A contract involving the sale of particular real estate; and
• A contract for sale of a particular business.

Specific performance is not allowed regarding a contract for the sale of personal property unless the property is unique in some way like an antique, coin collection, or art objects.

Generally, a party cannot obtain specific performance of personal service contracts or employment contracts. This is because of possibly violating the Thirteenth Amendment regarding involuntary servitude. However, breach of a service or employment contract can subject the breaching party to a suit for damages.

In general, a contract may limit the remedies that a non-breaching party may obtain. For example, Johnston purchases a new truck from Acme Truck Sales. The contract may limit Johnston’s remedies to having Acme repair the truck or replace the truck if it is defective.

A contract may state the amount of liquidated damages to be paid if the contract is breached. Upon a party’s breach, the other party will recover this amount of damages whether actual damages are more or less than the liquidated amount. For example, the parties to a construction contract stipulate that damages are to be paid of $1,000.00 per day that the construction exceeds its contracted completion date. Another example would be with regard to a contract for the sale of land where the contract provides that the earnest money paid will be the sole remedy upon breach of contract by the buyer.

Courts will honor liquidated damage provisions if:
• Actual damages are hard to determine (e.g., breach of a restrictive covenant), and
• The amount is not excessive when compared with probable damages.

If the agreed-upon liquidated damage amount is unreasonable, the Court will hold the liquidated damage clause to be void as a penalty. In such situations, you have to prove the actual damages if the clause were declared to be void.

What happens if a limitation of remedies clause or a limita¬tion of liability clause is not valid? In this situation, the plaintiff may sue for actual damages. For example, if a liquidated damage clause is held invalid, the plaintiff may sue for actual damages.

EMPLOYMENT LAW

The relationship of an employer and an employee exists when, pursuant to an agreement of the parties, one person, the employee, agrees to work under the direction and control of another, the employer, for compensation. The agreement of the parties is a contract, and it is therefore subject to all the principles applicable to contracts.  The contract may be an express contract.  In other words, the duties of the employee will be specifically set forth in the contract.  The contract may also be implied.  Most employment contracts are implied oral agreements.  In this type of arrangement, the employer is accepting the services of the employee that a reasonable person would recognize as being such that compensa­tion would be given to the employee.

Collective bargaining contracts govern the rights and obliga­tions of employers and employees in many employment relationships.  These occur when a union negotiates on behalf of employees.  Collective bargaining involves representatives of the employees bargaining with a single employer or a group of employers for an agreement.  This agreement will cover such things as wages, hours, and working conditions for the employees.  The employees, of course, make up a union and elect members to represent, and negotiate for, them with the employer. The National Labor Relations Act (NLRA) guarantees employees the right to form a labor union and requires employers to deal with a duly-elected union as the bargaining agent for the employees. The NLRA prohibits employers from interfering with employees and from discriminating against an employee as a result of the employee’s  union activity.

In most instances, an employment contract will not state its expiration date.  In such a case, the contract may be terminated at any time by either party.  However, the contract may expressly state that it will last for a specified period of time such as a contract to work as a general manager for five years.

Ordinarily a contract of employment may be terminated in the same manner as any other contract.  If it is to run for a definite period of time, the employer cannot terminate the contract at an earlier date without justification.  If the employment contract does not have a definite duration, it is terminable at will.  This is called employment at will.  Under the employment at will doctrine, the employer has historically been allowed to terminate the contract at any time for any reason or for no reason.  Some State Courts and some State Legislatures have changed this rule by limiting the power of the employer to discharge the employee without cause.  For example, Court decisions have carved out exceptions to this doctrine when the discharge violates an established public policy, such as discharging an employee in retaliation for insisting that the employer comply with a federal or state law.

Courts may sometimes construe an employer’s statements concerning continued employment as a part of the employment contract, and therefore require good cause for the discharge of an at-will employee.  Also, written personnel policies used as guide­lines for the employer’s supervisors have been interpreted as restricting the employer’s right to discharge at-will employees without just cause.  Employee handbooks or personnel manuals have been construed as part of the employee’s contract.  This is why all personnel manuals and employee handbooks should contain a dis­claimer.  A sample disclaimer would be: This employee handbook is not intended to create any contractual rights in favor of you or the company.  The company reserves the right to change the terms of this employee handbook at any time.

The Fair Labor Standards Act (FLSA) is also known as the Wage and Hour Act. requires payment of a minimum wage as well as the payment of overtime after 40 hours of work per week. Payment of overtime is to be 1-1/2 times the regular hourly rate. This Act also deals with child labor laws. Generally, children under the age of 14 are not supposed to work. Children between the ages of 14 and 16 can work in all industries with the exception of certain hazardous work. Certain exemptions are available under the FLSA to executives, administrative and professional employees, and for outside salesmen.

Generally, employees without work through no fault of their own, are eligible for unemployment compensation benefits. Unemployment compensation is provided primarily through a federal and State system under the unemployment insurance  provi­sions of the Social Security Act.  State agencies are loosely coordinated under this Act. Basically, States are generally free to prescribe the amount and the length of benefits and the conditions required for eligibility.  In most States, the unemployed person must be available for placement in a similar job and be willing to take such employment at a comparable rate of pay.  If an employee quits a job without cause, or is fired for misconduct, he ordinarily is disqualified for unemployment benefits.

The Family and Medical Leave Act (FMLA) is a federal act that entitles employees of an employer with 50 or more employees to up to 12 weeks of unpaid leave during any 12 month period for the following reasons:

  • birth or adoption of a child;
  • to care for a spouse, child or parent with a serious health problem; or
  • a serious health problem of the employee that makes the employee unable to do his or her job.

To be eligible for this leave, an employee must be employed by an employer for 12 months or more and have worked at least 1250 hours during the 12 months prior to the leave.

The Occupational Safety and Health Act of 1970 (OSHA) was passed in order to insure as much as possible safe and healthy working conditions for employees.  OSHA provides for establishing safety and health standards and for enforcement of these standards. The Secretary of Labor has been granted broad authority under OSHA to write occupational safety and health standards.  Any person adversely affected by these regulations of the Secretary of Labor can challenge their validity in a U.S. Court of Appeals.  The Secretary’s standards will be upheld if they are reasonable and supported by substantial evidence.  The Secretary must show a need for a new standard by showing that it is reasonably necessary to protect employees against a significant risk of material health impairment.  The Secretary also must show that the standard is economically feasible.

For most kinds of employment, state workers’ compensation statutes govern compensation for injuries.  The statutes provide that the injured employee is entitled to compensation for accidents occurring in the course of employment.  Every State has some form of workers’ compensation legislation.  The statutes vary widely from State to State.  When an employee is covered by a workers’ compensa­tion statute, and when the injury is job connected, the employee’s remedy is limited to what is provided in the worker’s compensation statute.  In other words, the employee cannot sue his employer for negligence. Generally, no compensation is allowed for a willful, self-inflicted, injury, or one sustained while the employee is intoxicated.

The Federal Wiretapping Act provides that it is unlawful to intercept  oral or electronic communications.  Both criminal and civil penalties are provided for by this Act.   There are two exceptions: 1) An employer can monitor his/her/its telephones in the ordinary course of business through the use of extension telephone; and 2) An employer can monitor employee communications with the employee’s consent.  Consent may be established by prior written notice to employees of the employer’s monitoring policy.  Consent signed by the employee is preferable. Personal calls can be monitored only to the extent necessary to determine whether the call is a personal or business call.  As soon as it is determined that the call is a personal call, the employer must quit listening. The Electronic Communications Privacy Act (ECPA) amended the federal wiretap statute to make it apply to e-mail communications.  However, the same two exceptions exist (i.e., ordinary course of business and consent).

Title VII of the Civil Rights Act of 1964 (which was substantially amended in 1972 and 1991) prohibits terminating an employee or refusing to hire an applicant for a reason which amounts to discrimina­tion because of race, color, sex, religion or national origin.  The Act prohibits disparate treatment which is treating one employee less favorably than another because of race, sex, etc.  The Act also prohibits disparate impact situations.  This would be an employment practice which was neutral on its face (e.g., height requirement), but had a disparate impact on a protected class (e.g., women).  Such policies must be justified by a bona fide job necessity. Certain tests which an employer might give to a job applicant might be found to be culturally biased and therefore have a disparate impact against a minority. This is not to say that all tests will be declared illegal by a Court. However, a test must have a reasonable relation to the job for which it is to be used. Word of Mouth hiring can also cause disparate impact.

The Pregnancy Discrimination Act requires that an employer treat pregnancy in the same manner that other disabilities are treated. Women that are temporarily disabled by pregnancy or childbirth must be provided with the same benefits as other disabled workers. This includes sick leave, insurance, and similar benefits. However, employers who do not provide sick leave or short term disability benefits to workers are not required to provide them to pregnant workers.

Quid pro quo sexual harassment involves supervisory personnel seeking sexual favors from employees under them in return for job benefits such as continued employment, promotions, raises, or a favorable performance evalua­tion.  In such a case, when a supervisor’s actions affect job benefits, Title VII’s prohibition against sex discrimination comes into play, and the employer is liable under this Act.

A second form of sexual harassment is the so-called hostile working environment harassment.  This a situation where a supervisor’s conduct has sexual connotations and has caused anxiety or poisoned the work environment.  This type of conduct may include such things as unwelcome flirtations, propositions, or any other abuse of a sexual nature.  If this type of conduct causes an employee to quit his or her job, the employer may be liable for any damage caused to the employee.

The Age Discrimination in Employment Act (ADEA) prohibits discrimination against men and women over 40 and also prohibits mandatory retirement because of age.  There are some exceptions to this mandatory retirement aspect.  This Act only covers employers with 20 or more employees. The Older Workers Benefit Protection Act of 1990 (OWBPA) prohibits age discrimination in connection with employee benefits unless the employer can prove that the cost of benefits for older workers is more than for younger workers. Employers commonly require that employees taking early retirement packages waive all claims against their employers, including, any claim they have under ADEA. The OWBPA requires that employees be given a specific period of time to evaluate the package, and also requires employers to pay for eight hours of an attorney’s time to aid each employee in this evaluation.

The Americans with Disabilities Act (ADA) makes it unlawful for an employer to discriminate against any qualified individual with a disability because of the disability.  A qualified individual with a disability is any person who, with or without reasonable accommodation, can perform the essential functions of the job. The ADA applies to virtually every employment practice, from the applica­tion procedures for hiring to compensation, training, other terms and conditions of employment, and discharge.  The statute defines reasonable accommodation to include physical alteration of existing facilities to make them accessible to people with disabilities, restructuring jobs, allowing part-time or modified working schedules, acquiring or modifying equipment, and hiring qualified readers for the blind or interpreters for the deaf. The ADA defines disability very broadly and includes any person with: (1) a physical or mental impairment which substantially limits one or more of the individual’s major life activities; (2) a record of such an impairment; or (3) an individual who is regarded by the employer as having such an impairment.  The test is a two-pronged test.  First, you must decide whether or not there is a physical or mental impairment.  If so, you must decide whether or not it substantially limits a major life function.

 

 

BUSINESS ORGANIZATIONS

The principal forms of business organizations are (1) sole proprietorships, (2) partnerships, (3) limited liability partnerships, (4) limited liability companies, and (5) corporations.

Sole Proprietorships
The simplest form of business is a sole proprietorship. Sole proprietorships constitute over two-thirds of American businesses. They are usually small enterprises (99 percent of those in the United States earn less than $1 million per year).

A sole proprietorship is a form of business ownership in which one individual owns a business. The owner may either be the only worker of the business or he may employ as many people as he needs to run the operation. He can use his own name or a trade name. If a trade name is used, oftentimes the business will be identified on official forms and in the case of a lawsuit by use of the designation “d/b/a” (doing business as). For example, “John Jones, d/b/a Multimedia Designs.”

Advantages of the Sole Proprietorship
Sole proprietorships are the easiest and least expensive business forms to set up. They are also the most flexible and, depending on the circumstances, may have the lowest tax rate.

Disadvantages of the Sole Proprietorship
The proprietor bears all of the financial risk of losses and liability, however, and the ability to raise capital is limited. A sole proprietorship cannot issue stock to raise money like a corporation.

Partnerships
The Uniform Partnership Act (UPA), as adopted by the states, governs the operation of partnerships in the absence of an express agreement among the partners to the contrary.

When Does a Partnership Exist?
A partnership is an association of two or more persons to carry on as co-owners a business for profit. Intent is significant. The three essential elements are:
• a sharing of profits or losses;
• a joint ownership of the business; and
• an equal right in the management of the busi¬ness.
Joint ownership of property, or a sharing of profits or losses does not alone create a partnership. Sharing both profits and losses may qualify, however.

Partnership Formation
Partners may agree in their partnership agreement to any terms, as long as they are not illegal or contrary to public policy.

Partnership Duration
A partnership for a term ends on a specific date or completion of a particular project. Dissolution without consent of all partners before the end of the term is a breach of the agreement. If there is no fixed term, a partnership is at will, and any partner can dissolve the firm any time.

Partnership by Estoppel
A person who represents himself or herself to be a partner in an actual or alleged partnership is liable to any third person who acts in good faith reliance. When a partner represents that a non-partner is a member of the firm, the non-partner is regarded as an agent of the firm.

Rights of Partners
Management Rights
All partners have equal rights in management unless the partnership agreement states otherwise. Each partner has one vote, and the majority rules in ordinary matters. Some extraordinary matters may require unanimous consent.
• Where the impact on individual partners will be significant, the partnership may wish to resolve these decisions through a unanimous vote in order to protect the interests of individual partners. The partners may want to require unanimous consent for areas that are deemed critical to the success of the partnership, such as hiring/firing of employees or things that will affect the interests of all existing partners and their stake in the enterprise such as bringing on a new partner or acquiring or selling partnership assets or assuming substantial debt.
• Individual partners do not have property rights in partnership property. In order to protect the interests of all partners from unauthorized behavior involving partnership property, the partners may want to enhance the control over the use and disposition of partnership property by requiring unanimous consent on issues involving the use and assignment of property rights in partnership property.
• All partners are jointly and severally liable for the debts and obligations of the partnership. Where expansion of the partnership requires a significant financial investment involving a large debt load, the interests of all partners must be considered before proceeding with that risk. Where the risk is great and where an individual partner may lose some or all of their personal holdings then the partnership may wish to protect the interests of individual partners in the partnership agreement. Within the partnership agreement the partners can agree what level of liability(dollar amount) is acceptable. Any liability over that amount would require the unanimous consent of all partners. Any liability under that amount would only require the consent of a majority of the partners.
• Since all partners are jointly and severally liable for the debts and obligations of the partnership, individual partners may be exposed to varying degrees of personal risk as the result of the failure of the partnership. A wealthy partner may be much more willing to accept substantial risk. A less wealthy partner may be risking all personal assets. To protect the interests of all partners, the unanimous consent of all partners may be required when making substantial purchases.
• Sale of significant partnership assets should require the unanimous consent of all partners so that the interests of all partners are protected. An individual partner cannot sell or otherwise dispose of partnership property. This option includes the situation where an individual partner cannot use partnership property as collateral for a loan (either a personal loan or a partnership loan) without the majority or unanimous consent of the partners where the property could be subject to seizure if the loan was in default.
• Individual partners do not have property rights in partnership property. Where partnership assets are put at risk either by loaning to a third party or placing the asset in an environment where the asset is subjected to theft or loss affects the interest of all partners. In these situations the partnership may wish to require the unanimous consent of all partners.

Interest in the Partnership Unless provided otherwise, profits and losses are shared equally, re¬gardless of the amount of a partner’s capital contribution.

Compensation
Conducting partnership business is a partner’s duty and gen¬erally not compensable.

Inspection of Books
Books must be kept at the firm’s principal office. Every partner, active or inactive, is entitled to inspect all books and records on demand (and can make copies).

Accounting of Partnership Assets or Profits
An accounting can be called for voluntarily or compelled by a court. Formal accounting occurs by right in connection with dissolution, but a partner also has the right to an account¬ing in other circumstances.

Property Rights
Property acquired in the name of the partnership or a partner, or with partnership funds, is normally partnership property. A partner can use partnership property only on the firm’s behalf. A partner is not a co-owner of this property and has no interest in it that can be transferred.

Duties and Liabilities of Partners
Every act of a partner concerning partnership business and every contract signed in the partnership name binds the firm.

Fiduciary Duties
A partner owes the firm and its partners duties of loyalty and care. The duty of loyalty is limited to accounting to the firm for any property, profit, or benefit in the conduct of its business or from a use of its property, and to refrain from dealing with the firm as an adverse party or competing with it. The duty of care is limited to refraining from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. A partner may pursue his or her own interests without automatically violating these duties.

Authority of Partners
Partners can exercise all implied powers reasonably necessary and customary to carry on partnership business. The firm is bound to honor a partner’s commitments to third parties.

Joint Liability of Partners
In a few states, partners are only jointly liable for partnership obligations. A third party must sue all of the partners as a group, but each partner is wholly liable for the judgment.

Joint and Several Liability of Partners
In most states, partners are jointly and severally liable for partnership obligations, including contracts, torts, and breaches of trust. A third party may sue all of the partners as a group or a partner individually, but a judgment against (or a release of) a single partner does not extinguish the others’ liability .A creditor cannot collect a partnership debt from the partner of a non-bankrupt partnership without first attempting to collect from the partnership, however. A partner who is liable for a tort is liable to the partnership for damages it pays.

Liability of Incoming Partner
A new partner to an existing partnership is liable only to the extent of his or her capital contribution for preexisting partnership debts and obligations.

Partner’s Dissociation
When a partner ceases to be associated in the carrying on of the partnership business, he can have his interest bought by the firm, which otherwise continues to do business.

Events Causing Dissociation
A partner may give notice and withdraw. A partner also dissociates by declaring bankruptcy, assigning his or her interest, or through death or incapacity. Other events can be specified in the partnership agreement, or a partner might be expelled by the firm or by a court.

Effects of Dissociation
On dissociation, a partner’s right to participate in the firm’s business ends. The duty of loyalty also ends, and the duty of care continues only with respect to events that occurred before dissociation, unless the partner participates in winding up. The partner’s interest in the firm may be purchased according to the rules in Uniform Partnership Agreement or a separate Buy Sell Agreement executed by the Partners.

Advantages of a Partnership:
One advantage is that a partnership allows more than one individual to pool financial resources without the requirement of a formal corporate structure and without the expense of organiza¬tional fees.

Disadvantages:
One disadvantage is that each partner has unlimited personal liability for the debts of the partnership. Also, the partnership is technically dissolved by the death of a partner, although there is some statutory relief with regard to winding up the affairs of the partnership after the death of one of the partners. A new partnership can then be formed.

Partnership Termination
Dissolution
A partnership may be dissolved by the partners’ agreement or dissociation of a partner. The firm may continue in business if the partners, including the withdrawing partner, agree. A partnership for a definite term or undertaking, or some other certain event, is dissolved when the term expires, the undertaking is accomplished, or the event occurs.

Winding Up
After dissolution and notice, partners complete transactions begun and not fin¬ished (but they can create no new obligations). Partnership assets are collected, debts are paid, the values of part¬ners’ interests in the partnership are accounted for, and profits and losses distributed. Creditors of the partnership have first claim on the assets of the partnership. Difficulties arise when there is a dispute between the creditors of the partnership and the creditors of the individ¬ual partners. The general rule is that the partnership creditors have first claim on the assets of the firm, and the individual creditors (creditors of the individual partners) share in the remaining assets, if any. After the partnership’s liabilities to non-partners have been paid, the assets of the partnership are distributed as follow:
• Each partner is entitled to a refund of advances made to, or for the benefit of, the partnership;
• Contributions to the capital of the partnership are then returned; and
• The remaining assets, if any, are divided equally as profits among the partners unless there is some agreement which would provide for unequal distribution.
• If the partnership has sustained a loss, the partners share it equally unless there is an agreement between them to the contrary.

Limited Liability Partnerships
A limited liability partnership (LLP) offers the pass-through tax advantages of a partnership but limits its partners’ liability. Family businesses and professional services are often LLPs. Organizing an LLP requires filing a form with a state and including “Limited Liability Partnership” or “LLP” in its name. Annual reports must be filed with the state.

Liability in an LLP
The LLP allows professionals to avoid personal liability for the mal¬practice of other partners. The UPA exempts partners from personal liability for any partnership obligation, whether arising in contract, tort, or otherwise.

Family Limited Liability Partnerships
A family limited liability partnership is a limited liability partnership (LLP) in which the majority of the partners are persons related to each other. All of the partners must be natural persons or persons acting in a fiduciary capacity for the benefit of natural persons. The most significant use of the family LLP is in agriculture, e.g., family-owned farms.

Limited Partnerships
A limited partnership is a modified partnership. It is half corporation and half partnership. This kind of partnership is a creature of State statutes. Many States have either adopted the Uniform Limited Partnership Act or the Revised Uniform Limited Partnership Act. In a limited partnership, certain members contribute capital, but do not have liability for the debts of the partnership beyond the amount of their investment. These members are known as limited partners. The partners who manage the business and who are personally liable for the debts of the business are the general partners. A limited partnership can have one or more general partners and one or more limited partners.

Under the ULPA, a limited partnership has to be created by executing a certificate which sets forth the name and business address of each partner, states which partners are general partners and which are limited partners, and states certain details about the partnership and the relative rights of the partners. This, of course, is not true in a general partnership. A general partnership is governed by a partnership agreement which is private and which may be oral or written. The limited partnership certificate usually must be recorded in an office, such as a County Clerk’s office. It must be recorded in the County in which the principal place of business of the partnership is located.

The Revised Uniform Limited Partnership Act is somewhat less restrictive as to what needs to be disclosed in this certificate. For example, the names of the limited partners are not required. Also, a certificate must only be filed with the office of the Secretary of State as opposed to County filing.

If there is no filing of a limited partnership certificate, both the limited and general partners will have the status and liability of general partners.

The general rule is that the limited partner’s name cannot appear in the firm name. If the limited partner’s name is used, and this gives the public the impression that the limited partner is an active partner, the limited partner can lose his protection of limited liability and will become liable as a general partner.

The general partners manage the business of the partnership and are personally liable for its debts. Limited partners have the right to share in the profits of the business and, if the partner¬ship is dissolved, will be entitled to a percentage of the assets of the partnership. A limited partner may lose his limited liability status if he participates in the control of the business.

Both the Revised Uniform Limited Partnership Act and the Uniform Limited Partnership Act lists some activities known as safe harbor activities in which limited partners may participate without losing their limited liability. Pursuant to the ULPA these “safe harbor” activities include:
• Being an agent, employee, or contractor for the limited partnership;
• Consulting with the advising a general partner with respect to the business of the limited partnership;
• Approving or disapproving of an amendment to the partnership agreement; or
• Voting on specified matters.
Also, the partnership agreement may grant to all limited partners, or to a specified group thereof, the right to vote on a per capita or other basis upon any matter.

The RULA expands the safe harbor rules as follows:
• Guaranteeing or assuming one or more specific obligations of the limited partnership;
• Taking any action required or permitted by law to bring or pursue a derivative action in the right of the limited partnership;
• Requesting or attending a meeting of partners; and
• Winding up the partnership.
A limited partner should be careful to follow the principles outlined or face the possibility of being personally liable for all partnership debts.

Dissociation and Dissolution
The death, retirement, or mental incompetence of a general partner does not dissolve the partnership, if the other partners continue business. A general partner’s bankruptcy or withdrawal may dissolve the firm. In the case of a limited partner, none of these occurrences will dissolve the firm. A limited partnership can be dissolved by court decree.

Limited Liability Companies
LLC’s are a relatively new form of business organization that can be formed in almost all, if not all, states. An LLC is a separate legal entity that can conduct business just like a corporation with many of the advantages of a partnership. It is taxed as a partnership. Its owners are called members and receive income from the LLC just as a partner would. There is no tax on the LLC entity itself. The members are not personally liable for the debts and obligations of the entity like partners would be. Basically, an LLC combines the tax advantages of a partnership with the limited liability feature of a corporation.

An LLC is formed by filing articles of organization with the secretary of state in the same type manner that articles of incorporation are filed. The articles must contain the name, purpose, duration, registered agent, and principle office of the LLC. The name of the LLC must contain the words limited liability company or LLC.

Management of an LLC is vested in its members. An operating agreement is executed by the members and operates much the same way a partnership agreement operates. Members may delegate authority to managers who run the LLC much the same way officers of a corporation would run a corporation. Profits and losses are shared according to the terms of the operating agreement.

Advantages and Disadvantages of the LLC
Advantages of the LLC
An LLC is a hybrid form of business enterprise that offers the limited liability of the corpo¬ration and the tax advantages of a partnership. LLCs with two or more members can elect to be taxed as either a partnership or a corporation. If no choice is made, an LLC is taxed as a partnership. One-member LLCs are taxed as sole proprietorships unless they elect to be taxed as corpora¬tions. Other advantages include the LLC’s flexible operations and man¬agement characteristics.

Disadvantages of the LLC
These include the lack of uniformity among state LLC statutes and the lack of case law.

Dissociation and Dissolution of an LLC
Dissociation occurs when a member ceases to be associated with the carrying on of a business. A member of an LLC has the power, but may not have the right, to dissociate from the firm. Events that trigger dissociation under the Uniform Limited Liability Company Act are the same as those under the Uniform Partnership Act.

Effect of Dissociation
On dissociation, a member’s right to participate in the firm’s business ends. The duty of loyalty also ends, and the duty of care continues only with respect to events that occurred before dissociation. The member’s interest in the firm must be bought out according to the LLC agreement, or for its “fair” value.

Dissolution
A dissociating member does not normally have the right to force the firm to dissolve (although the other members can dissolve the firm if they want and a court might order dissolution). On dissolution, any member can participate in winding up. After liquidation of the assets, the proceeds are distributed first to creditors (which may include members), second to capital contributors, and finally to members according to the operating agreement or in equal shares.

How Do You Choose between LLCs and LLPs
One of the most important decisions that an entrepreneur makes is the selection of the form in which to do business. To make the best decision, a businessperson should understand all aspects of the various forms, including legal, tax, licensing, and business considerations. It is also important that all of the participants in the business understand their actual relationship, regardless of the or¬ganizational structure.

Number of Participants
During the last decade or so, new forms of business organizations, including limited liability partnerships (LLPs) and limited liability companies (LLCs), have been added to the options for business entities. An initial consideration in choosing between these forms is the number of participants. An LLP must have two or more partners, but in many states, an LLC can have a single member (owner).

Liability Considerations
The members of an LLC are not liable for the obligations of the organization. The liability of the partners in an LLP varies from state to state. About half of the states exempt the partners from liability for any obligation of the firm. In some states, the partners are individually liable for the con¬tractual obligations of the firm but are not liable for obligations arising from the torts of others. In either situation, each partner may be on his or her own with respect to liability unless the other part¬ners decide to help.

Distributions from the Firm
Members and partners are generally paid by allowing them to withdraw funds from the firm against their share of the profits. In many states, a member of an LLC must repay so-called wrongful distributions even if he did not know that the distributions were wrongful. Under most LLP statutes, by contrast, the partners must repay only distributions that were fraudulent.
Management Structure

Both LLPs and LLCs can set up whatever management structure the participants desire. Also, all unincorporated business organizations, including LLPs and LLCs, are treated as partnerships for federal income tax purposes (unless an LLC elects to be treated as a corporation). This means that the firms are not taxed at the entity level. Their income is passed through to the partners or mem¬bers who must report it on their individual income tax returns. Some states impose additional taxes on LLCs. The chief benefits of electing corporate status for tax purposes are that the members generally are not subject to self-employment taxes, and fringe benefits may be provided to employee-members on a tax-reduced basis. The tax laws are com-plicated, however, and a tax professional should be consulted about the details.

The Nature of the Business
The business in which a firm engages is another factor to consider in choosing a business form. For example, with a few exceptions, professionals, such as accountants, attorneys, and physicians, may organize as either an LLP or an LLC in any state. In many states, however, the ownership of an entity that engages in a certain profession and the liability of the owners are prescribed by state law.

Financial and Personal Relationships
Despite their importance, the legal consequences of choosing a business form are often secondary to the financial and personal relationships among the participants. Work effort, motivation, ability, and other personal attributes can be significant factors, as may fundamental business concerns such as the expenses and debts of the firm. Other practical factors to consider include the willingness of others to do business with an LLP or an LLC. A supplier, for example, may not be willing to extend credit to a firm whose partners or members will not accept personal liability for the debt.
Checklist for Choosing a Limited Liability Business Form
• Determine the number of participants, the forms a state allows, and the limits on liability the state provides for the participants.
• Evaluate the tax considerations.
• Consider the business in which the firm engages, or will engage, and any restrictions imposed on that type of business.
• Weigh such practical concerns as the financial and personal relationships among the participants and the willingness of others to do business with a particular organizational form.

CORPORATIONS
Business corporations are created when a branch of the State government approves articles of incorporation prepared by incorpo¬ra¬tors. In most states, this branch of government is the Secretary of State. Each State has a Corporation Act which is a series of statutes regulating the creation and operation of a corporate structure. Corporations formed for profit have to have shareholders, directors and officers. The shareholders are responsible for electing the board of directors. The board of directors are ultimately responsible for the management of the business, but they employ or elect officers who run the day-to-day operations. Corporations may range in size from an incorporated one-person business to a large multinational business.

Advantages:
One advantage is that the shareholder’s risk of loss from the business is limited to the amount of capital that the shareholder invested in the business. Also, a corporation can raise capital by issuing stock which can allow the corporation to expand.

A corporation is a separate legal entity (a legal person) and can own property, make contracts, bring lawsuits, and be sued as a person.

Disadvantages:
A corporation is required to pay corporate income taxes. Share¬holders who receive dividends from the corporation are required to pay personal taxes on these dividends. This results in double taxation which may certainly be a disadvantage against incorporation of small businesses with just a few shareholders (e.g., close corporations). One way around double taxation in a close corporation situation where the shareholders also work for the corporation, is to make sure that they receive salaries and bonuses sufficient to wipe out any profits that would have to be distributed as dividends. However, any salary and bonus paid cannot be more than what would be reasonable considering the type of business the corporation is involved in. If the salary is unreasonable, the IRS may declare that part of the salary is really a dividend, and tax the corporation on this portion as well as the individual.

The organization and operation of a corporation does involve some expenses which would not be required in a sole proprietorship. For example, certain filing fees have to be paid upon filing the articles of incorporation. Also, State corporation laws may also require the filing of an annual report, as well as other reports. In many states, this is not really a problem since the filing fees are very low (e.g., $50.00 for the filing of the articles). Also, the reports that must be filed on a yearly basis are not that difficult to prepare and file.

CLASSIFICATION OF CORPORATIONS
A public corporation is one established for governmental purposes and for the administration of public affairs. A city is a public or a municipal corporation acting under authority granted to it by the State.

A private corporation is one organized by persons, either profit or nonprofit. Private corporations are often called “public” when the stock is sold to the public and traded on the stock exchanges.

A corporation is called a domestic corporation with respect to the State under whose law it has been incorporated. Any other corporation going into that State is called a foreign corporation. For example, a corporation holding a Texas Charter is a domestic corporation in Texas, but a foreign corporation in all other States. A foreign corporation must qualify to do business in a foreign State.

Special service corporations are corporations formed for transportation, banking, insurance, and similar specialized functions. These corporations are subject to separate codes or statutes with regard to their organization.

A corporation whose shares are held by a single shareholder or a closely-knit group of shareholders (such as a family) is known as a close corporation. The shares of stock are not traded publicly. Many of these types of corporations are small firms that in the past would have been operated as a sole proprietorship or partnership, but have been incorporated in order to obtain the advantages of limited liability or a tax benefit or both.

A corporation may be organized for the business of conducting a profession. These are known as professional corporations. Doctors, attorneys, engineers, and CPAs are the types of profes¬sionals who may form a professional corporation. Usually there is a designation P.A. or P.C. after the corporate name in order to show that this is a professional association or professional corporation.

A nonprofit corporation is one that is organized for chari¬table or benevolent purposes. These corporations include certain hospitals, universities, churches, and other religious organizations. A nonprofit entity does not have to be a nonprofit corporation, however. Nonprofit corporations do not have shareholders, but have members or a perpetual board of directors or board of trustees.

A Subchapter S corporation is a corporation in which the shareholders elect to be treated as partners for income tax purposes. Shareholders still have limited liability protection of a corporation, but income is treated like partnership income. Subchapter S refers to a particular subdivision of the Internal Revenue Code. The number of shareholders is limited to 75 shareholders and neither corporations nor partnerships can be shareholders in a Subchapter S corporation. Also, shareholders must be U.S. citizens or resident aliens.

IGNORING THE CORPORATE ENTITY
Ordinarily, a corporation will be regarded and treated as a separate legal person, and the law will not look beyond a corpora¬tion to see who owns it.

Piercing the Corporate Veil
A Court may disregard the corporate entity and pierce the corporate veil in exceptional circumstances. The decision whether to disregard the corporate entity and go directly against the shareholders is made on a case-by-case basis. Factors that may lead to piercing the corporate veil are:
• Failure to maintain adequate corporate records and the commingling of corporate and personal funds;
• Grossly inadequate capitalization (debt/equity ratio too high);
• The formation of a corporation to evade an existing obligation;
• The formation of a corporation to perpetrate a fraud;
• Improper diversion of corporate assets; and
• Injustice and inequitable circumstances would result if the corporate entity were recognized.

Courts generally will look to more than one factor.

Hypothetical: Susan sued the Mobile Construction Company. Philip was the only shareholder of the corporation. Susan obtained a judgment against the corporation. Philip then dissolved the corporation and took over all its assets. He agreed to pay all outstanding debts of the corporation except the judgment in favor of Susan. She sued Philip on the ground that he was liable for the judgment against the corporation. He claimed that the judgment was only the liability of the corporation and that he was not liable because he was merely a shareholder and had not assumed the liability for the judgment. Is Philip liable on the judgment? YES. If the corporation alone were liable to Susan, an injustice would be done because the corporation had been stripped of all its assets and therefore could not pay the judgment. The timing of the dissolution of the corporation and assumption of all of its debts but Susan’s judgment showed that Philip maneuvered the corporate assets to his personal advantage. It would be unjust to allow him to keep the corporate assets after he had made it impossible for the corporation to pay the judgment to Susan. To prevent this injustice, the corporate entity would be ignored, and Philip would be liable on the judgment against the corporation.

It is extremely difficult to pierce a corporate veil in most situations. Some Courts use different terminology when disregarding the corporate entity. The Court may state that the corporation is the alter ego of the shareholders, and the share¬holders should therefore be held liable.

The Court will not go behind the corporate identity merely because a corporation has been formed to obtain tax savings or to obtain limited liability for its shareholders. One-person, family, and other closely-held corporations are permissible and fully entitled to all of the advantages of corporate existence. However, factors that lead to piercing the corporate veil more commonly exist in these kinds of corporations.

PROMOTERS
Promoters are the people that bring the corporation into existence. They bring together other people interested in the company, solicit stock purchasers, and sometimes make contracts to be assigned later to the corporation. A corporation is not liable on a contract made by a promoter unless the corporation takes some sort of affirmative action to adopt the contract. The promoter still remains personally liable on the contract unless released by the other contracting party. The contract can provide that the promoter will be released from personal liability upon adoption of the contract by the corporation.

INCORPORATION
One or more natural persons or corporations may act as incorporators of a corporation by signing and filing Articles of Incorporation with the designated government official (usually the Secretary of State). These Articles are filed in duplicate, and the Secretary of State, when satisfied that the Articles conform to the State’s corporation statutes, stamps filed and the date on each copy. The Secretary of State then retains one copy and returns the other copy, along with a filing fee receipt, to the corporation.

The Articles of Incorporation must contain the following:

• The name of the corporation;
• The number of shares of stock the corporation is authorized to issue;
• The street address of the corporation’s initial registered office and the name of its initial registered agent; and
• The name and address of each incorporator.

The Articles may contain optional provisions such as the purpose for which the corporation is organized. However, if the Articles contain no purpose clause, the corporation will automatically have the purpose of engaging in any lawful business. Also, if no reference is made to the duration of the corporation in the Articles, it will automatically have a perpetual duration.

Under the RMBCA, corporate existence begins when the Articles are filed with the Secretary of State. Under the older practice still followed by many States, corporate existence begins upon the issuance of a Certificate of Incorporation by the Secretary of State.

FORFEITURE OF CHARTER
Under the RMBCA, the Secretary of State may administratively dissolve a corporation if:
• the corporation does not pay franchise taxes (these taxes are payable to the State, and the amount depends on the capital assets of the corporation);
• the corporation does not file its annual report within 60 days after it is due;
• the corporation is without a registered agent or a registered office for 60 days or more.

An annual report is a report filed with the Secretary of State which sets forth information such as the name of the corporation and the State where incorporated, the address of its registered office and name of its registered agent, the address of its principal office, the names and businesses addresses of its directors and principal officers, a brief description of the nature of the business, and information regarding the total number of authorized shares of stock.

Owners and officers of a dissolved corporation are not shielded from personal liability by using the corporate name in making contracts.

JUDICIAL DISSOLUTION
In some States, statutes provide that a judicial dissolution of a corporation may be implemented if the management of the corporation is deadlocked, and the deadlock cannot be broken by the shareholders.

CORPORATE POWERS
Corporations have some of the same powers as a natural person, such as the right to own property. If a corporation acts beyond the limits of its powers, the act is ultra vires. This is an act or contract that the corporation did not have authority to do or make. Modern corporation statutes give corporations broad powers, and the likelihood that a corporation will act beyond its powers is rare.

All corporations do not have the same powers. For example, corporations that operate banks, insurance companies, and railroads generally have special powers and are subject to special statutory restrictions.

As long as the Federal and State Constitutions are not violated, a State Legislature may give corporations any lawful powers. The RMBCA grants a corporation the same powers as an individual to do all things necessary or convenient to carry out its business and affairs.

PARTICULAR POWERS
Modern corporation statutes give corporations a wide range of powers. A corporation has perpetual succession or continuous life. In other words, it has the power to continue as a unit indefinitely or for a stated period of time regardless of any changes in the owner¬ship of its stock. If no period of time is fixed for the duration of the corporation, the corporation will exist indefinitely until it is legally dissolved. If the period of existence is limited, the corporation can extend the period by meeting certain statutory requirements.
• A corporation may issue certificates representing corporate stock.
• Corporations have the power to enter into contracts just like an individual.
• Corporations have the power to borrow money in carrying out their business purposes.
• A corporation can borrow money by issuing bonds. The bonds issued by a corporation are subject to Article 8 of the UCC (“Investment Securities”).
• A corporation may sell or lease its property. However, in most States a corporation may not sell or mortgage all or substan¬tially all of its assets without the consent of the majority of the shareholders.
• Obviously a corporation has the power to incur debt and mortgage its property as security for debt.
• A corporation may be a member of a partnership and may be a limited or general partner of a limited partnership.
• Corporations can pay pensions and establish pension plans for its employees.
• The RMBCA even authorizes a corporation to make charitable contributions.

A corporation must have a name to identify it. Most States require that the corporate name contain some indication that it is a corporation, such as corporation, company, incorporated, limited, or an abbreviation of these words.

A corporation may have a seal which can be used to show that a contract or a document is being executed pursuant to valid corporate authority.

Bylaws are the rules and regulations of a corporation which govern its internal affairs. They are adopted by the shareholders, though in some States they may be adopted by the directors of the corporation. Of course the bylaws cannot conflict with the general corporate statutes of a State or the bylaws will be void.

Corporations may acquire the stock of another corporation and be a stockholder of another corporation. A corporation owning stock in another corporation can own such a large percentage of the stock that it controls the operations of the corporation. In such a case, the corporation owning the stock is commonly called a holding company. Sometimes a holding company is organized solely for the purpose of controlling other companies. These other companies are called subsidiary companies. Courts normally recognize the holding company and its subsidiary company as separate and distinct legal entities. A corporation does not have to be a holding company to own a subsidiary.

Generally, a corporation may purchase its own stock if it is solvent, and this stock will be known as treasury stock. Treasury stock maintains the status of outstanding stock, but is regarded as inactive and cannot be taken into consideration regarding votes by the shareholders. Also, dividends cannot be declared regarding treasury stock. The RMBCA eliminates the concept of treasury stock and calls this type of stock authorized, but unissued, stock.

A corporation has the power to do business in other States. However, by doing business in other States, the corporation may have to qualify as a foreign corporation to do business in that State which usually involves registering with the Secretary of State.

ULTRA VIRES ACTS
If a corporation acts beyond the scope of the powers granted by its charter and the statutes of the State under which it is governed, the corporation’s act is declared as ultra vires. However, modern corporation statutes give such a broad scope of powers that it is difficult to find an action that is ultra vires. The text gives an example of a mining corporation which begins to manufacture television sets. In such a situation, there might be an ultra vires transaction if the corporate charter restricted the corporation’s powers to mining and related-such activities. How¬ever, this type of situation is extremely rare.

Nonprofit corporations have a more restricted range of powers than business corporations, and it would be more likely to find an ultra vires act in a nonprofit corporation than a profit corporation.

CONSOLIDATIONS, MERGERS, AND CONGLOMERATES
DEFINITIONS
In a consolidation of two or more corporations, their separate existences cease, and a new corporation with the property and the assets of the old corporations comes into being.

A merger is different from a consolidation in that when two corporations merge, one absorbs the other. One corporation preserves its original charter and identity and continues to exist. The other corporation disappears, and its corporate existence terminates.

A conglomerate is the term describing the relationship of a parent corporation to subsidiary corporations engaged in diversified activities which are unrelated to the activity of the parent corporation. A subsidiary corporation is a corporation whose majority shareholder is another corporation (parent corporation). An example of a conglomerate could be a wire-manufacturing corporation that owns all of the stock of a newspaper corporation and of a drug-manufacturing corporation.

LEGALITY
Consolidations, mergers, and asset acquisitions are sometimes prohibited by federal antitrust legislation on the grounds that the effect is to lessen competition in interstate commerce.

LIABILITY OF SUCCESSOR CORPORATIONS
When corporations are combined in any way, the question arises as to who is liable for the debts and obligations of the predeces¬sor corporations.

Generally, the corporate entity which continues the business after a merger or a consolidation will succeed to all of the rights and property of the predecessors and will also be subject to all of the debts and liabilities of the predecessor corporations. For example, A merges into B. Suppose A had a contract with C. B did not. After the merger, B is liable to C on the contract.

A corporation may merely purchase the assets of another business. This would not be a merger or consolidation. In an acquisition situation, the purchaser does not become liable for the obligations of the business whose assets are being purchased.

JOINT VENTURES
A joint venture is a relationship between two or more people who combine their labor or property for a single business under¬taking. They share profits and losses equally, or as otherwise provided in the joint venture agreement. The single business undertaking aspect is a key to determining whether or not a business entity is a joint venture as opposed to a partnership.

Hypothetical: Elizabeth, Josephine, and Mark entered into an agreement to purchase a tract of land, build houses on it, sell the houses, and then divide the net profit. What kind of business organization was this? This would be a joint venture because resources were pooled, and the profit-sharing operation was limited to one particular operation. The fact that a long period of time might pass before the venture ended would not cause this organization to lose its status as a joint venture.

A joint venture is very similar to a partnership. In fact, some States treat joint ventures the same as partnerships with regard to partnership statutes such as the Uniform Partnership Act. The main difference between a partnership and a joint venture is that a joint venture usually relates to the pursuit of a single transaction or enterprise even though this may require several years to accomplish. A partnership is generally a continuing or ongoing business or activity. While a partnership may be expressly created for a single transaction, this is very unusual. The duties owed by joint venturers to each are the same as those that partners owe to each other. For example, partners have a duty of loyalty to one another, and joint venturers would also have the same duty. If a joint venture is entered into to acquire and develop a certain tract of land, but some of the venturers secretly purchase and develop land in their own names to compete with the joint venture, the other joint venturers may be liable for damages for the breach of this duty of loyalty.

A joint venture will last generally as long as stated in the joint venture agreement. If the joint venture agreement is silent on this, it can be terminated by any participant unless it clearly relates to a particular transaction. For example, if a joint venture is created to construct a particular bridge, it will last until the project is completed or becomes impossible to complete because of bankruptcy or some other type situation.

With regard to liability to third persons, generally, joint venturers have the same liability as partners in a general partnership.

UNINCORPORATED ASSOCIATIONS
An unincorporated association involves two or more persons who combine their efforts to further a common purpose, usually nonprofit. Social clubs, fraternal associations, and sororities are common examples of unincorporated associations.

Unless provided otherwise by statute, an unincorporated association does not have any legal existence. It is not a separate legal entity. It cannot sue or be sued in its own name.

Generally, the members of an unincorporated association are not liable for debts or liabilities of the association merely because they are members. Generally, they must authorize or ratify the act in question before they can be held liable for it. A case in point is the Golden Spike Little League case. In this case, Golden Spike Little League was an unincorporated association of persons who formed to promote Little League Baseball in Ogden, Utah. They sent one of their members to arrange credit at a local sporting goods store. After getting this credit, various members went to the store and picked up and signed for different items of baseball equipment and uniforms. When the store requested payment, the members had a fund-raising activity, but this only produced $149.00. The store was owed $3,900.00. The store sued Golden Spike Little League as an entity, as well as the members who had picked up the equipment and signed for it individ¬ually. The individuals argued that they would not have any personal liability since only the association could be held responsible. The Court held for the store against the individual members. The Court also held that the store could not recover from the unincorporated association since it is not a legal entity. However, the Court pointed out that the individuals that were sued did enter into contracts, and therefore they were personally liable to the store even though they argued that they were making these contracts for the association.

It is generally preferable to form a non-profit corporation than do business through an unincorporated association.

COOPERATIVES
A cooperative consists of two or more persons or enterprises that cooperate with respect to a common purpose or function. An example would be farmers who pool their farm products and sell them. Statutes commonly provide for the special incorporation of coopera¬tive enterprises. For example, an agricultural association in Mississippi can incorporate. The suffix used on the name of the corporation is “AAL” rather than “Inc.”

FRANCHISES
There is a definition of a franchise which has been developed by the Federal Trade Commission. Basically, a franchise involves an owner of a trademark, trade name and/or copyright giving others a license under certain conditions to use these trademarks, trade names or copyrights in providing goods or services to the public. The franchisor is the party who grants the franchise, and the franchisee is the party who receives the franchise.

THE FRANCHISE AGREEMENT
Technically, the relationship between a franchisor and franchisee is a relationship between two independent contractors. Their rights are determined by the franchise agreement. A franchise then is not a separate business entity, but is a business relationship between two separate business organizations such as a sole proprietorship, a corporation, or a partnership. The relationship between the franchisor and franchisee is controlled by the franchise contract. A corporation, sole proprietorship, or partnership may own the franchise contract or may be the entity entering into the franchise contract.

The word franchise does not have to be used in order to create a franchise. A relationship is treated as a franchise if it meets the applicable legal test for a franchise.

A franchise may last as long as the parties agree. In other words, this is set forth in the franchise contract. Franchise contracts also will specify events which will cause the franchise to terminate. For example, the contract may provide that it will terminate upon the franchisee’s death, bankruptcy, failure to make franchise fee payments, or failure to meet sales quotas.

SPECIAL PROTECTION UNDER FEDERAL LAWS
There are laws that restrict termination of some franchises. In some States, prior notice of termination is required. Owners of automobile dealership franchises are protected from termination of their dealerships in bad faith. This protection is provided by the Federal Automobile Dealers Franchise Act.

DISCLOSURE
Governmental regulation of franchises generally has to do with problems of fraud in the sale of the franchise and protecting the franchisees from unreasonable demands and bad faith terminations. The FTC adopted extensive regulations to protect franchisees from deception. These regulations require a franchisor to give a prospective franchise a disclosure statement ten days before the franchisee signs a contract or pays any money for a franchise. If a franchisor fails to follow the regulations, he may be fined up to $10,000.00 for each violation.

FAQ Regarding Small Business Law

What is a business?

A business is an activity performed for the expectation of profit in a systematic, continuous and commercial manner.

What are the most common types of business organizations for small businesses?

The most common forms of business organizations include:

  • Sole proprietorship;
  • General Partnership;
  • Limited partnership;
  • Limited liability partnership;
  • Corporation;
  • Subchapter S corporation; and
  • Limited liability company.

What is a sole proprietorship?

A sole proprietorship is an informal business that doesn’t involve the complexities and expenses of formal incorporation procedures. It is typically owned by an individual or family members. The owner operates the business, is personally liable for all business debts, and can freely transfer all or part of the business. If a lawsuit is filed because the business owes money or because someone was harmed by the business, the owner (the sole proprietor) is personally liable for any judgment that the plaintiff might be awarded by the court. In this form of business, the law and the taxing authorities (IRS, etc.) do not distinguish the business from the individual who owns it. Profit or loss is reported on the owner’s personal income tax return and all net income is taxed to the individual at his/her personal tax rate. If the business has employees, the owners are required by law to withhold federal income taxes, state income taxes and FICA (Social Security) Insurance from the wages paid to employees.

What are some advantages and disadvantages of a sole proprietorship?

Advantages of a Sole Proprietorship over other Business forms:

  • It is simpler to form than a corporation, LLC, LLP, partnership or LP, and the startup costs for a sole proprietorship are minimal.
  • The sole proprietor controls all of the financial and management decisions and receives all of the profits.
  • The business’ net earnings are not subject to corporate income tax, but are taxed as personal income. All profits and losses of the business are reported directly to the owner’s income tax return. A separate tax return for the business or balance sheet is not required.
  • Decision-making is in the direct hands of owner.

 Disadvantages:

  • The owner is subject to unlimited personal liability for the debts of the business. Both the business and personal assets of the sole proprietor are subject to the claims of creditors.
  • It is difficult for a sole proprietorship to raise capital. Financial resources are generally limited to the owner’s funds and any loans outsiders are willing to provide. Corporations can issue stock and raise capital that way.
  • Owner could spend unlimited amount of time responding to business needs.
  • Because a sole proprietorship is not a separate legal entity, it usually terminates when the owner becomes disabled, retires, or dies. As a result, the sole proprietorship lacks continuity and does not have perpetual existence like other business organizations.
  • Some employee benefits, such as owner’s medical insurance premiums, are not directly deductible from business income (only partially deductible as an adjustment to income).

 What is a general partnership?

A partnership involves combining the capital resources and the business or professional abilities of two or more people in a business.  It is a business enterprise entered into for profit which is owned by more than one person, each of whom is a partner. A partnership may be created by a formal written agreement, but can also be established through an oral agreement or just a handshake. Each partner has an agreed percentage of ownership in return for an investment of a certain amount of money, assets and/or effort. Each partner is responsible for all the debts and contracts of the partnership even though another partner may have created the debt or entered into the contract. General partners share in management decisions, and share in profits and losses according to the percentage of the total investment or partnership agreement.

What are some of the advantages and disadvantages of a partnership form of business?

One advantage is that a partnership allows more than one individual to pool financial resources without the requirement of a formal corporate structure and without the expense of organiza­tional fees. Some disadvantages are:

  • Each partner has unlimited personal liability for the debts of the partnership.
  • The partnership is technically dissolved by the death of a partner, although there is some statutory relief with regard to winding up the affairs of the partnership after the death of one of the partners.  A new partnership can then be formed.

What is a limited partnership?

A limited partnership is a modified partnership.  It is half corporation and half partnership.  This kind of partnership is a creature of state statutes. In a limited partnership, certain members contribute capital, but do not have liability for the debts of the partnership beyond the amount of their investment.  These members are known as limited partners.  The partners who manage the business and who are personally liable for the debts of the business are the general partners.  A limited partnership can have one or more general partners and one or more limited partners.

What is a limited liability company?

A limited liability company (LLC) is a separate legal entity that can conduct business just like a corporation with many of the advantages of a partnership. It is taxed as a partnership. Its owners are called members and receive income from the LLC just as a partner would. There is no tax on the LLC entity itself. The members are not personally liable for the debts and obligations of the entity like partners would be. Basically, an LLC combines the tax advantages of a partnership with the limited liability feature of a corporation.

What is a limited liability partnership?

A Limited Liability Partnership (LLP) is essentially a general partnership with the limited liability of an LLC. It is owned by partners rather than members.  It is may be easier in some respects to convert a general partnership into an LLP as opposed to an LLC. The partnership agreement would only have to be amended for an LLP, but redrafted as an operating agreement for an LLC.

 What are the advantages and disadvantages of operating as a corporation?

Advantages:

  • The shareholder’s risk of loss from the business is limited to the amount of capital that the shareholder invested in the business.
  • A corporation can raise capital by issuing stock which can allow the corporation to expand.

Disadvantages:

  • A corporation is required to pay corporate income taxes.  Share­holders who receive dividends from the corporation are required to pay personal taxes on these dividends.  This results in double taxation which may certainly be a disadvantage against incorporation of small businesses with just a few shareholders (e.g., close corporations).  One way around double taxation in a close corporation situation where the shareholders also work for the corporation, is to make sure that they receive salaries and bonuses sufficient to wipe out any profits that would have to be distributed as dividends.  However, any salary and bonus paid cannot be more than what would be reasonable considering the type of business the corporation is involved in.  If the salary is unreasonable, the IRS may declare that part of the salary is really a dividend, and tax the corporation on this portion as well as the individual.
  • The organization and operation of a corporation does involve some expenses which would not be required in a sole proprietorship.  For example, certain filing fees have to be paid upon filing the articles of incorporation.
  • State corporation laws may also require the filing of an annual report, as well as other reports

What are S Corporations?

An S corporation combines the limited liability of a corporation and the “pass-through” tax-treatment of a partnership. It is a business structure suited to small business owners who want the continuity and liability protection of a corporation but wish to be taxed as a sole proprietorship or partnership. An S corporation is essentially a  corporation that has elected to become an S corporation for tax treatment purposes. The S corporation election form 2553 is filed with the Internal Revenue Service. Instead of being taxed at the corporate level, the income “passes through” to the individual shareholders. This is the same basic “pass-through” treatment afforded partnerships and limited liability companies. Any income or loss generated by the S corporation is reported on the individual tax returns of the shareholders, rather than being taxed at the corporate level. Thus, the S corporation election is a popular choice for many small businesses.

Can I run a business out of my home?

For some types of businesses, especially those where you visit your customers rather than being dependent on their coming to your place of business, this is fine. In some situations, you may be able to deduct the value of the space you use for your business operations on your income tax return. To qualify for the deduction, however, your home office must, as a general rule, be your principal place of business (i.e., your main location for administrative/management activities) and be regularly and exclusively used by the business.

Some zoning ordinances in some strictly residential areas will absolutely prohibit all in-home businesses. Other communities permit a home business, but may have restrictions like the following:

  • Specification of the kinds of work that can be run out of your home (e.g.,, music, beauty salon, tutoring);
  • Limit the amount of floor space that can be utilized;
  • Restrict the hours the business can operate;
  • Limit the use of on-street parking;
  • Prohibit or limit the number of employees you may hire;
  • Ban or require a entrance to your business that is separate from your residence; or
  • Ban advertising signs.

Do I need a taxpayer identification number?

Any business that has employees must generally have a taxpayer identification number, which is often referred to as an “EIN” (employer identification number). An EIN is a number assigned to a business for tax reporting and withholding deposit purposes. It is different from your individual social security number. Both a federal and a state EIN are required.

An EIN is required so that withholdings (federal and state income tax, social security and Medicare taxes, unemployment insurance, and other taxes) can be remitted to the Internal Revenue Service and state tax authorities. The Internal Revenue Service and many state tax authorities publish pamphlets and booklets which can help you determine whether you need a separate EIN for your business.

What is a close corporation?

A close corporation is one in which, as a general rule, all or most of the shareholders are actively involved in managing the business. Most corporations could qualify as a close corporation.

What is a buy-sale agreement?

A buy-sell agreement is an agreement between the owners of the business for purchase of each others interest in the business.  Such an agreement will spell out the terms governing sale of company stock to an outsider and thus protect control of the company. It can be triggered in the event of the owner’s death, disability, retirement, withdrawal from the business or other events. Life insurance owned by the corporation is often used to provide the funds to purchase the shares of a closely held company if one of the owners dies.

 What is a professional corporation?

A corporation may be organized for the business of conducting a profession.  These are known as professional corporations.  Doctors, attorneys, engineers, and CPAs are the types of profes­sionals who may form a professional corporation.  Usually there is a designation P.A. or P.C. after the corporate name in order to show that this is a professional association or professional corporation. Shareholders must be licensed to practice in the profession for which the corporation was created.

 Do I need any licenses or permits?

Whether you need a license or permit depends upon the type of business you engage in, the location of your business, and federal, state, county, city, and local rules and ordinances. Cities and counties require permits for many business activities (such as construction or elevator operations permits). In addition, many local governments require a business license before you start your business (a license requiring payment of an annual fee or tax to do business in that city or town).

In addition to municipal license requirements, each state has its own system of licensing and its own restrictions, whether you work for yourself or for someone else. Typically, licensing is required:

  • For those businesses or professionals that go through extensive training before practicing, such as lawyers, physicians, nurses, accountants, dentists, teachers, or
  • Before carrying on a particular trade or business, in order to protect the environment and consumers from fraudulent activities and unsafe products or services. Real estate agents, restaurants, bars, insurance agents, pawnbrokers, peddlers, cosmologists, private investigators, and mechanics are representative of this group, to name a tiny fraction.

Do I need a fictitious business name statement?

Depending on your state law, most businesses that operate under a fictitious name are required to complete a fictitious business name statement, publish the statement in a newspaper of general circulation, and then record this information with the County Recorder where the business is located. Corporations are generally exempt, as are businesses that use the individual proprietor’s own name. If you are “doing business as” (d/b/a), generally you need to comply with fictitious business name rules.

What types of insurance will I need to start a business?

Whether you need insurance depends on your business activities and the amount of liability exposure that you have from the activity. In addition, insurance may be required for employees (such as worker’s compensation insurance, state disability insurance, or unemployment insurance).

Some common forms of business insurance include:

  • Commercial multi-peril policies (covering a variety of exposures);
  • Liability insurance covering premises, activities, and products;
  • Business interruption insurance;
  • Surety and performance bonds;
  • Employee fidelity bonds; and
  • Malpractice and errors and omissions coverage;

In deciding whether to purchase insurance, an analysis of your risk exposure should be performed. If you are unable to determine your risk of loss from engaging in business, consider contacting a commercial lines insurance broker.

Is a business required to provide medical, life and similar insurance coverage for its employees?

While it is common to provide these types of “employee benefit” coverage for workers, the law generally does not require a business to do so. Many businesses provide these and similar benefits to attract and retain good employees and as an additional form of compensation. However, businesses that employ unionized workers must provide whatever benefits are required by the terms of their union contracts, and it also may be necessary to provide certain types of employee benefits as a condition of doing business with or for certain governmental entities or agencies. Some states have adopted laws requiring employers that are of a certain size to provide health insurance.

Are all companies required to have a pension plan?

No, but if a company adopts a pension plan, it has to be managed according to standards established under Federal law.

What is a franchise?

Basically, a franchise involves an owner of a trademark, trade name and/or copyright giving others a license under certain conditions to use these trademarks, trade names or copyrights in providing goods or services to the public.  The franchisor is the party who grants the franchise, and the franchisee is the party who receives the franchise. Technically, the relationship between a franchisor and franchisee is a relationship between two independent contractors.  Their rights are determined by the franchise agreement. The rela­tion­ship between the franchisor and franchisee is controlled by the franchise contract.

What kinds of fees and costs must a franchisee pay to the franchisor?

Typically, the franchisee will pay a franchise fee, which can often be spread out over a period of years, for the right to use the trademarks, trade names, and trade secrets of the franchisor and for managerial services involved in getting the franchise established. Frequently, a franchisee will also be required to purchase all its initial equipment, including signs and trade fixtures, from the franchisor. The franchisee may also be required to purchase many of its supplies from the franchisor or from franchisor-approved sources. In addition, a franchisee will normally pay the franchisor a royalty, which is usually based on a percentage of the gross receipts from the franchised goods or services. The royalty covers such items as advertising and continuing managerial services as well as a licensing fee for use of the franchisor’s trademark and trade names. If the franchisor owns the franchised location, the franchisee will obviously have to pay rent for the building to the franchisor.

What is the Fair Trade Commission franchise disclosure rule?

Governmental regulation of franchises generally has to do with problems of fraud in the sale of the franchise and protecting the franchisees from unreasonable demands and bad faith terminations.  The FTC adopted extensive regulations to protect franchisees from deception.  These regulations require a franchisor to give a prospective franchise a disclosure statement ten days before the franchisee signs a contract or pays any money for a franchise.

What kind of tax liabilities do I have to worry about in my business?

There are federal, state and local taxes assessed against every business, and a lot of the time you can be held personally liable for them. These taxes can include:

  • Business license fees (essentially a tax on the cost of doing business);
  • Payroll taxes and withholdings (both the employer and the employee portions);
  • Excise taxes on products, goods or services (e.g., petroleum products);
  • Franchise taxes (for the privilege of doing business);
  • Permit and application fees (essentially another tax on the cost of doing business);
  • Sales and use taxes;
  • Property taxes;
  • Federal and state income taxes (personal and corporate);
  • Federal and state capital gains taxes (personal and corporate); and
  • Penalties and interest that accrue on taxes that are not timely paid.

As an employer, a business has the responsibility for withholding certain taxes from an employee’s paycheck (for example, income tax withholdings, social security, federal and state unemployment and disability taxes). These amounts are not the employer’s money and the employer is responsible for collecting them on behalf of the government. The IRS and other tax authorities are very unforgiving about failing to pay over these withholdings in a timely manner. In addition, the employer is responsible for the business’s portion of social security and other payroll taxes that must also be paid on time. If the employer fails to pay in these taxes and withholdings, penalties can be assessed against the owners and/or managers of the business up to 100% percent of the amounts owed.

Religious Discrimination in Employment

Title VII of the Civil Rights Act of 1964 prohibits discrimination in employment on the basis of race, color, religion, sex, or national origin. It was amended in 1972 by the Equal Employment Opportunity Act. This Act created the Equal Employment Opportunity Commission which is commonly referred to as the EEOC. If you are the victim of employment discrimination, you can file a charge with the EEOC if you employer or prospective employer has 15 or more employees. The EEOC will then investigate the charge and can file suit on behalf of the employee if it believes that the charge has merit. Title VII prohibits discrimination in employment based upon religion – either its practices or beliefs.

While litigation on the basis of religious discrimination does not occur as frequently as some of the other categories, or may not have as high a profile, it is just as important a concern for employers. Discrimination against Muslims and Middle Easterners has increased dramatically since 9/11 and involve issues such as females wearing of head scarves at work, Sikhs wearing turbans at work, having a place to perform pre-prayer ablutions at work for Muslims, Muslims needing breaks and a place to say their religiously-mandated prayers several times per day.

Federal and state constitutional guarantees of due process, equal protection, and freedom of religion also provide protection for federal, state and local government employees. If the employer is a governmental entity, the employer must avoid workplace policies which have the effect of tending to establish or of interfering with the practice of the employee’s religion. Title VII is the only legislation specifically prohibiting religious discrimination in employment and there is consideration given to constitutional issues where necessary.

To a great extent, religious organizations are exempt from the prohibitions in Title VII.
As a general rule, they can discriminate so that, for instance, a Catholic church may legitimately refuse to hire a Baptist minister as its priest. That is, religion is recognized as a possible basis for a BFOQ reasonably necessary to the normal operation of that particular business or enterprise under section 703 (e)(1) of Title VII. If the church has sectarian activities such as running a day care center, bookstore or athletic club, which in no way involves religion, it may not enjoy the same broad type of freedom to discriminate since these activities do not necessarily have religion or propagation of the religion as an integral part of their activity.

What is “Religion”?
Title VII originally provided no guidance as to what it meant by the word “religion”. In the 1972 amendments to Title VII, Congress addressed the issue. In section 701 providing definitions for terms within Title VII, section (j) states that “The term ‘religion’ includes all aspects of religious observance and practice, as well as belief, unless an employer demonstrates that he is unable to reasonably accommodate an employee’s or prospective employee’s religious observance or practice without undue hardship on the conduct of the employer’s business.”
The question frequently arises “What if I never heard of the employee’s religion? Must I still accommodate it?” The answer is based upon two considerations: whether the belief is closely held and whether it takes the place of religion in the employee’s life. The latter requirement means that even atheism has been considered a “religion” for Title VII purposes. The religious belief need not be a belief in a religious deity as we generally know it. However, courts have determined that groups like the Ku Klux Klan are not religious organizations even though their members have closely held beliefs.

The employer need not previously know of, or have heard of, or approve of the employee’s religion in order to be required to accommodate it for Title VII purposes. The employer cannot question the sincerity of the belief merely because it may appear to the employer to be unorthodox.

The duty to accommodate the religious conflict arises whenever the conflict arises. It does not matter that the employee did not have the conflict when hired.

Religious Conflicts
Workplace conflict between an employee’s religious beliefs and workplace policies is probably the most frequent type of religious discrimination case. For instance, the employer may have a no-beard policy and the employee’s religion forbids shaving his beard.

The conflict can also come about because of the employer’s religious beliefs; like an atheist employee being required to attend workplace religious services at the manufacturing plant at which he worked. As more and more different types of employees come into the workplace, this conflict can become more frequent and employers must be attuned to them.

Once an employer is aware of a religious conflict, the employer must make a good faith attempt to accommodate the conflict and the employee must assist in the attempted accommodation. If no accommodation can be worked out without undue hardship on the part of the employer, the employer has fulfilled his or her Title VII duty and is not liable if the religious conflict cannot be accommodated.

The Employer’s Duty to Reasonably Accommodate
Unlike the other categories under Title VII, the prohibition against religious discrimination is not “absolute.” An employer can discriminate against an employee for religious reasons if to not do so causes the employer undue hardship. When the employer discovers a religious conflict between the employer’s policy and the employee’s religious belief, the employer’s first responsibility is to attempt accommodation. If it happens that accommodation is not possible, the employer can implement the policy even though it has the effect of discriminating against the employee on the basis of religion.

Due to the nature of religious conflicts and the fact that they can arise in all types of contexts and in many different ways, there is not one single action an employer must take in order to show that she or she has reasonably accommodated conflicting religious considerations. It depends upon the circumstances and will vary from situation to situation. For example, say an employer owns a sandwich shop. The employer’s policy is that employment entitles employees to eat all the restaurant food they wish during their lunch break. Employee’s religion does not allow eating meat. Aside from the meat used for sandwiches, the employer has little else other than sandwich trimmings like lettuce and tomatoes. The employee alleges it is religious discrimination to provide as part of employment benefits lunch the employee cannot eat for religious reasons while other employees receive as a benefit full free lunches they can eat because there is no religious prohibition. The duty to accommodate may be as simple as the employer arranging to have peanut butter and jelly, eggs, or a variety of vegetables available for the employee.

Say the employer requires employees to work six days per week. One employee cannot work on Saturdays due to a religious conflict. The accommodation may be that the employee switches days with an employee who does not wish to work on Sundays – a day that the employee with the religious conflict is available to work.

Another example: Employer grocery store has a policy requiring all counter clerks to be clean-shaven in order to present the employer’s view of a “clean cut” image to the public. Employee cannot shave for religious reasons. The accommodation may be that the employer switches the employee to a job the employee can perform which does not require public contact, such as stocking shelves or handling paperwork.

Employee’s Duty to Cooperate in Accommodation
The U.S. Supreme Court has held that in attempting to accommodate the employee all that is required is that the employers make any reasonable accommodation and this need not necessarily be the most reasonable accommodation available. The employee must also be reasonable in considering accommodation alternatives.

The employer’s only alternative may involve demoting the employee. This is not forbidden if all other alternatives present the employer with an undue hardship.

EEOC and courts will look to the following factors in determining whether the employer has successfully borne the burden of reasonably accommodating the employee’s religious conflict. Each factor will be considered and weighed as appropriate for the circumstances. If on balance the employer has considered the factors appropriate for the employer’s particular circumstances and accommodation is not possible, there is usually no liability for religious discrimination. The factors include:
• whether the employer made an attempt at accommodation;
• the size of the employer’s workforce;
• the type of job in which the conflict is present;
• the employer’s checking with other employees to see if anyone was willing to assist in the accommodation;
• the cost of accommodation; and
• the administrative aspects of accommodation

What Constitutes Undue Hardship?
What constitutes undue hardship also varies from situation to situation and will be addressed by the EEOC and the courts on an individual basis. There are no set rules as to what constitutes undue hardship since each employer operates under different circumstances. The accommodation the employer rejects as undue hardship may not be a mere inconvenience to the employer.

EEOC has provided employers with guidelines as to what factors it will consider in answering the question of whether the employer’s accommodation would cause undue hardship. Such factors include:
• the nature of the employer’s workplace;
• the type of job needing accommodation;
• the cost of the accommodation;
• the willingness of other employees to assist in the accommodation;
• the possibility of transfer of the employee and its effects;
• what is done by similarly situated employers;
• the number of employees available for accommodation; and
• the burden of accommodation upon the union

Generally speaking, EEOC’s interpretation of what constitutes undue hardship and reasonable accommodation has been more stringent than the interpretation of undue hardship by the courts. Since EEOC’s guidelines are not binding, and court decisions are, employers must look to the interpretation by courts in their own jurisdictions.

Among other things, courts have found that it would be an undue hardship if an employer had to:
• violate the seniority provision of a valid collective bargaining agreement;
• pay out more than a de minimis cost (in terms of money or efficiency) to replace a worker who has religious conflicts; and
• force other employees who do not wish to do so to trade places with the employee who has a religious conflict.

Religion as a BFOQ
Title VII permits religion to be a bona fide occupational qualification if it is reasonably necessary to the employer’s particular normal business operations. Title VII specifically permits educational institutions to employ those of a particular religion if they are owned in whole or substantial part by a particular religion.

Religious Harassment
This area has gotten more active lately, including the workplace display of crosses or other religious artifacts in their work space, religious study groups during the workday, handing out religious tracts to co-workers, and preaching, “witnessing,” or “testifying” about their religious beliefs to co-workers. Activity in the religious harassment area is due, in part, to matters relating to various religious issues in the past several years.

In 1990 the U.S. Supreme Court rejected Native Americans’ argument that they should be permitted the ritual use of peyote in their tribal religious ceremonies as part of their First Amendment right to freedom of religion.

In 1993 Congress passed the Religious Freedom Restoration Act (RFRA) to ensure the free exercise of religious practices. The law had tremendous support from many quarters. RFRA was an attempt to restore the previous status quo under which religious practices must be accommodated unless a compelling governmental interest can be demonstrated, and advanced in the least restrictive manner. In 1997, the U.S. Supreme Court overturned RFRA as giving a governmental preference for religion, in violation of the First Amendment.

Though not directed toward religious practices in the workplace, per sé, national attention and debate about these issues, along with a growing religious presence in political forums extended the religious practices into the workplace by extrapolation. When the religious practices were challenged, religious harassment claims arose.

It is often the non-religious employees who allege they are being harassed by religious employees. For example, information systems manager Rosamaria Machado-Wilson filed a case in 1998 alleging that she was fired after less than six months on the job, after reporting religious harassment to her employer, BSG Laboratories. Machado-Wilson said that a simple walk to the coffee pot sometimes meant “weaving past prostrate, praying co-workers and stopping for impromptu ceremonies spoken in tongues.” Machado-Wilson alleged she was forced to attend company prayer meetings and be baptized; employees were subjected to inquiries into and comments about their religious beliefs, and those found to be nonbelievers were fired.

Since Title VII prohibits religious discrimination, it also prohibits religious harassment.
The EEOC issued guidelines on liability for harassment in 1999, explicitly covering religious harassment.

On August 14, 1997, President Clinton issued guidelines for religious freedom of federal employees. The purpose is to accommodate religious observance in the workplace as an important national priority by striking a balance between religious observance and the requirements of the workplace. Under the guidelines, employees:
• should be permitted to engage in private religious expression in personal work areas not regularly open to the public to the same extent that they may engage in nonreligious private expression;
• should be permitted to engage in religious expression with fellow employees, to the same extent they may engage in comparable nonreligious private expression, subject to reasonable restrictions; and
• be permitted to engage in religious expression directed at fellow employees, and may even attempt to persuade fellow employees of the correctness of their religious views. But employees must refrain from such expression when a fellow employee asks that it stop or otherwise demonstrates that it is unwelcome.

To best prevent religious harassment liability, employers should be sure to protect employees from those somewhat zealous religious employees who attempt to proselytize others who do not wish to be approached about religious matters, as well as protect employees with permissible religious practices who are given a hard time by those who do not follow such practices. It is also important that employees are given comparable opportunities to use workplace time and resources for religious practices if given for secular activities.

There has been a marked increase in religious harassment of Muslims, Sikhs and other Middle Eastern religions since the events of September 11, 2001, leading the EEOC to reiterate its rules in this area. There is also the recent issue on the horizon of religious backlash in response to workplace diversity policies that may be at odds with an employee’s religious beliefs.

Union Activity and Religious Discrimination
At times the religious conflicts that arise between the employee and the employer are caused by collective bargaining agreement provisions rather than policies unilaterally imposed by the employer. It has been determined that even though Title VII defines the term “religion” with reference to an employer having to accommodate, unions are also under a duty to reasonably accommodate religious conflicts. The most frequent conflicts are requirements that employees be union members or pay union dues. Union membership, payment of union dues, or engaging in concerted activity such as picketing and striking conflicts with some religious beliefs.

Employees have also objected to the payment of union dues as violating their First Amendment right to freedom of religion and Title VII’s prohibition against religious discrimination. Unions have claimed that applying the religious proscription of Title VII violates the Establishment Clause of the First Amendment to the U.S. Constitution insuring government neutrality in religious matters.

Courts have ruled that union security agreements requiring that employees pay union dues within a certain time after the effective date of their employment or be discharged does not violate an employee’s First Amendment rights. However, it violates Title VII for an employer to discharge an employee for refusal to join the union because of his religious beliefs. Employees with religious objections must be reasonably accommodated, including the possibility of the alternative of keeping their job without paying union dues.

The union could prove undue hardship if many of the employees chose to have their dues instead paid to a non-union, non-sectarian charitable organization chosen by the union and the employer, since the impact on the union would not be insubstantial.

Whether the objection under Title VII is directed toward the employer or the union, a government employer still has a duty to reasonably accommodate the employee’s religious conflict unless to do so would cause undue hardship, excessive entanglement with religion or violate the Establishment Clause.