Solution and Answer Guide to Anderson's Business Law & The Legal Environment 2022 24th Edition By Da

Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 1: The Nature and Sources of Law

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 1: The Nature and Sources of Law

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................... 1 Questions and Case Problems .............................................................................................................. 1

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

The Family Educational Rights and Privacy Act (FERPA) protects students‘ rights to keep their academic records private. What duties are imposed and upon whom because of this protection of rights? Discuss the relationship between rights and duties.

Answer: Privacy as a right. The right is the student‘s and is one that allows students to have their grades remain private. The schools have a duty to ensure grades are not released to third parties without permission of the student.

2.

List the sources of law.

Answer: Sources of law. Statutory law such as ordinances, case law, precedent, common law, uniform state laws, constitutions, administrative regulations, treaties.

3.

What is the difference between common law and statutory law?

Answer: Common law/sources of law. Statutes are codified law; the common law evolves by case precedent and has existed in unwritten form since England in some areas of law.

4.

Classify the following laws as substantive or procedural: a.

A law that requires public schools to hold a hearing before a student is expelled.

b.

A law that establishes a maximum interest rate for credit transactions of 24 percent.

c.

A law that provides employee leave for the birth or adoption of a child for up to 12 weeks.

d.

A law that requires the county assessor to send four notices of taxes due and owing

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Solution and Answer Guide:

before a lien can be filed (attached) to the property.

Answer: Classifications of law.

5.

a.

Procedural

b.

Substantive

c.

Substantive

d.

Procedural

What do uniform laws accomplish? Why do states adopt them? Give an example of a uniform law.

Answer: Uniform state laws. Law is not uniform throughout the United States because of a historical accident: the United States was never a single nation. As of now, there are 50 state governments and a federal government within the area we call the United States.

This means that 51 political bodies have the freedom to their own law (provided constitutional rights are not violated). As a practical matter, this has not resulted in 51 different sets of rules of law because the common law has tended to dominate the legal system of most communities. As stated in the text, the uniform laws have been a ―nationalizing‖ force. It is likely that among areas that are truly ―in business,‖ there will be greater uniformity in the near future. In contrast, as to other matters where the need for uniformity is not as great, we can expect local variations in the law, encouraged by local economic and cultural differences. The Uniform Commercial Code and Uniform Partnership Act are examples of uniform laws.

6.

Cindy Nathan is a student at West University. While she was at her 9:00 a.m. anthropology class, campus security entered her dorm room and searched all areas, including her closet and drawers. When Cindy returned to her room and discovered what had happened, she complained to the dorm‘s senior resident. The senior resident said that this was the university‘s property and that Cindy had no right of privacy. Do you agree with the senior resident‘s statement? Is there a right of privacy in a dorm room?

Answer: Privacy. Several issues should be raised: a.

Terms and conditions of dorm residency

b.

Access issues and safety issues

There can be a right of privacy in a dorm room subject to disclosed university policies, processes and procedures. Just as landlords have access for emergencies, the university could have some limited access without breaching privacy.

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7.

Professor Lucas Phelps sent the following e-mail to Professor Marlin Jones: ―I recently read the opinion piece you wrote for the Sacramento Bee on affirmative action. Your opinion is incorrect, your reasoning and analysis are poor, and I am embarrassed that you are a member of the faculty here at Cal State Yolinda.‖ Professor Jones forwarded the note from Professor Phelps to the provost of the university and asked that Professor Phelps be disciplined for using the university e-mail system for harassment purposes. Professor Phelps objected when the provost contacted him: ―He had no right to forward that e-mail to you. That was private correspondence. And you have no right of access to my e-mail. I have privacy rights.‖ Do you agree with Professor Phelps? Was there a breach of privacy?

Answer: Privacy. Professor Phelps is wrong. His musings on his employer‘s e-mail system are not private. There is no expectation of privacy and anything written can be reviewed by his employer.

8.

Under what circumstances would a court disregard precedent?

Answer: Precedent. Courts could disregard precedent when facts differ, circumstances change and social mores differ. Cases are examined for similarities as well as distinguishing factors. Courts don‘t follow precedent when differences exist.

9.

What is the difference between a statute and an administrative regulation?

Answer: Sources of law. A statute is passed by an elected body. A regulation is passed by an administrative agency. An administrative regulation is one passed by a federal or state agency. Its procedures for adoption are different from a statute which is a law enacted by Congress, a state legislature or a city or county governing body. Statutes are generally passed by elected officials whereas regulations are the actions of appointed officials who are government employees. Administrative regulations must be grounded in statutory authority.

10. The Eminem ad for Chrysler that ran during the Super Bowl in February 2011 was rated as one of the best ads for the game. In May 2011, Audi ran an ad at a German auto show that had the ―feel‖ of the Eminem Chrysler ―Lose Yourself‖ ad. Subsequently, the German auto show ad made its way onto the Internet. The German ad caught the attention of Eminem and 8 Mile, Eminem‘s publishing company. They notified Audi that the ad constituted an unauthorized use of their intellectual property. Explain what rights Eminem and 8 Mile have and how the courts can help.

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Solution and Answer Guide:

Answer: Law and equity. Equitable remedies suitable here; an injunction to stop the ad from being run. Legal remedies include money damages for use of Eminem's image. Now courts can award either legal or equitable remedies.

Eminem and 8 Mile obtained an injunction against Audi—the company was prohibited from running the ad because of a likelihood of confusion and the continuing problem of use of an image or likeness without permission. Emphasize that only equitable remedies help Eminem and 8 Mile—damages cannot recoup for the continuing use.

11. Arizona Revised Statute § 28-8336 establishes a license tax for ―a nonresident whose aircraft is based in this state for more than ninety days but less than two hundred ten days in a calendar year.‖ The Arizona Department of Transportation defined a day (for purposes of taxes and licensing) as any day when the plane‘s tires are on the ground in Arizona, even if those tires were there for only part of a day. The taxpayer says that what counts should be whether the plane was on the ground for a full day. What will the court look at to determine the definition of a day? BSI Holdings, LLC v. Arizona Department of Transportation, 417 P.3d 782.

Answer: Laws and precedent. The court looked at how the term day is defined for other tax issues, in computing legal deadlines, in residency questions to make the determination and concluded that an aircraft does not lose its base in the state simply by leaving for part of a day, nor does it acquire a state base merely by briefly touching down in the state. BSI Holdings, LLC v. Arizona Department of Transportation, 417 P. 3d 782 (Az. 2018).

12. What is the principle of stare decisis?

Answer: Common law. Stare decisis is ―Let the decision stand‖ or following case precedent.

13. Explain how Twitter, Facebook, and LinkedIn have resulted in the development of new laws and precedent.

Answer: Law and precedent. The social media have resulted in many new laws (cyberbullying) as well as case law on issues such as whether Google, Yahoo, etc., must reveal identities. Throughout the remaining chapters you will study examples of issues evolving and precedent being set.

These forms of social media have expanded greatly how widespread personal information

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Solution and Answer Guide:

is available to many we would not necessarily voluntarily give it to. So, for example, when you are authorized as someone‘s friend, you can click on the Facebook sites of their friends and obtain information without them realizing that so many have such access.

Employers can gain information through a Google search and social media sites that you might not volunteer. As a result, laws have developed to require elections on privacy controls for these sites. Other laws have developed to provide access to information about who is posting what on certain sites when criminal activity results.

14. During the 2001 baseball season, San Francisco Giants player Barry Bonds hit 73 home runs, a new record that broke the one set by Mark McGwire in 2000 (72 home runs). When Mr. Bonds hit his record-breaking home run, the ball went into the so-called cheap seats.

Alex Popov was sitting in those seats and had brought along his baseball glove for purposes of catching any hits that might come into the stands. Everyone sitting in the area agreed that Mr. Popov‘s glove touched Bonds‘s home-run ball. Videotape also shows Mr. Popov‘s glove on the ball. However, the ball dropped and, following a melee among the cheap-seat fans, Patrick Hayashi ended up with Bonds‘s home-run ball. Mr. Popov filed suit for the ball, claiming it as his property. Such baseballs can be very valuable. The baseball from Mr. McGwire‘s record-breaking home run in 2000 sold for $3 million. List those areas of law that will apply as the case is tried and the owner of the baseball is determined.

Answer: Sources of law. In this example, the court making the decision will be required to draw on any property law (personal) in the state as well as the common law on property ownership. There may also be some ordinances that cover sporting events or finding property. If there are intellectual property rights in the baseball, then federal law will apply.

The areas of law that would govern would include state laws, statutes and case precedent on the transfer of property rights. There might also be some ordinances that would govern conduct and rights at public events such as a baseball game as well as rights on lost property.

15. Alma Alvarado has just started her own tax preparation firm. She has leased office space in a building, and she is incorporating her business as a Subchapter S corporation under the Internal Revenue Code. She has purchased desks, chairs, computers, and copiers from Staples through a line of credit they have established for her. Alma is a CPA in the state of Arizona and her license fees and continuing education hours are due within 90 days. Alma will begin with only a clerical person as an employee to serve as receptionist and bookkeeper. List all of the areas of the law that affect Alma in her new business. 63744_

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 2: The Court System and Dispute Resolution

Answer: Types of laws. The areas of law are private law (for her lease); state law for her CPA license renewal and incorporation; federal laws (Internal Revenue Code) for the knowledge and information for preparing the tax returns, state and federal employment law will apply to her relationship with her employee—wages, overtime, workers‘ compensation, unemployment compensation, equality in the workplace, etc. That relationship will also have private law as Alma develops office rules and procedures. Local law applies to any use of the buildings and safety codes for the office and building. Credit and contract law (UCC and federal credit regulations) will apply to the contracts and purchases with Staples. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 2: The Court System and Dispute Resolution

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................... 6 Questions and Case Problems .............................................................................................................. 6

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

List the steps in a lawsuit. Begin with the filing of the complaint, and explain the points at which there can be a final determination of the parties‘ rights in the case.

Answer: Trial process. Steps in litigation: i.

Complaint by plaintiff

ii.

Service of process on defendant

iii.

Defendant's answer: deny, counterclaim, admit

iv.

Discovery: depositions, interrogatories, requests for production

v.

Motion for summary judgment (if no factual issues)

vi.

Trial

a.

Jury selection: voir dire, challenge for cause, peremptory challenge

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2.

b.

Opening statements

c.

Plaintiff's case: direct, cross, redirect, recross

d.

Motion for directed verdict

e.

Defendant's case

f.

Summation

g.

Jury instructions

h.

Jury verdict or mistrial (deadlocked)

i.

Motion for new trial or judgment

j.

Recovery: fees, execution, garnishment

Explain why a businessperson would want to use alternative dispute resolution methods.

Discuss the advantages. What disadvantages have you learned?

Answer: Arbitration. The benefits are, in theory, that alternatives are faster. However, these arbitration methods are now dragging out nearly as much as a trial. ADR allows for no public hearing and all the problems that go along with the media covering a contract dispute. These methods allow the parties to gain the perspective of an outside party, something that often needs to be done in order to move the parties forward in their negotiations.

3.

Mossimo Zambordino has been charged with a violation of the Electronic Espionage Act, a federal statute that prohibits the transfer, by computer or disk or other electronic means, of a company‘s proprietary data and information. Mossimo is curious. What type of court has jurisdiction? Can you determine which court?

Answer: Jurisdiction. Mossimo‘s case will go to federal district court because it is a trial involving a violation of a federal statute.

4.

Jerry Lewinsky was called for jury duty. When voir dire began, Jerry realized that the case involved his supervisor at work. Can Jerry remain as a juror on the case? Why or why not?

Answer: Trial process. No. Jerry could be removed for cause. There is a conflict with his independence.

5.

Carolyn, Elwood, and Isabella are involved in a real estate development. The development is a failure, and Carolyn, Elwood, and Isabella want to have their rights determined. They could bring a lawsuit, but they are afraid the case is so complicated that a judge and jury not familiar with the problems of real estate development would not reach a proper result.

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What can they do?

Answer: Arbitration. The danger feared by the three developers is a real one. It would be better for them to agree to submit the matter to arbitration. Persons who were experienced with real estate developments and the law of such developments could be selected as arbitrators; this would eliminate the potential dangers.

6.

Larketta Randolph purchased a mobile home from Better Cents Home Builders, Inc., and financed her purchase through Green Tree Financial Corporation. Ms. Randolph signed a standard form contract that required her to buy Vendor‘s Single Interest insurance, which protects the seller against the costs of repossession in the event of default. The agreement also provided that all disputes arising from the contract would be resolved by binding arbitration. Larketta found that there was an additional $15 in finance charges that were not disclosed in the contract. She and other Green Tree customers filed a class-action suit to recover the fees. Green Tree moved to dismiss the suit because Larketta had not submitted the issue to arbitration. Larketta protests, ―But I want the right to go to court!‖ Does she have that right? What are the rights of parties under a contract with an arbitration clause? [Green Tree Financial Corp. v. Randolph, 531 U.S. 79] Answer: Mandatory arbitration clauses. The U.S. Supreme Court held that the arbitration clause was valid because (1) there was strong federal policy favoring arbitration; and (2) the party challenging the validity of an arbitration clause has the burden of showing that arbitration is an unsuitable method for resolving the dispute. In this case, Mrs. Randolph had alleged that the arbitration costs made pursuit of her remedies too expensive.

However, she had not presented evidence to indicate why arbitration would be more expensive than litigation. [Green Tree Financial Corp. v. Randolph, 531 U.S. 79]

7.

John Watson invested $5,000,000 in SmartRead, Inc., a company that was developing an electronic reading device. Within a few months, the $5,000,000 was spent but SmartRead never developed the reading device. John filed suit against the directors of SmartRead for their failure to supervise SmartRead‘s CEO in his operation of the company. The directors used an expert on corporate governance to testify that the directors had done all that they could to oversee the company. The expert did not disclose that he had served as a director of a company and had been found to be negligent in his role there and had been required to pay $370,000 to shareholders. The directors won the case. Is there anything Watson can do?

Answer: Expert witnesses; evidence. The answer can be found in the Yates case. When an

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expert does not disclose evidence that helps to evaluate his or her credibility, there has been a reversible error that is grounds for reversal. This information that the expert has been a defendant in a case and lost goes to their expertise and credibility both.

8.

Indicate whether the following courts are courts of original, general, limited, or appellate jurisdiction: a.

Small claims court

b.

Federal bankruptcy court

c.

Federal district court

d.

U.S. Supreme Court

e.

Municipal court

f.

Probate court

g.

Federal court of appeals

Answer: Types of courts.

9.

a.

Small claims court—original; limited

b.

U.S. Bankruptcy court—original; limited

c.

Federal district court—general; original

d.

U.S. Supreme Court—appellate; original

e.

Municipal court—limited; original

f.

Probate court—limited; original

g.

Federal or U.S. Court of Appeals—appellate

The Nursing Home Pension Fund filed suit against Oracle Corporation alleging that Larry Ellison, the company‘s CEO, misled investors in 2001 about the true financial condition of the company. During the time of the alleged misrepresentation, Mr. Ellison was working with a biographer on his life story and there are videotapes of Mr. Ellison‘s interviews with his biographer as well as e-mails between the two that discuss Oracle. Could the Nursing Home Pension Fund have access to the tapes and e-mails? Explain how. [Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 (9th Cir.)] Answer: Discovery. Yes, the Pension Fund would be entitled to have access to determine whether Mr. Ellison had said anything that contradicted his public statements. The court did, in fact, allow the Pension Fund to have access. However, all but 15 of the e-mails had been destroyed. The court did not sanction Mr. Ellison, but it did allow the jury to have an instruction read that allowed them to presume that those e-mails contained information that would have been adverse to Mr. Ellison. [Nursing Home Pension Fund, Local 144 v.

Oracle Corp., 380 F.3d 1226 (9th Cir.)]

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10. Mostek Corp., a Texas corporation, made a contract to sell computer-related products to North American Foreign Trading Corp., a New York corporation. North American used its own purchase order form, on which appeared the statement that any dispute arising out of an order would be submitted to arbitration, as provided in the terms that appeared on the back of the order. Acting on the purchase order, Mostek delivered almost all of the goods but failed to deliver the final installment. North American then demanded that the matter be arbitrated. Mostek refused to do so. Was arbitration required? [Application of Mostek Corp., 502 N.Y.S.2d 181 (App. Div.)] Answer: Federal Arbitration Act. Yes. When the seller delivered pursuant to the purchase order, it became bound by the terms of the purchase order, including the arbitration clause of that order. Because the buyer and seller were corporations of different states, the contract between them related to an interstate transaction. The Federal Arbitration Act was therefore applicable, and the arbitration agreement was made binding by the act.

Both parties were required to arbitrate the dispute. [Application of Mostek Corp., 502 N.Y.S.2d 181 (App. Div.)] 11. Ceasar Wright was a longshoreman in Charleston, South Carolina, and a member of the International Longshoremen‘s Association (AFL-CIO). Wright used the union hiring hall.

The collective bargaining agreement (CBA) of Wright‘s union provides for arbitration of all grievances. Another clause of the CBA states: ―It is the intention and purpose of all parties hereto that no provision or part of this Agreement shall be violative of any Federal or State Law.‖ On February 18, 1992, while Wright was working for Stevens Shipping and Terminal Company (Stevens), he injured his right heel and back. He sought permanent compensation from Stevens and settled his claims for $250,000 and another $10,000 in attorney fees. Wright was also awarded Social Security disability benefits. In January 1995, Wright, whose doctor had approved his return to work, returned to the hiring hall and asked to be referred for work. Wright did work between January 2 and January 11, 1995, but when the companies realized that Wright had been certified as permanently disabled, they deemed him not qualified for longshoreman work under the CBA and refused to allow him to work for them. Wright did not file a grievance under the union agreement but instead hired a lawyer and proceeded with a claim under the Americans with Disabilities Act. The district court dismissed the case because Wright had failed to pursue the grievance procedure provided by the CBA. Must Wright pursue the dispute procedure first, or can he go right to court on the basis of his federal rights under the Americans with Disabilities Act? [Wright v. Universal Maritime Service Corp., 525 U.S. 70]

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Answer: Arbitration/mandatory clauses. The presumption that arbitration clauses in contracts (here in a collective bargaining agreement) are valid and enforceable does not extend to those statutory rights that parties to the contract may have. In this situation, the employee had a clear right to pursue remedies under federal statute and by litigation. For that right to be waived and the case to go to arbitration, the contract must expressly provide that these statutory rights are waived. The waiver must be clear and unmistakable, and, in this case, the language was not enough to indicate a waiver of right to litigation under the ADA. The arbitration clause in the union collective bargaining agreement is too general to indicate a waiver of rights. The court reversed and remanded the case for trial.

Distinguish for the students the difference between these litigation rights and generic statutory protections, such as in the Green Tree case, that provide simple remedies and not a specific right of litigation. Also, point out that union, disability and labor issues have an extensive federal statutory scheme with rights, protections and processes that would require more than a generic arbitration clause. [Wright v. Universal Maritime Service Corp., 525 U.S. 70] 12. Winona Ryder was arrested for shoplifting from Saks Fifth Avenue in California. One of the members of the jury panel for her trial was Peter Guber, a Hollywood executive in charge of the production of three films in which Ms. Ryder starred, including Bram Stoker’s Dracula, The Age of Innocence, and Little Women. If you were the prosecuting attorney in the case, how could you discover such information about this potential juror, and what are your options for excluding him from selection? [Rick Lyman, ―For the Ryder Trial, a Hollywood Script,‖ New York Times, November 3, 2002, SL-1] Answer: Trial; jury selection. The lawyers can obtain information about prospective jurors through questionnaires as well as the process of voir dire. Some of the background questions on voir dire are place of employment and whether they know any of the parties in the case. Mr. Guber could be excused because of his relationship with Ms. Ryder. The prosecuting attorney could find this out using voir dire, the process of questioning the jury panel for screening them for bias, connection and relationship. The attorney could use a challenge for cause or a peremptory challenge. In the Ryder case, both sides let Mr. Guber remain and he served on the jury after his assurances that he would be impartial. Ms. Ryder was found guilty of theft and burglary. She was sentenced to community service and probation. [Rick Lyman, ―For the Ryder Trial, a Hollywood Script,‖ New York Times, November 3, 2002, SL-1] 13. Antonio Gagliostro joined LA Fitness on April 27, 2015. That same day Antonio fractured his ankle at the LA Fitness facility because of a faulty drain in the sauna there. Pursuant to

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Solution and Answer Guide:

his membership contract, Antonio submitted his claim for damages to arbitration. Using AAA guidelines, the arbitrator awarded Antonio $20,500 for pain and suffering. Fitness International, LLC (dba LA Fitness) filed suit to have the award set aside because the arbitrator‘s computation of damages was contrary to New Jersey law on damage determinations. The trial court vacated the arbitration award on the issue of damages and sent the case back to arbitration before a different arbitrator. Antonio appealed. What should the court do with the arbitration award? [Gagliostro v. Fitness International, LLC, 2019 WL 5206047 (Sup. Ct. N.J.)] Answer: Arbitration. The court held that the arbitration agreement did not require that the arbitrator follow New Jersey law. The arbitrator was required to simply follow the procedures of the AAA. The court noted that the arbitrator had explained his award of damages in detail and that there were not sufficient grounds to set the award aside.

[Gagliostro v. Fitness International, LLC, 2019 WL 5206047 (Sup. Ct. N.J.)] 14. Martha Simms is the plaintiff in a contract suit she has brought against Floral Supply, Inc., for its failure to deliver the green sponge Martha needed in building the floral designs she sells to exclusive home decorators. Martha had to obtain the sponge from another supplier and was late on seven deliveries. One of Martha‘s customers has been called by Martha‘s lawyer as a witness and is now on the witness stand, testifying about Martha‘s late performance and the penalty she charged. The lawyer for Floral Supply knows that Martha‘s customer frequently waives penalties for good suppliers. How can Floral Supply‘s lawyer get that information before the jury?

Answer: Discovery evidence. Trial. On cross-examination, the lawyer can confront the witness on the business practice.

15. Saint Claire Adams was hired by Circuit City as a sales counselor. When he was hired, he signed an employment contract that included a mandatory arbitration clause. Two years later he filed a suit against Circuit City for discrimination in the workplace. Circuit City moved to have the suit dismissed because of the arbitration requirement. Mr. Adams responded that he has certain rights under Title VII of the federal anti-discrimination laws that cannot be taken away through an arbitration clause. Is he correct? [Circuit City Stores, Inc. v. Adams, 532 U.S. 105] Answer: Arbitration. Arbitration agreements can be enforced under Federal Arbitration Act (FAA) without contravening policies of congressional enactments giving employees specific protection against discrimination prohibited by federal law.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 3: Business Ethics, Social Forces, and the Law

Section 1 of the Federal Arbitration Act (FAA) excludes from the Act's coverage "contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce." 9 U.S.C. § 1. All but one of the Courts of Appeals which have addressed the issue interpret this provision as exempting contracts of employment of transportation workers, but not other employment contracts, from the FAA's coverage. A different interpretation has been adopted by the Court of Appeals for the Ninth Circuit, which construes the exemption so that all contracts of employment are beyond the FAA's reach, whether or not the worker is engaged in transportation. It applied that rule to the instant case. The U.S. Supreme Court decided that the Ninth Circuit was wrong and that the better interpretation is to construe the statute, as most of the Courts of Appeals have done, to confine the exemption to transportation workers. Adams is subject to arbitration and such arbitration does not deprive him of his rights under the antidiscrimination laws.

[Circuit City Stores, Inc. v. Adams, 532 U.S. 105] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 3: Business Ethics, Social Forces, and the Law

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 13 Questions and Case Problems ............................................................................................................ 13

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Marty Mankamyer, the president of the United States Olympic Committee (USOC), resigned in early February 2003 following reports in The Denver Post that indicated she had demanded a commission from a fellow real estate broker in the Colorado Springs area, the home of the USOC, who had sold property to Lloyd Ward, the CEO of the USOC. Mr. Ward had purchased a 1.3-acre lot in Colorado Springs for $475,000 and had paid the listing broker, Brigette Ruskin, a commission.

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Solution and Answer Guide:

Ms. Mankamyer allegedly demanded a portion of the commission from Ms. Ruskin, and Ms. Ruskin sent her a check. Ms. Mankamyer had shown Mr. Ward and his wife properties in the area when they were being considered for the job and when he was considering taking the job. However, Mrs. Ward indicated that Ms. Mankamyer did not identify herself as a real estate agent and that she assumed that Ms. Mankamyer was showing the properties as a ―goodwill gesture.‖ What conflicts of interest do you see here?

Answer: Categories of ethical breaches. The parties have engaged in conduct that constitutes a conflict of interest. The payment from an outside source for housing for your organization‘s employees represents a conflict.

2.

During the inauguration for President Obama in January 2013, Beyoncé was scheduled to sing the national anthem. The question arose: Did she lip-sync during her performance?

No answer was forthcoming from the singer‘s representatives, but it was clear from those attending that the National Marine Band was not playing during her performance. Those in charge of the event felt that since she had not had an opportunity to rehearse with the band that it was best to use a tape. Are there any ethical issues involved in this choice for the performance? Was there an obligation of disclosure?

Answer: Categories of ethical dilemmas. Yes, there is the issue of a false impression. The audience was not aware of the issues and assumed a live performance. However, it was a non-paying audience, so there are no contractual rights—it is very much an ethical issue.

The conduct affects the reputation of the singer as well as those who were involved in allowing her to not sing. The best advice would be to be truthful—it was difficult to sing in the cold weather; it was difficult for her to sing because of so many engagements before and after—just let the folks know up front. Saves face and with an explanation we accept the performance as it is.

3.

Fred Sanguine is a New York City produce broker. Ned Santini is a 19-year-old college student who works for Sanguine from 4:00 a.m. until 7:00 a.m. each weekday before he attends classes at Pace University. Fred has instructed Ned on the proper packing of produce as follows: ―Look, put the bad and small cherries at the bottom. Do the same with the strawberries and blueberries. Put the best fruit on top and hide the bad stuff at the bottom. This way I get top dollar on all that I sell.‖ Ned is uncomfortable about the instructions, but, as he explains to his roommate, ―It‘s not me doing it. I‘m just following orders. Besides, I need the job.‖ Should Ned just follow instructions? Is the manner in which the fruit is packed unethical?

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Solution and Answer Guide:

Would you do it? Why or why not? Is anyone really harmed by the practice?

Answer: Categories of ethical breaches. The method by which Fred packs fruit is unfair and deceitful. The method takes advantage of customers. Newspaper exposure of Fred‘s packing and selling practices could be very harmful to Fred‘s business. Ned has to make a decision about whether he can engage in such behavior or whether he must confront Fred and possibly leave his job. However, Ned‘s and Fred‘s reputations are both on the line if the packing practices are made public.

4.

Alan Gellen is the facilities manager for the city of Milwaukee and makes all final decisions on purchasing items such as chairs, lights, and other supplies and materials. Alan also makes the final decisions for the award of contracts to food vendors at event sites. Grand Beef Franks has submitted a bid to be one of the city‘s vendors. Alan went to school with Grand Beef‘s owner, Steve Grand, who phones Alan and explains that Grand Beef owns a condominium in Maui that Alan could use. Steve‘s offer to Alan is: ―All it would cost you for a vacation is your airfare. The condo is fully stocked with food. Just let me know.‖ Should Alan take the offer? Would you? Be sure to determine which category of ethical values this situation involves and to apply several models as you resolve the question of whether Alan should accept the invitation.

Answer: Categories of ethical breaches. Alan should not take the offer. It would be a conflict of interest. The public disclosure of Alan‘s conduct if he accepted the condo would be a breach and loss of public trust. Alan‘s career would be stalled as he would certainly lose his position and possibly his job. Front-page-of-the-newspaper test is a model that provides an obvious answer. Also, Alan could not disclose his trip to the city council and his supervisors.

5.

A Dillard‘s customer brought in a pair of moderately expensive dress shoes, expressing a desire to return them because they just weren‘t quite right. As the manager processed the order, she checked inside the box to be sure that the shoes in the box were the shoes that matched the box—past experience dictated that follow-up on returns. The shoes were the correct ones for the box, but there was another issue. The shoes had masking tape on the bottom—masking tape that was dirty. When the manager returned to the customer she said, ―You forgot to remove the masking tape from your shoes.‖ The customer responded, ―I only wore them once. That‘s all I needed them for.‖ From Neiman Marcus to Saks to Dillard‘s, managers have to stay one step ahead of

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customers, or lessees, who buy, or lease for free, dresses and now shoes for one use with premeditated intent to return the merchandise. Stores now place tags strategically so that the dresses cannot be worn without cutting them off and there are no returns if the tags are cut off on formal wear.

Ace Hardware and Home Depot have customers who ―buy‖ a special tool, try to use it once, and then return it. The hardware/home improvement stores are left with opened packaging and used goods by buy-it-temporarily customers.

List some consequences for this behavior by customers.

Answer: Consequences of ethical breaches. Discuss with the students the economic ripple effects—damaged/used goods cannot be sold for full price. They have to be marked down. A good question to ask is, ―What if everyone behaved this way?‖ We would quickly become a nation of second-hand purchasers and retailers would be forced to raise prices to cover the costs of the lessees.

Those who buy items intending to use and then return them use someone else‘s property without any form of compensation. Stores have to introduce new tools and techniques for preventing customers from wearing and returning the merchandise after just one use.

Another good question is, ―What if it were my store?‖ "How would I feel about borrowers then?"

6.

Adam Smith wrote the following in The Theory of Moral Sentiments: In the practice of the other virtues, our conduct should rather be directed by a certain idea of propriety, by a certain taste for a particular tenor of conduct, than by any regard to a precise maxim or rule; and we should consider the end and foundation of the rule, more than the rule itself.

Do you think Adam Smith adhered to positive law as his ethical standard? Was he a moral relativist? Does his quote match stakeholder analysis? What would his ethical posture be on violating the law?

Answer: Resolving ethical dilemmas; ethical standards. Smith initially touts the idea of propriety as important and then adds that following rules is not a matter of precision but a matter of understanding why the rule is there and what it is designed to accomplish. Smith

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advocates some flexibility in application and interpretation of rules.

7.

A new phenomenon for admissions to MBA programs is hiring consultants to help applicants hone their applications. About 20 percent of those who apply to the top MBA programs have hired consultants at a cost of $150 to $200 per hour to help them say and do the right things to be admitted. The total cost for most who use a consultant is $5,000.

The consultants help with personal essays and applications. One admissions officer points out that one function of the consultant is to draw out and emphasize skills that the applicant may not see as important. For example, playing the piano is looked upon favorably because it shows discipline and focus.

However, admissions committees are becoming adept at spotting the applications via consultant because, as the faculty describe it, these essays and applications have a certain ―sameness‖ to them. The Fuqua School at North Carolina suggests that students simply call the admissions office and get comparable advice for free. Is it ethical to use an admissions consultant? When would you cross a line in using the consultant on the essay?

Answer: Legal standards; ethical standards.The use of a consultant is legal, but whether it is ethical is a different question. There are no specific prohbitions against such assistance, but their use boils down to unfair advantage and misrepresentation of the applicant‘s abilities and skills. The real question is whether the package that is put together for application accurately reflects the abilities, experience and interest of the applicant. To the extent it was done by someone else or molded and exaggerrerated, then the admission process is skewed. Those who compete should be able to do so on a level playing field, with the same rules and level of knowledge.

8.

―I was very upset that there‘s that many dishonest people,‖ said Andrea Reuland, the owner of Trigs Shell Station in Minocqua, Wisconsin.

She lost $3 per gallon on 586 gallons of gas sold during a 45-minute period when local residents phoned others to come and get gas because an employee had made a mistake and entered the price at 32.9 cents versus $3.299 per gallon.

Eighty-seven percent of the people who responded to a survey about the incident said they would have done the same thing as the Minocqua residents. Describe who is affected by what buyers did by not paying the correct price for the gas.

Describe a simple test for resolving an ethical dilemma such as this where you can get

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Solution and Answer Guide:

something for free or very little.

Answer: Categories of ethical behavior; taking something that doesn't belong to you. A simple test would be, what if you were on the other side—how would you want to be treated. Those who purchased the gas were taking advantage of an unsuspecting owner. If we owned the gas station, we would be hurt that our friends and neighbors were willing to do that to us. We can apply the same standards to ourselves that we want others to uphold.

Who is affected? The owner of the gas station. Somehow that revenue has to be made up—she may have to charge more. If she is unable to recoup the losses, then her creditors are affected—they will not be paid. She might have to lay off employees—they lose their jobs and their families and creditors are affected because they cannot pay. You then have a ripple effect through the local economy. Emphasize that there are always consequences to others when we are dishonest 9.

The state of Arizona mandates emissions testing for cars before drivers can obtain updated registrations. The state hires a contractor to conduct the emissions tests in the various emissions-testing facilities around the state. In October 1999, the Arizona attorney general announced the arrest of 13 workers at one of the emissions-testing facilities for allegedly taking payoffs of between $50 and $200 from car owners to pass their cars on the emissions tests when those cars fell below emissions standards and would not have been registered. Nearly half of the staff at the emissions facility were arrested.

Why is it a crime for someone working in a government-sponsored facility to accept a payment for a desired outcome? Do the payoffs to the workers really harm anyone?

Answer: Conflicts; bribery. Discuss with the students why the employees took and demanded the money. Discuss how a culture of bribery can overtake an organization.

Have the students list the harms: emissions; corruption; bribery; trust lost.

10. The president and athletic director at the University of California at Los Angeles (UCLA) fired the school‘s basketball coach because an expense form he had submitted for reimbursement had the names of two students he said had joined him for a recruiting dinner. The students had not been to the dinner. The coach was stunned because he had been at UCLA for eight years and had established a winning program. He said, ―And to throw it all away on a meal?‖ Do you agree with the coach‘s assessment? Was it too harsh to fire him for one inaccurate expense form? Did the coach commit an ethical breach?

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Solution and Answer Guide:

Answer: Ethical breaches; enforcement of ethical standards. Have the students discuss whether amount is the issue, or a breach of trust is grounds for termination regardless of amount.

11. When some runners in the New York City Marathon hit the Queensboro Bridge, temptation sets in and, rather than finishing the last 10 miles through Harlem and the Bronx, they hop a ride on the subway and head toward the finish line at Central Park. A total of 46 runners used the subway solution to finish the race in the 2008 NYC Marathon.

When one runner was questioned about his unusual time, he admitted to using the subway and said, ―So I skipped a few boroughs. I didn‘t do anything illegal.‖ How would you respond to his point that he did not break the law? Why should we worry about some runners?

Answer: Fairness and disclosure. The runners did not really run the race. They did not tell officials of their shortcut. No, they did not violate the law, but the law is only one ethical standard.

There are always consequences to short-cut behaviors such as those taken by the subway rider/runners. Those who run the race will have to add additional checks, monitors, and procedures to make sure there is not cheating. Those who run the race honestly and suffer through the physical consequences lose some of their sense of achievement when the race is completed so easily by others. Trust is lost when we compete without honor—we also no longer have valid measurements for achievement because we don‘t know if they really ran the race in the time at the finish or if they cheated. As rules disappear, so does the concept of an orderly society. The shortcuts in the marathon provide parallel comparisons to business and the shortcuts businesses often take to win. However, those shortcuts, such as accounting fraud, do not last and do bring consequences to those who use them.

12. David A. Vise, a Pulitzer Prize winner and a reporter for the Washington Post, wrote the book The Bureau and the Mole. When the book hit the market, Mr. Vise purchased 20,000 copies via Barnes & Noble. com, taking advantage of both free shipping offered by the publisher and a discounted initial price. Mr. Vise‘s book had already hit the New York Times’ bestseller list in the week before the purchases. He used the books he purchased to conduct online sales of autographed copies of the books, and then returned 17,500 books and asked for his money back. However, that return of 17,500 books represented more books than a publisher generally runs for a book. Mr. Vise said that he did not intend to manipulate the market or profit from the transactions. He said his only intent was to

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―increase awareness of The Bureau and the Mole.‖ Mr. Vise‘s editor offered to pay Barnes & Noble for any expenses it incurred. Was it ethical to do what Mr. Vise did? Was he within his rights to return the books? What are his remedies? Does Barnes & Noble have any rights?

Answer: False impression and fairness. The conduct of the author resulted in an impact on the market, i.e., the market for the book moved with the resulting rankings, but the sales were not real. The purchases were made with the intent to return them and to use them only temporarily to pump up publicity and sales for the book. The market mechanism was manipulated, and the transaction was dishonest—the books were not really sold and there are costs to the book publisher of such transactions. Making good on any damages for the orders does not remedy the false impression the large sales created.

13. The VA put into place incentives and bonuses for administrators to ―reduce the queue.‖ That is, the goal of the VA was to reduce the amount of time it took for veterans seeking care to actually receive that care to two weeks. Staffs at VA facilities all over the United States did meet those reduction goals and earn their bonuses. However, the way they earned those bonuses was through falsified patient appointment schedules.* The real results showed that three of every five veterans did not receive their care within two weeks as the documents showed. An inspector general‘s report found that the falsifications caused patients to be dropped, with many dying while awaiting calls back from VA facilities. Thirteen percent to 62 percent of VA schedulers (depending on the facility) were instructed on how to falsify records that were submitted to central administration for purposes of awarding bonuses.** The VA used Darrell Huff‘s book, How to Lie with Statistics, in training VA staffers.

Evaluate what went wrong at the VA and discuss how employees were able to be talked into participating.

Answer: Categories of ethical dilemmas. Discuss with the students why incentives can have such an impact on employee behavior and the importance of monitoring paperwork and numbers for goals. When wages and salary are on the line, employees can be talked into falsifying data if someone in authority authorizes it.

14. Piper High School in Piper, Kansas, a town located about 20 miles west of Kansas City, experienced national attention because of questions about students Pelton, a high school science teacher, had warned students in her sophomore class not to use papers posted on

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the Internet for their projects. When their projects were turned in, Ms. Pelton noticed that the writing in some of the papers was well above the students‘ usual quality and ability.

She found that 28 of her 118 students had taken substantial portions of their papers from the Internet. She gave these students a zero grade on their term paper projects with the result that many of the students were going to fail the course for that semester. The students‘ parents protested, and the school board ordered Ms. Pelton to raise the grades.

She resigned in protest. She received a substantial number of job offers from around the country following her resignation. Nearly half of the high school faculty as well as its principal announced their plans to resign at the end of the year. Several of the parents pointed to the fact that there was no explanation in the Piper High School handbook on plagiarism. They also said that the students were unclear about what could be used, when they had to reword, and when quotations marks were necessary.

The annual Rutgers University survey on academic cheating has revealed that 15 percent of college papers turned in for grades are completely copied from the Internet.

Do you think such copying is unethical? Why do we worry about such conduct? Isn‘t this conduct just a function of the Internet? Isn‘t it accepted behavior?

Answer: Honesty. Putting paragraphs of material in term papers without attribution is dishonest. The students had been warned about such a practice and they had violated the rules of the class as well as the rules on copyright and attribution. The Internet makes the conduct quite easy to do, but ease does not make the conduct correct. The students had used someone else‘s work and not done the papers themselves. There was a violation of the class and school rules as well as an ethical violation.

NOTE: Ms. Pelton received 23 job offers but turned them down to run a day care out of her home. Property values in Piper declined following this story‘s publication.

15. Heinz Ketchup holds 54 percent of the ketchup market in the United States. Nine of every 10 restaurants feature Heinz ketchup. However, Heinz has learned that many restaurant owners are simply refilling Heinz Ketchup bottles with other ketchup to capture Heinz prestige without actually buying Heinz. There are no specific regulations that apply to the practice. Discuss the ethical issues. One restaurant owner has said that customers do not notice and that it is not a big deal. Evaluate the ethical issues in his comment.

Answer: Categories of ethical dilemmas. Using the Heinz name for off-brand ketchup gives

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 4: The Constitution as the Foundation of the Legal Environment

a false impression. Also, the restaurant owners are capitalizing on the Heinz brand and image without having to pay for that image—they are taking something that does not belong to them. Very often what seems to be a clever way of keeping costs down costs someone else. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 4: The Constitution as the Foundation of the Legal Environment

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 22 Questions and Case Problems ............................................................................................................ 22

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Federal law requires most interstate truckers to obtain a permit that reflects compliance with certain federal requirements. The 1965 version of the law authorized states to require proof that a truck operator had such a permit. By 1991, 39 states had demanded such proof, requiring a $10 per truck registration fee and giving each trucker a stamp to affix to a multistate ―bingo card‖ carried in the vehicle. Finding this scheme inefficient and burdensome, Congress created the current Single State Registration System (SSRS), which allows a trucking company to fill out one set of forms in one state, thereby registering in every participating state through which its trucks travel. A subsection of Michigan‘s Motor Carrier Act imposes on truck companies operating in interstate commerce an annual fee of $100 for each self-propelled motor vehicle operated by or on behalf of the motor carrier.

The American Truckers Association (ATA) and others challenged the $100 fee as preempted by the extensive federal regulation of interstate trucking and trucking companies. The ATA and others appealed to the U.S. Supreme Court. What should the U.S. Supreme Court do? Be sure to discuss what portion of the Constitution applies to this issue. [American Trucking Associations, Inc. v. Michigan Public Service Com’n, 545 U.S. 429] Answer: Preemption. The U.S. Supreme Court held that the $100 fee charged interstate

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trucking companies by Michigan was not preempted by the SSRS. Congress did not specifically prohibit such a system and indicated that the SSRS may well be only a temporary system. The SSRS covers only those areas of registration including proof of insurance and the name of an agent for process. The SSRS did not address regulations such as this on specific items and conduct of truck deliveries. The court held that additional regulation did not return us to the so-called ―bingo card system‖ of licensing and registration. [American Trucking Associations, Inc. v. Michigan Public Service Com'n, 545 U.S. 429] 2.

Twenty-two passengers filed suit against Spirit Airlines for breach of contract. The passengers, who booked their flights through Cheapoair, Expedia, Priceline, and Travelocity, claimed that they were blindsided by carry-on bag fees because they were not made aware of those fees before they bought their tickets.

At the district court level, Cox v. Spirit Airlines, Inc., 340 F. Supp. 3d 154 (E.D.N.Y. 2019), the court dismissed the suit on the grounds that the Federal Airline Deregulation Act (ADA) preempted the passengers‘ contract claim because their claim was based on something beyond the face of their so-called contract of carriage. In other words, the rates that the airline has filed with the federal government are the permissible fees that can be charged under the ADA. Further, the ADA does not permit state law to preempt the provisions of the act that permit airlines to charge such fees as they have filed for their carriage rates.

The court held that the passengers were trying to impose their understanding of what was free (i.e., carry-on bags) as opposed to what the airline had defined it to be through its public filing. What should the court decide? Be sure to consider what the consequences will be if the suit goes forward. Discuss the effect of the third-party ticket sales for airlines.

[Cox v. Spirit Airlines, 786 Fed. Appx. 283, 2019 WL 4263385 (2d Cir. 2019)] Answer: Individual rights. The court held that there was only an agreement as to the price term, destination and dates of travel, and no other terms were either disclosed or made part of the contract. And the ADA precludes litigation related to that contract UNLESS there is an ambiguity. When there is an ambiguity, then the parties must rely on state law for an interpretation of the term. The court held that "price" is an ambiguous term.

The court then noted that contract law on ambiguities provides that an ambiguity exists where the terms of the contract suggest more than one meaning when viewed objectively by a reasonably intelligent person—a person who is aware of customs, practices, usages and terminology as generally understood in that industry or business. The court noted that

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the passengers' argument that most people who fly understand that one carry-on bag travels for free. Even when there is a charge for a roller bag, passengers may still carry a purse, briefcase, or other small item.

The court noted that if the question of ambiguity is resolved in favor of the passengers, then Spirit, despite its intent, would be responsible for honoring the terms as the court finds them to be defined. So, the case turns on what we mean when the term "price" is used in a contract. The lesson from this litigation is that using the term price in a contract is not necessarily well defined unless what is included or not included is specified. Without clarity, the courts, even when dealing with airlines, apply the standard rules of contract interpretation. [Cox v. Spirit Airlines, 786 Fed. Appx. 283, 2019 WL 426 3385 (2d Cir. 2019)] 3.

Alfonso Lopez, Jr., a 12th-grade student at Edison High School in San Antonio, Texas, went to school carrying a concealed .38-caliber handgun and five bullets. School officials, acting on an anonymous tip, confronted Lopez. Lopez admitted that he had the gun. He was arrested and charged with violation of federal law, the Gun-Free School Zones Act of 1990.

Lopez moved to dismiss his indictment on the grounds that the provision of the Gun-Free School Zones Act with which he was charged was unconstitutional in that it was beyond the power of Congress to legislate controls over public schools. The district court found the statute to be a constitutional exercise of congressional authority.

Lopez was found guilty and sentenced to two years in prison. He appealed and challenged his conviction on the basis of the commerce clause. The Court of Appeals agreed with Lopez, found the Gun-Free School Zones Act an unconstitutional exercise of congressional authority, and reversed the conviction. The U.S. Attorney appealed. Who should win at the U.S. Supreme Court and why? [United States v. Lopez, 514 U.S. 549] Answer: Commerce Clause. The law did not apply to business activity. Although guns and schools with problems can have an impact on commerce, the underlying activity must be tied to commerce. [United States v. Lopez, 514 U.S. 549]

4.

The University of Wisconsin requires all of its students to pay, as part of their tuition, a student activity fee. Those fees are used to support campus clubs and activities. Some students who objected to the philosophies and activities of some of the student clubs filed suit to have the fees halted. What constitutional basis do you think they could use for the suit? [Board of Regents of Wisconsin System v. South-worth, 529 U.S. 217] Answer: Individual rights. In the case, the right of association was used and students could

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not be forced to support groups they objected to personally. [Board of Regents of Wisconsin System v. Southworth, 529 U.S. 217] 5.

The Crafts‘ home was supplied with gas by the city gas company. Because of some misunderstanding, the gas company believed that the Crafts were delinquent in paying their gas bill. The gas company had an informal complaint procedure for discussing such matters, but the Crafts had never been informed that such a procedure was available. The gas company notified the Crafts that they were delinquent and that the company was shutting off the gas. The Crafts brought an action to enjoin the gas company from doing so on the theory that a termination without any hearing was a denial of due process. The lower courts held that the interest of the Crafts in receiving gas was not a property interest protected by the due process clause and that the procedures the gas company followed satisfied the requirements of due process. The Crafts appealed. Were they correct in contending that they had been denied due process of law? Why or why not? [Memphis Light, Gas and Water Division v. Craft, 436 U.S. 1] Answer: Due process. The U.S. Supreme Court held that the expectation or interest in continuing to receive gas was an interest that came within the protection of property in the due process clause of the Fourteenth Amendment. It was therefore necessary that the gas company provide an informal complaint meeting or hearing at which the customer could discuss the problem with the gas company and that the gas company give the customer notice of the availability of such procedure. The Crafts had never been informed that they could discuss the matter with the gas company. Because this had never been done, the gas company could not shut off the gas until such a meeting or hearing was held. If it did so, the Crafts would be deprived of property without due process of law, in violation of the Fourteenth Amendment. [Memphis Light, Gas and Water Division v. Craft, 436 U.S. 1]

6.

In 2002, the Williamson family, riding in their 1993 Mazda minivan, was struck head-on by another vehicle. Thanh Williamson was sitting in a rear aisle seat, wearing a lap belt; she died in the accident. Delbert and Alexa Williamson were wearing lap-and-shoulder belts; they survived. Thanh‘s estate brought suit in a California state court to recover from Mazda for her wrongful death. The basis of the suit was that Mazda should have installed lap-andshoulder belts on all seats, including the rear aisle seats, and that Thanh died because Mazda equipped her seat with only a lap belt instead. Federal safety requirements do not require lap-and-shoulder belts except for seats located next to doors and windows.

Middle seats (aisle) can have a lap belt only. Mazda asked for a dismissal on the grounds that allowing Thanh‘s estate to recover would contradict federal law and that federal law

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preempts state tort laws on product liability. The trial court dismissed the suit as preempted by federal law, and the Court of Appeal affirmed. The U.S. Supreme Court granted certiorari. What should the court decide and why? [Williamson v. Mazda Motor of America, Inc., 562 U.S. 323] Answer: Preemption. The justices allowed the state suit to go forward because they could not see that state tort law was preempted because of its role in having manufacturers make good choices of the choices the DOT has made available to them through its regulations. Below is an excerpt from the court‘s opinion: Like the regulation in Geier, the regulation here leaves the manufacturer with a choice.

And, like the tort suit in Geier, the tort suit here would restrict that choice. But unlike Geier, we do not believe here that choice is a significant regulatory objective.

The more important reason why DOT did not require lap-and-shoulder belts for rear inner seats was that it thought that this requirement would not be cost-effective. But that fact— the fact that DOT made a negative judgment about cost effectiveness—cannot by itself show that DOT sought to forbid common-law tort suits in which a judge or jury might reach a different conclusion.

For one thing, DOT did not believe that costs would remain frozen. [C]osts were falling as manufacturers were ―voluntarily equipping more and more of their vehicles with rear seat lap/shoulder belts.‖ For another thing, many, perhaps most, federal safety regulations embody some kind of cost effectiveness judgment. While an agency could base a decision to pre-empt on its cost-effectiveness judgment, we are satisfied that the rulemaking record at issue here discloses no such pre-emptive intent .And to infer from the mere existence of such a cost-effectiveness judgment that the federal agency intends to bar States from imposing stricter standards would treat all such federal standards as if they were maximum standards, eliminating the possibility that the federal agency seeks only to set forth a minimum standard potentially supplemented through state tort law.

We cannot reconcile this consequence with a statutory saving clause that foresees the likelihood of a continued meaningful role for state tort law.. . . [a] standard giving manufacturers ―multiple options for the design of‖ a device would not pre-empt a suit claiming that a manufacturer should have chosen one particular option, where ―the Secretary did not determine that the availability of options was necessary to promote safety.‖ [Williamson v. Mazda Motor of America, Inc.,562 U.S. 323]

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7.

Montana imposed a severance tax on every ton of coal mined within the state. The tax varied depending on the value of the coal and the cost of production. It could be as high as 30 percent of the price at which the coal was sold. Montana mine operators and some out-of-state customers claimed that this tax was unconstitutional as an improper burden on interstate commerce. Decide. [Commonwealth Edison Co. v. Montana, 453 U.S. 609] Answer: The commerce powers as a limitation on state ability to tax. The statute was valid.

The commerce power given to the federal government is a limitation on the power of states to act when the state action places a burden on interstate commerce. However, the fact that a state law that is not limited to interstate commerce may have some effect on out-of-state markets does not make the law unconstitutional. The Montana tax law was a general law, and its effect on foreign markets was not sufficient to condemn the law as imposing a burden on interstate commerce. The Montana law was constitutional.

[Commonwealth Edison Co. v. Montana, 453 U.S. 609]

8.

Ollie‘s Barbecue is a family-owned restaurant in Birmingham, Alabama, specializing in barbecued meats and homemade pies, with a seating capacity of 220 customers. It is located on a state highway 11 blocks from an interstate highway and a somewhat greater distance from railroad and bus stations. The restaurant caters to a family and white-collar trade, with a take-out service for ―Negroes.‖ (Note: This term is used by the Court in its opinion in the case.) In the 12 months preceding the passage of the Civil Rights Act, the restaurant purchased locally approximately $150,000 worth of food, $69,683 or 46 percent of which was meat that it bought from a local supplier who had procured it from outside the state. Ollie‘s has refused to serve Negroes in its dining accommodations since opening in 1927, and since July 2, 1964, it has been operating in violation of the Civil Rights Act. A lower court concluded that if it were required to serve Negroes, it would lose a substantial amount of business. The lower court found that the Civil Rights Act did not apply because Ollie‘s was not involved in ―interstate commerce.‖ Will the commerce clause permit application of the Civil Rights Act to Ollie‘s? [Katzenbach v. McClung, 379 U.S. 294] Answer: Commerce clause. The court upheld the constitutionality of the Civil Rights Act because of the impact on commerce. The following is an excerpt from the case: There is no claim that interstate travelers frequented the restaurant. The sole question, therefore, narrows down to whether Title II, as applied to a restaurant annually receiving about $70,000 worth of food which has moved in commerce, is a valid exercise of the power of Congress.

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The record is replete with testimony of the burdens placed on interstate commerce by racial discrimination in restaurants. A comparison of per capita spending by Negroes in restaurants, theaters, and like establishments indicated less spending, after discounting income differences, in areas where discrimination is widely practiced. This diminutive spending springing from a refusal to serve Negroes and their total loss as customers has, regardless of the absence of direct evidence, a close connection to interstate commerce.

The fewer customers a restaurant enjoys the less food it sells and consequently the less it buys.

Moreover, there was an impressive array of testimony that discrimination in restaurants had a direct and highly restrictive effect on interstate travel by Negroes. This resulted, it was said, because discriminatory practices prevent Negroes from buying prepared food served on the premises while on a trip, except in isolated and unkempt restaurants and under most unsatisfactory and often unpleasant conditions. This obviously discourages travel and obstructs interstate commerce, for one can hardly travel without eating.

Likewise, it was said that discrimination deterred professional, as well as skilled, people from moving into areas where such practices occurred and thereby caused industry to be reluctant to establish there.

We believe that this testimony afforded ample basis for the conclusion that established restaurants in such areas sold less interstate goods because of the discrimination, that interstate travel was obstructed directly by it, that business in general suffered and that many new businesses refrained from establishing there as a result of it. Hence the District Court was in error in concluding that there was no connection between discrimination and the movement of interstate commerce. The court‘s conclusion that such a connection is outside ―common experience‖ flies in the face of stubborn fact.

It goes without saying that, viewed in isolation, the volume of food purchased by Ollie‘s Barbecue from sources supplied from out of state was insignificant when compared with the total foodstuffs moving in commerce. But, as our late Brother Jackson said for the Court in Wickard v. Filburn, 317 U.S. 111, 63 S. Ct. 82, 87 L.Ed. 122 (1942): That appellee’s own contribution to the demand for wheat may be trivial by itself is not enough to remove him from the scope of federal regulation where, as here, his contribution, taken together with that of many others similarly situated, is far from trivial.

At 127-128, 63 S.Ct. at 90.

The power of Congress in this field is broad and sweeping; where it keeps within its sphere

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Solution and Answer Guide:

and violates no express constitutional limitation it has been the rule of this Court, going back almost to the founding days of the Republic, not to interfere. The Civil Rights Act of 1964, as here applied, we find to be plainly appropriate in the resolution of what the Congress found to be a national commercial problem of the first magnitude. We find it in no violation of any express limitations of the Constitution and we therefore declare it valid.

[Katzenbach v. McClung, 379 U.S. 294] 9.

terms of his contract, he could be discharged only for cause. After working for six years, he was told that he was going to be discharged because of his inability to generate safety and self-insurance programs, because of his failure to win the confidence of employees, and because of his poor attendance. He was not informed of the facts in support of these conclusions and was given the option to resign. He claimed that he was entitled to a hearing. Is he entitled to one? Why or why not? [Ellis v. City of Lakewood, 789 P.2d 449 (Colo. App.)] Answer: Due process protection of property rights. Ellis was correct. When a government employee can be discharged only ―for cause,‖ the employee has a property right that must be afforded due process protection. This requires that there be a hearing on the question of cause for discharge and that the employee be given reasonable notice of the hearing and be allowed to be present at the hearing with an attorney. The procedure that had been followed violated this guaranty of due process. [Ellis v. City of Lakewood, 789 P.2d 449 (Colo. App.)]

10. The Federal Food Stamp Act provided for the distribution of food stamps to needy households. In 1971, section 3(e) of the statute was amended to define households as limited to groups whose members were all related to each other. This was done because of congressional dislike for the lifestyles of unrelated hippies who were living together in hippie communes. Moreno and others applied for food stamps but were refused them because the relationship requirement was not satisfied. An action was brought to have the relationship requirement declared unconstitutional. Is it constitutional? Discuss why or why not. [USDA v. Moreno, 413 U.S. 528] Answer: Equal protection. No. The regulation must be related to administration of the program and not targeted at specific lifestyles. [U.S.D.A. v. Moreno, 413 U.S. 528] 11. New Hampshire adopted a tax law that in effect taxed the income of nonresidents working in New Hampshire only. Austin, a nonresident who worked in New Hampshire, claimed that the tax law was invalid. Was he correct? Explain. [Austin v. New Hampshire, 420 U.S.

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Solution and Answer Guide:

656] Answer: The privileges and immunities clause and discriminatory taxation. Yes. A state tax law that taxes nonresidents but not residents is unconstitutional because it violates the privileges and immunities clause of the U.S. Constitution. [Austin v. New Hampshire, 420 U.S. 656] 12. California passed a law that prohibited the sale or rental of ―violent video games.‖ The act defined violent video games as games ―in which the range of options available to a player includes killing, maiming, dismembering, or sexually assaulting an image of a human being, if those acts are depicted‖ in a manner that ―[a] reasonable person, considering the game as a whole, would find appeals to a deviant or morbid interest of minors.‖ The association of video game manufacturers and developers brought suit, challenging the California statute as an unconstitutional violation of their First Amendment right and a violation of their due process rights because it is so vague. What should the U.S. Supreme Court hold on the constitutionality of the statute and why? [Brown v. Entertainment Merchants Ass’n, 131 S. Ct. 2729] Answer: First Amendment Rights. (1) Video games qualify for First Amendment protection; (2) while there are limited exceptions to prohibition against content-based governmental restrictions on expression, for obscenity, incitement and fighting words, new categories of unprotected speech may not be added; and (3) California failed to satisfy burden of showing either that the law was justified by compelling government interest, or that law, which was both over-and under inclusive, was narrowly drawn to serve that interest.

[Brown v. Entertainment Merchants Ass'n, 131 S.Ct. 2729] 13. Fed up with the warning signals and being outnumbered on the highways by drivers looking out for one another, police officers and state troopers began issuing tickets to those who send signals and warnings to drivers so that they can slow down and avoid being caught going above the speed limit. On November 17, 2012, a police officer pulled Michael Elli over and issued a citation for ―[f ]lashing lights on certain vehicles prohibited; warning of RADAR ahead.‖ Mr. Elli was advised by the municipal judge that the standard punishment imposed in the City of Ellisville for using headlamps to communicate the presence of a speed trap is a $1,000 fine. Mr. Elli told the judge that he wanted to plead not guilty because he did not believe flashing headlamps violated §375.100 of the Ellisville city code. The judge became agitated and asked Mr. Elli if he had ever heard of ―obstruction of justice.‖ Mr. Elli then

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entered a plea of not guilty, and he was ordered to return to court on February 21, 2013.

However, the prosecution terminated the case by dismissing the charge prior to the hearing date. Mr. Elli, with the help of the ACLU, filed a civil rights action in federal court.

Have Mr. Elli‘s rights been violated? Is flashing your headlights a form of speech? What do you think the courts decided? [Elli v. City of Ellisville, No. 4:13-CV-711 HEA (E.D. Mo. 2014),] Answer: In the case, the city of Ellisville offered as a defense that its officers had stopped issuing tickets for flashing headlights. However, the judge found that other statutes could be used to prosecute individuals and that such prosecution, under any ordinance or statute, would inhibit Mr. Elli‘s right to communicate with other drivers. The court held that there was a valid civil rights action and issued a preliminary injunction against the city on ticketing drivers for flashing their headlights. The case will now proceed to trial for a determination of damages and whether the ticketing should be stopped permanently.

Radar detectors may be outlawed, but the age-old practice of headlight flashing is now protected as a First Amendment right.[Elli v. City of Ellisville, No. 4:13-CT-711 HEA (E.D. Mo. 2014)] 14. Barnesandnoble.com LLC (Bn.com) is a Delaware corporation that sells books, movies, and other media over the Internet. In 2006, the New Mexico Taxation and Revenue Department (the Department) assessed gross receipts tax against bn.com on its sales to New Mexico residents during a period from January 1998 through July 2005. Bn.com protested the assessment, and a hearing officer granted summary judgment to bn.com, finding that it lacked a substantial nexus with the state of New Mexico, and, therefore, it could not constitutionally be required to pay the tax. The Department appealed, and the Court of Appeals held that bn.com had a substantial nexus with the state. bn.com appealed. What should the court decide and why? [New Mexico Taxation and Revenue Department v.

BarnesandNoble.com LLC, 303 P.3d 824 (N.M. 2014)] Answer: The court found the following interconnected activities of the stores (Booksellers): (1) Booksellers‘ promotion of bn.com through sales of gift cards redeemable at bn.com and bearing bn.com‘s name, (2) Booksellers‘ policy of sharing customers‘ e-mail addresses with bn.com, (3) Booksellers‘ implicit endorsement of bn.com through the companies‘ shared loyalty program and Booksellers‘ return policy, and (4) Booksellers‘ instate use of Barnes & Noble logos and trademarks, which bn.com also used. Because Booksellers‘ activities in New Mexico were significantly associated with bn.com‘s ability to

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 5: Government Regulation of Competition and Prices

establish and maintain a market here, bn.com had a substantial nexus with the state of New Mexico. Therefore, New Mexico may collect gross receipts tax on bn.com‘s sales in the state without offending the commerce clause of the United States Constitution.

Affirmed and remanded.

This case was decided before the Wayfair decision, but it appears to have come out the same way that case would now dictate with different reasoning. [New Mexico Taxation and Revenue Department v. BarnesandNoble.com LLC, 303 P.3d 824 (N.M. 2014)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 5: Government Regulation of Competition and Prices

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 32 Questions and Case Problems ............................................................................................................ 32

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

American Crystal Sugar Co. was one of several refiners of beet sugar in northern California, and it distributed its product in interstate commerce. American Crystal and the other refiners had a monopoly on the seed supply and were the only practical market for the beets. In 1939, all of the refiners began using identical form contracts that computed the price paid to the sugar beet growers using a ―factor‖ common to all the refiners. As a result, all refiners paid the same price for beets of the same quality. Though there was no hard evidence of an illegal agreement, the growers brought suit under the Sherman Act against the refiners, alleging that they conspired to fix a single uniform price among themselves to hold down the cost of the beets. The growers sued for the treble damages available under the Sherman Act. Can they recover? [Mandeville Island Farms v. American Crystal Sugar Co., 334 U.S. 219] Answer: Monopolization. Yes, they can recover. This case is one of many in which highly

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Solution and Answer Guide:

integrated industries were found to be fixing prices. The expansion of the definition of interstate commerce, began by NLRB, continued with the Mandeville decision. The court looked beyond the artificial and mechanical separation of ―manufacturing‖ from ―commerce‖ to arrive at its decision. Highly integrated industry and manufacturing became the norm during the industrial revolution and the law began to catch up with this reality after 1937. Prior to 1937, the Court limited the scope of interstate commerce by the use of artificial divisions to find activities like that engaged in by the refiners in Mandeville, a local activity. Mandeville is consistent with the famous doctrine laid down by Justice Holmes in 1905 in Swift & Co. v. U.S. The ―stream of commerce‖ was used to apply the Sherman Act to meat-dealer price-fixing at a cattle stockyard. The stockyard was a temporary stop for cattle whose eventual destination was determined there by its purchaser. Under this theory, Congress can regulate what appeared to be an intrastate activity if that activity is connected to the interstate movement of goods or services (i.e., the activity was in the stream of commerce). [Mandeville Island Farms v. American Crystal Sugar Co., 334 U.S. 219] 2.

The National Association for College Admission Counseling (NACAC) is an association of the admissions officers of colleges and universities and high school guidance counselors.

The NACAC had a Code of Ethics and Professional Practices. However, the Justice Department investigated several provisions in the code for their anticompetitive effects.

Under the code, members were prohibited from doing the following: 1.

soliciting transfer students from other colleges;

2.

offering incentives to early decision applicants;

3.

recruiting and offering of enrollment incentives after May 1 to students who had registered, declared their intent, or submitted deposits to other institutions.

Examine the code of ethics provisions and discuss what possible effects they would have on the recruiting process. How would students being recruited be affected by the code provisions?

Answer: Anticompetitive behavior. With the restriction removed, colleges would have the opportunity to provide students with different types of incentives and colleges and universities that are not members would be able to make more of a headway into recruiting. Students could simply get better deals, especially near the end as the final decisions are being made (a time period that was blocked off by the rules in the code).

Not recruiting transfer student was a particularly punishing restriction for students who wished to transfer and would not be able to enjoy the types of packages that other students might be getting.

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Solution and Answer Guide:

The rules made recruiting more uniform and easier for the admissions counselors, but it meant the students were not getting the best possible deals for themselves.

The Justice Department reached a settlement with the NACAC—they had already removed three of the provisions prior to the settlement. The NACAC also promised to not put such provisions back into the code of ethics.

3.

David Ungar holds a Dunkin‘ Donuts franchise. The terms of his franchise agreement require him to use only those ingredients furnished by Dunkin‘ Donuts. He is also required to buy its napkins, cups, and so on, with the Dunkin‘ Donuts trademark on them. Is this an illegal tying arrangement? What if Dunkin‘ Donuts maintains that it needs these requirements to maintain its quality levels on a nationwide basis? [Ungar v. Dunkin’ Donuts of America, Inc., 429 U.S. 823] Answer: Tying. Tying is illegal if the company doing the tying has market power (the ability to command a tying arrangement) unless the tied product is something required to maintain quality, such as in a franchise for purposes of quality or goodwill. Dunkin‘ Donuts is a franchise organization that has a brand to protect and wants uniform quality. This tying arrangement was not a violation of federal antitrust laws because the paper goods help to endure uniformity, brand recognition, and quality. Consumers are drawn to uniformity, so the requirement enhances Dunkin‘ Donuts ability to compete with other doughnut shops. [Ungar v. Dunkin' Donuts of America, Inc., 429 U.S. 823]

4.

During the 1980s, the NCAA, a voluntary unincorporated association of approximately 1,100 educational institutions, became concerned over the steadily rising costs of maintaining competitive athletic programs. As a way of containing those costs, the association imposed salary caps on college and university athletic coaches. The caps on salaries as well as limits on the number and types of coaches were imposed pursuant to NCAA procedures and members‘ votes. A group of coaches filed suit, challenging the caps on salaries and hiring as being anticompetitive. The NCAA responded that it had a goal of containing athletic program costs as well as ensuring that entry-level coaching positions were available. Are the salary caps legal under the federal antitrust laws? [Law v. National Collegiate Athletic Ass’n, 134 F.3d 1010 (10th Cir.)] Answer: Monopolization; price-fixing. The elements for price fixing are that competitors act together to keep prices at a certain level or agree to price. A price maximum is a form of price fixing, and here the NCAA had imposed a price maximum. There must be evidence of

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Solution and Answer Guide:

an agreement to fix prices and market power. The agreement was a written one entered into by an organization created to apply uniform rules to sports, but good intentions are not a defense to antitrust violations.

The NCAA might have had the best of intentions, but the NCAA is a group of college and university competitors acting in concert to control coaches‘ salaries (prices). The result was that coaches‘ salaries were kept artificially low and were not determined by market forces, with a resulting anticompetitive effect on the coaching market. The NCAA cap on coaches‘ salaries was a violation of the Sherman Act. [Law v. National Collegiate Athletic Ass'n, 134 F.3d 1010 (10th Cir.)] 5.

Hines Cosmetic Co. sold beauty preparations nationally to beauty shops at a standard or fixed-price schedule. Some of the shops were also supplied with a free demonstrator and free advertising materials. The shops that were not supplied with them claimed that giving the free services and materials constituted unlawful price discrimination. Hines replied that there was no price discrimination because it charged everyone the same. What it was giving free was merely a promotional campaign that was not intended to discriminate against those who were not given anything free. Was Hines guilty of unlawful price discrimination? Explain.

Answer: Price discrimination. Yes. The providing of anything free to one and not to other competitors is an unlawful price discrimination. The net effect of what Hines did was that some shops purchased merchandise, a demonstrator, and advertising for less money than competing shops paid for the same things. Consequently, there was a price discrimination.

Moreover, the fact that Hines had no intent to harm anyone did not alter the fact that improper price discrimination had occurred.

6.

Moore ran a bakery in Santa Rosa, New Mexico. His business was wholly intrastate. Meads Fine Bread Co., his competitor, engaged in an interstate business. Meads cut the price of bread in half in Santa Rosa but made no price cut in any other place in New Mexico or in any other state. This price-cutting drove Moore out of business. Moore then sued Meads for damages for violating the Clayton and Robinson-Patman Acts. Meads claimed that the price-cutting was purely intrastate and, therefore, did not constitute a violation of federal statutes. Was Meads correct? Why or why not? [Moore v. Meads Fine Bread Co., 348 U.S. 115] Answer: Price discrimination in interstate commerce. No. Although the price discrimination occurred only locally, it was made by an interstate business and was therefore within the

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Solution and Answer Guide:

scope of the federal laws. [Moore v. Meads Fine Bread Co., 348 U.S. 115] Authors’ Comment: The effect of this decision is to amend the federal statute so that it is violated whenever the business discriminating as to prices is an interstate business. The Court is concerned with the danger that the interstate business, which is already sufficiently big to be interstate, will become still bigger at the expense of those local enterprises it could wipe out by price discrimination if the federal statute were not interpreted as was done by the Court.

7.

A&P Grocery Stores decided to sell its own brand of canned milk (referred to as private label milk). A&P asked its longtime supplier, Borden, to submit an offer to produce the private label milk. Bowman Dairy also submitted a bid, which was lower than Borden‘s.

A&P‘s Chicago buyer then contacted Borden and said, ―I have a bid in my pocket. You people are so far out of line it is not even funny. You are not even in the ballpark.‖ The Borden representative asked for more details but was told only that a $50,000 improvement in Borden‘s bid ―would not be a drop in the bucket.‖ A&P was one of Borden‘s largest customers in the Chicago area. Furthermore, Borden had just invested more than $5 million in a new dairy facility in Illinois. The loss of the A&P account would result in underutilization of the plant. Borden lowered its bid by more than $400,000. The Federal Trade Commission charged Borden with price discrimination, but Borden maintained it was simply meeting the competition. Did Borden violate the RobinsonPatman Act? Does it matter that the milk was a private label milk, not its normal trade name Borden milk? [Great Atlantic & Pacific Tea Co., Inc. v. FTC, 440 U.S. 69] Answer: Price discrimination. Yes, the different prices violate Robinson-Patman unless there are differences in cost, quality, etc. Even with a different label, manufacturer can‘t price discriminate on commodities of like quality. [Great Atlantic & Pacific Tea Co., Inc. v.

FTC, 440 U.S. 69]

8.

Department 56 is a company that manufactures and sells collectible Christmas village houses and other replica items to allow collectors to create the whimsical ―Snow Village‖ town or ―Dickens Christmas.‖ Department 56 has only authorized dealers. Sam‘s Club, a division of Wal-Mart Stores, Inc., began selling Department 56 pieces from the Heritage Village Collection. Susan Engel, president and CEO of Department 56, refused to sell Department 56 products to Wal-Mart. Does her refusal violate any antitrust laws?

Answer: Vertical price controls. This case is the Leegin case with a different product that depends on quality and customer relations.

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Solution and Answer Guide:

9.

Dr. Edwin G. Hyde, a board-certified anesthesiologist, applied for permission to practice at East Jefferson Hospital in Louisiana. An approval was recommended for his hiring, but the hospital‘s board denied him employment on grounds that the hospital had a contract with Roux & Associates for Roux to provide all anesthesiological services required by the hospital‘s patients. Dr. Hyde filed suit for violation of antitrust laws. Had the hospital done anything illegal? [Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2] Answer: Tying. The District Court dismissed the suit. Court of Appeals reversed and held the contract with Roux was illegal per se. There was no illegal per se tying arrangement— i.e., people who used Jefferson had to use Roux? The arrangement was subject to the rule of reason. The practice raises ethical issues but not per se illegal issues. [Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2]

10. BRG of Georgia, Inc. (BRG), and Harcourt Brace Jovanovich Legal and Professional Publications (HJB) are the nation‘s two largest providers of bar review materials and lectures. HJB began offering a Georgia bar review course on a limited basis in 1976 and was in direct, and often intense, competition with BRG from 1977 to 1979 when the companies were the two main providers of bar review courses in Georgia. In early 1980, they entered into an agreement that gave BRG an exclusive license to market HJB‘s materials in Georgia and to use its trade name ―Bar/Bri.‖ The parties agreed that HJB would not compete with BRG in Georgia and that BRG would not compete with HJB outside of Georgia. Under the agreement, HJB received $100 per student enrolled by BRG and 40 percent of all revenues over $350. Immediately after the 1980 agreement, the price of BRG‘s course was increased from $150 to more than $400. Is their conduct illegal under federal antitrust laws? [Palmer v. BRG of Georgia, Inc., 498 U.S. 46] Answer: Monopolization. The parties are dividing up markets, not competing. They are also controlling prices. Their conduct is a violation of the Sherman Act. [Palmer v. BRG of Georgia, Inc., 498 U.S. 46] 11. Favorite Foods Corp. sold its food to stores and distributors. It established a quantity discount scale that was publicly published and made available to all buyers. The top of the scale gave the highest discount to buyers purchasing more than 100 freight cars of food in a calendar year. Only two buyers, both national food chains, purchased in such quantities, and, therefore, they alone received the greatest discount. Favorite Foods was prosecuted for price discrimination in violation of the Clayton Act. Was it guilty?

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Solution and Answer Guide:

Answer: Functional price discrimination. Yes. It was obvious to Favorite Foods that the practical result of the ―open policy‖ was the same as if it had set a standard price for everyone, then secretly gave a discount to the two large buyers. It would not be a defense that any buyer meeting the 100-freight-car test would receive the maximum discount for the simple reason that Favorite Foods knew that no buyer other than the two favored giants could meet this test. While a large bulk discount could in some cases be sustained as justified by savings of labor, transportation, or administrative costs, the mere fact that the discount was ―open to the public‖ was not justification.

12. Public Interest Corporation (PIC) owned and operated television station WTMV-TV in Lakeland, Florida. MCA Television Ltd. (MCA) owns and licenses syndicated television programs. In 1990, the two companies entered into a licensing contract for several firstrun television shows. With respect to all but one of these shows, MCA exchanged the licenses on a ―barter‖ basis for advertising time on WTMV. However, MCA conditioned this exchange on PIC‘s agreeing to license the remaining show, Harry and the Hendersons, for cash as well as for barter. Harry and the Hendersons was what some in the industry would call a ―dog,‖ a show that was not very good that attempted to capitalize on a hit movie.

PIC agreed to this arrangement, although it did not want Harry and the Hendersons. The shows that PIC did want were List of a Lifetime, List of a Lifetime II, Magnum P.I., and 17 other miscellaneous features. Is this an illegal tying arrangement? [MCA Television Ltd. v.

Public Interest Corp., 171 F.3d 1265 (11th Cir.)] Answer: Tying. Requiring stations to take one program in order to get the program that they want would be an illegal tying arrangement. You cannot force a non-desirable good or service on a customer in order to give them what they want. Such arrangements countermand free-market forces and competition. [MCA Television Ltd. v. Public Interest Corp., 171 F.3d 1265 (11th Cir.)] 13. The Quickie brand wheelchair is the most popular customized wheelchair on the market.

Its market share is 90 percent. Other manufacturers produce special-use wheelchairs that fold, that are made of mesh and lighter frames, and that are easily transportable. These manufacturers do not compete with Quickie on customized chairs. One manufacturer of the alternative wheelchairs has stated, ―Look, it‘s an expensive market to be in, that Quickie market. We prefer the alternative chairs without the headaches of customizations.‖ Another has said, ―It is such a drain on cash flow in that market because insurers take so long to pay. We produce chairs that buyers purchase with their own money, not through insurers. Our sales are just like any other product.‖ Quickie entered the market nearly 40 years ago and is known for its quality and attention to detail. Buying a Quickie custom

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Solution and Answer Guide:

chair, however, takes time, and the revenue stream from sales is slow but steady because of the time required to produce custom wheelchairs. Has Quickie violated the federal antitrust laws with its 90 percent market share? Discuss.

Answer: Monopolization. No. Quickie has its position because of market niche, not unlawful conduct. They devote time and resources to a market others decline.

14. Gardner-Denver is the largest manufacturer of ratchet wrenches and their replacement parts in the United States. Gardner-Denver had two different lists of prices for its wrenches and parts. Its blue list had parts that, if purchased in quantities of five or more, were available for substantially less than its white list prices. Did Gardner-Denver engage in price discrimination with its two price lists? [D. E. Rogers Assoc., Inc. v. Gardner-Denver Co., 718 F.2d 1431 (6th Cir.)] Answer: Price discrimination. No. Quantity discounts are not price discrimination because there are differences in marginal costs for quantities. [D. E. Rogers Assoc., Inc. v. GardnerDenver Co., 718 F.2d 1431 (6th Cir.)] 15. The Aspen ski area consisted of four mountain areas. Aspen Highlands, which owned three of those areas, and Aspen Skiing, which owned the fourth, had cooperated for years in issuing a joint, multiple-day, all-area ski ticket. After repeatedly and unsuccessfully demanding an increased share of the proceeds, Aspen Highlands canceled the joint ticket.

Aspen Skiing, concerned that skiers would bypass its mountain without some joint offering, tried a variety of increasingly desperate measures to re-create the joint ticket, even to the point of in effect offering to buy Aspen Highland‘s tickets at retail price. Aspen Highlands refused even that. Aspen Skiing brought suit under the Sherman Act, alleging that the refusal to cooperate was a move by Aspen Highlands to eliminate all competition in the area by freezing it out of business. Is there an antitrust claim here in the refusal to cooperate? What statute and violation do you think Aspen Skiing alleged? What dangers do you see in finding the failure to cooperate to be an antitrust violation? [Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585] Answer: Anticompetitive behavior. Under certain circumstances, a refusal to cooperate with rivals can constitute anticompetitive conduct and violate § 2 of the Sherman Act. We have been very cautious in recognizing such exceptions, because of the uncertain virtue of forced sharing and the difficulty of identifying and remedying anticompetitive conduct by a single firm. The court upheld a jury verdict for the plaintiff (Aspen Skiing), reasoning that "[t]he jury may well have concluded that [the defendant] elected to forgo these short-run

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 6: Administrative Agencies

benefits because it was more interested in reducing competition. . .over the long run by harming its smaller competitor." [Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585] 16. Suture Express was a new upstart specializing in the medical supply network by selling only sutures and no other medical supplies. Owens & Minor was a medical supply distributor that carried all types of medical supplies, including sutures. Owens & Minor began bundling provisions that required its customers to pay a premium for all medical products unless the customer agreed to purchase its sutures. Suture Express brought suit alleging that Owens & Minor was using anticompetitive practices. Is this a tying situation that violates federal antitrust laws? Why or why not? [Suture Express, Inc. v. Owens & Minor Distribution, Inc., 851 F.3d 1029 (10th Cir.)] Answer: Tying. To squelch tying under the Sherman Act, the plaintiff must prove that the defendant had market power. The court held that there are many places to buy both medical supplies and sutures and the tying was not anticompetitive. [Suture Express, Inc. v.

Owens & Minor Distribution, Inc., 851 F.3d 1029 (10th Cir.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 6: Administrative Agencies

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 40 Questions and Case Problems ............................................................................................................ 40

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Following the events of September 11, 2001, in which four airplanes crashed as a result of the presence of terrorists on those flights, the FAA concluded that it needed to implement new procedures for airports and flights. The new procedures for security and flights took effect when the airports reopened five days later. Why did the FAA not need to go

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Solution and Answer Guide:

through the promulgation and public comment processes and time periods to have the new rules take effect?

Answer: Rule promulgation. The FAA could put the rules into place without the comment period and rulemaking process because it was a national emergency.

2.

The FDA was challenged by tobacco companies for its new rules that required the tobacco companies to put one of the FDA‘s 12 picture labels on its packaging. The tobacco companies argued that their First Amendment rights were violated by the rules, forcing them to speak in a certain way using government- mandated materials. The new labels were promulgated by both the FDA and the Department of Health and Human Services (HHS) pursuant to authority granted by Congress in 2009 under the Family Smoking Prevention and Tobacco Control Act. Under the law, the following nine textual statements were to be included on cigarette labels: WARNING: Cigarettes are addictive.

WARNING: Tobacco smoke can harm your children.

WARNING: Cigarettes cause fatal lung disease.

WARNING: Cigarettes cause cancer.

WARNING: Cigarettes cause strokes and heart disease.

WARNING: Smoking during pregnancy can harm your baby.

WARNING: Smoking can kill you.

WARNING: Tobacco smoke causes fatal lung diseases in nonsmokers.

WARNING: Quitting smoking now greatly reduces serious risks to your health.

The act required that these warnings and graphic labels take up 50 percent of the cigarette package label and 20 percent of all cigarette ads.

After publishing the proposed rule and receiving more than 1,700 comments, the FDA published its final rule in June 2011. Explain how the tobacco companies could challenge the rules. Discuss whether the rules will be set aside. [In the case of R.J. Reynolds Tobacco Company et al. v. FDA et al., 696 F.3d 1205 (D.C. Cir.)] Answer: Rulemaking; challenging rules. The court held that the FDA did not have the authority to control ad content. The regulation was too broad. The rules were struck down.

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Judge Leon granted the injunction based on First Amendment precedent that has held that the government cannot mandate speech that a speaker would not otherwise make in order to tilt the public debate in its direction. Sorrell v. IMS Health, Inc., 131 S. Ct. 2653 (2011). By imposing its will on a speaker, the government is altering speech. Judge Leon also had constitutional difficulties with imposing speech and advertising requirements even in the case of commercial speech when such requirements are not based in fact and not within the role of the FDA and HHS of protecting consumers.

The following, included as part of the decision, explains the First Amendment concerns: ―The graphic images here were neither designed to protect the consumer from confusion or deception, nor to increase consumer awareness of smoking risks; rather, they were crafted to evoke a strong emotional response calculated to provoke the viewer to quit or never start smoking.‖ The FDA will appeal the decision, but will miss the deadline of September 2012 that Congress placed in the statute for the new packaging and ad warnings. You can read more on the history of the rule and see photos of the labels at Mike Esterl, ―Grisly Tobacco Labels Blocked,‖ Wall Street Journal, March 2, 2012, p. A6. [R.J. Reynolds Tobacco Company et al. v. FDA et al., 696 F.3d 1205 (D.C. Cir. 2012)] 3.

The Tacoma-Pierce County Health Department conducted an investigation into the quality of care provided by ambulance service providers in its jurisdiction. On the basis of that investigation, the department issued a set of temporary rules and regulations that established minimum requirements for equipment, drugs, and service availability for ambulance service providers in Pierce County. The Tacoma News wanted to publish an article on the matter and sought discovery of everything that had led to the adoption of the regulations, including all details of the investigation made by the health department.

The health department objected to disclosing the names of the persons who had volunteered information on which the department had based its action and the names of the ambulance companies. Were the names subject to a Freedom of Information Act (FOIA) request? [Tacoma News, Inc. v. Tacoma-Pierce County Health Dept., 778 P.2d 1066 (Wash. App.)] Answer: FOIA. No. There are exemptions from disclosure which include individual privacy, competitive, proprietary information. Exemptions would include privacy on medical matters. Perhaps, though, the court would present the experiences used as background without names. [Tacoma News, Inc. v. Tacoma-Pierce County Health Dept., 778 P.2d 1066

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(Wash. App.)] 4.

Congress adopted a law to provide insurance to protect wheat farmers. The agency in charge of the program adopted regulations to govern applications for this insurance.

These regulations were published in the Federal Register. Merrill applied for insurance, but his application did not comply with the regulations. He claimed that he was not bound by the regulations because he never knew they had been adopted. Is he bound by the regulations? [Federal Crop Ins. Corp. v. Merrill, 332 U.S. 380] Answer: Effect of publication in the Federal Register. Yes. Merrill‘s ignorance of the regulations did not excuse him. The Federal Register Act declares that everyone is bound by regulations properly published in the Federal Register, without regard to whether the existence of the regulations is actually known. [Federal Crop Ins. Corp. v. Merrill, 332 U.S. 380]

5.

Santa Monica adopted a rent control ordinance authorizing the Rent Control Board to set the amount of rents that could be charged. At a hearing before it, the board determined that McHugh was charging his tenants a rent higher than the maximum allowed. McHugh claimed that the action of the board was improper because there was no jury trial. Is McHugh correct? Why or why not? [McHugh v. Santa Monica Rent Control Board, 777 P.2d 911 (Cal.)] Answer: Administrative decision without a jury trial. McHugh is not correct. The proceedings were not improper because there was no jury. It is constitutional for an administrative agency to make determinations even though money is concerned, and there is no constitutional right that a jury be used. [McHugh v. Santa Monica Rent Control Board, 777 P.2d 911 (Cal.)]

6.

New York City‘s charter authorized the New York City Board of Health to adopt a health code that it declared to have the force and effect of law. The board adopted a code that provided for the fluoridation of the public water supply. A suit was brought to enjoin the carrying out of this program on the grounds that it was unconstitutional and that money could not be spent to carry out such a program in the absence of a statute authorizing the expenditure. It was also claimed that the fluoridation program was unconstitutional because there were other means of reducing tooth decay; fluoridation was discriminatory by benefiting only children; it unlawfully imposed medication on children without their consent; and fluoridation was or may be dangerous to health. Was the code‘s provision valid? [Paduano v. City of New York, 257 N.Y.S.2d 531]

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Answer: Legislative power of an agency. Yes. There was no question that the dental care of half a million children in New York City was a significant public health problem. Also, there was no evidence that fluoridation was harmful; therefore, the rule-making body had to determine whether fluoridation was the way to cope with the evil that was present. It was not for the court to say whether a better way was available. The fact that the program benefited primarily children did not make it discriminatory and not applicable to adults, particularly in view of the fact that the benefit received as a child would continue into adulthood. The court noted that the case differed from the typical situation in which chlorine is added to water or a person is required to be vaccinated, for in such cases the action is taken to prevent the spread of harm. In fluoridation of water, the purpose is to bestow a benefit on the recipient. This difference, however, did not deprive the fluoridation requirement of its character as a ―health code,‖ and it was thus within the authorization of the statute and was valid. [Paduano v. City of New York, 257 N.Y.S.2d 531] 7.

What is the Federal Register? What role does it play in rulemaking? What is the difference between the Federal Register and the Code of Federal Regulations?

Answer: Openness of agencies. The Federal Register is the daily publication of the federal government that includes notice of proposed rulemakings, hearings, public comments periods and the newly promulgated rules. Part of the requirement for rulemaking is that there be publication of intent to promulgate rules and provisions for public comments, all disclosed in the Federal Register.

8.

The Consumer Product Safety Commission is reconsidering a rule it first proposed in 1997 that would require child-resistant caps on household products, including cosmetics. When the rule was first proposed in 1997, it was resisted by the cosmetics industry and abandoned. However, in May 2001, a 16-month-old baby died after drinking baby oil from a bottle with a pull-tab cap. The proposed rule would cover products such as baby oil and suntan lotion and any products containing hydrocarbons such as cleansers and spot removers. The danger, according to the commission, is simply the inhalation by children, not necessarily the actual ingestion of the products. Five children have died from inhaling such fumes since 1993, and 6,400 children under the age of five were brought into emergency rooms and/or hospitalized for treatment after breathing in hydrocarbons.

There is no medical treatment for the inhalation of hydrocarbons.

Several companies in the suntan oil/lotion industry have supported the new regulations.

The head of a consumer group has said, ―We know these products cause death and injury.

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That is all we need to know.‖ What process must the CPSC follow to promulgate the rules? What do you think of the consumer group head‘s statement? Will that statement alone justify the rulemaking?

Answer: Rule promulgation. The outcry of a consumer group cannot automatically produce a rule. The agency must study, propose rules and take feedback. The process is the same even when there is great outcry. While there is clearly an issue with regard to safety, the promulgation of the rule will require more than what the head of the consumer group has alleged. The CPSC must open rulemaking proceedings after it has had the chance to research the issue and provide background information on the problem. Once the evidence is presented, along with the proposed rule, a public comment period of at least 30 days is required. Both manufacturers and consumers, pro and con on both sides, will have the chance to provide input.

9.

The Federal Register contained the following provision from the Environmental Protection Agency on January 14, 2002: We, the U.S. Fish and Wildlife Service (Service), announce the re-opening of the comment period on the proposed listing of Lomatium cookii (Cook’s lomatium) and Limnanthes floccosa ssp. grandiflora (large-flowered wooly meadowfoam) as endangered species under the Endangered Species Act of 1973, as amended (Act). We are re-opening the comment period to provide the public an opportunity to review additional information on the status, abundance, and distribution of these plants, and to request additional information and comments from the public regarding the proposed rule. Comments previously submitted need not be resubmitted as they will be incorporated into the public record as part of this extended comment period; all comments will be fully considered in the final rule.

DATES: We will accept public comments until March 15, 2002.

What was the EPA doing and why? What could those who had concerns do at that point?

Answer: Rulemaking. The EPA has proposed a rule creating an endangered species classification. There has been a comment period but because of additional information, the EPA is extending the comment period to consider new information.

10. Macon County Landfill Corp. applied for permission to expand the boundaries of its

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landfill. Tate and others opposed the application. After a number of hearings, the appropriate agency granted the requested permission to expand. Tate appealed and claimed that the agency had made a wrong decision on the basis of the evidence presented. Will the court determine whether the correct decision was made? [Tate v.

Illinois Pollution Control Board, 544 N.E.2d 1176 (Ill. App.)] Answer: Scope of review of administrative agency and decision. No. The task of weighing all of the evidence presented at the hearings is entrusted to the administrative agency. A court is not in the position to reweigh the evidence but is in a position to determine whether the administrative agency‘s decision is against the manifest weight of the evidence. Nothing in the case indicates that the decision was against the manifest weight of the evidence, and therefore, it will not be reexamined by the court. [Tate v. Illinois Pollution Control Board, 544 N.E.2d 1176 (Ill. App.)] 11. The planning commissioner and a real estate developer planned to meet to discuss rezoning certain land that would permit the real estate developer to construct certain buildings not allowed under the then-existing zoning law. A homeowners association claimed it had the right to be present at the meeting. This claim was objected to on the theory that the state‘s Open Meetings Act applied only to meetings of specified government units and did not extend to a meeting between one of them and an outsider.

Was this objection valid?

Answer: What constitutes a meeting. No. The objection wasn‘t valid. The statute was to be liberally construed to allow the presence of those interested at any meeting that could affect them. Whether outsiders were taking part in the discussion at the meeting was irrelevant. Note that this hypothetical case is based on the case of Brookwood Area Homeowners Ass‘n., Inc. v Anchorage (Alaska), 702 P2d 1317 (1985). The only difference between the actual case and the hypothetical case is that in the actual case, it was the municipal assembly or city council that met with the real estate developer. Nothing in the case or in logic would require reaching a different result when an agency is involved. This conclusion is reinforced by the court statement that ―a ‗meeting‘ includes every step of the deliberative and decision-making process when a governmental unit meets to transact public business.‖ Moreover, a good argument could be made that because members of an agency such as a planning commission are not elected, in contrast with members of a municipal assembly, the agency is much less representative of the people than the public assembly, and therefore, a greater rather than a lesser scrutiny of agency activity should be allowed.

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12. The Michigan Freedom of Information Act declares that it is the state‘s policy to give all persons full information about the actions of the government and that ―the people shall be informed so that they may participate in the democratic process.‖ The union of clerical workers at Michigan State University requested the trustees of the university to give them the names and addresses of persons making monetary donations to the university.

Michigan State objected because the disclosure of addresses was a violation of the right of privacy. Decide. [Clerical-Technical Union of Michigan State University v. Board of Trustees of Michigan State University, 475 N.W.2d 373 (Mich.)]

Answer: Exceptions to disclosure of public records. The addresses at which the donors lived was a matter of their private lives. The disclosure of that information would not enable persons so informed to take part more effectively in the democratic process. The only people who would benefit by the disclosure would be solicitors. The disclosure of the addresses was not required, but was prohibited by the exception to the statute protecting the right of privacy. [Clerical-Technical Union of Michigan State University v. Board of Trustees of Michigan State University, 475 N.W.2d 373 (Mich.)]

13. The Department of Health and Human Services has proposed new guidelines for the interpretation of federal statutes on gifts, incentives, and other benefits bestowed on physicians by pharmaceutical companies. The areas on which the interpretation focused follow: 

Paying doctors to act as consultants or market researchers for prescription drugs



Paying pharmacies fees to switch patients to new drugs



Providing grants, scholarships, and anything more than nominal gifts to physicians for time, information sessions, and so on, on new drugs

The Office of Inspector General is handling the new rules interpretation and has established a public comment period of 60 days. Explain the purpose of the public comment period. What ethical issues do the regulations attempt to address?

Answer: Rulemaking. The change in the rules requires comments because the proposal is a change in rules. The public comment period is required under the Administrative Procedures Act so that the public has the chance to provide input on proposed rules and interpretations. The notice of the comment period must be made public; publishing in the Federal Register is one part of that public notice.

The ethical issue is conflict of interest between the doctors and pharmacies and the best

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interests of their patients and customers and the benefits they receive from the drug companies for prescribing certain drugs.

14. San Diego Air Sports (SDAS) Center operates a sports parachuting business in Otay Mesa, California. SDAS offers training to beginning parachutists and facilitates recreational jumping for experienced parachutists. It indicates that the majority of SDAS jumps occur at altitudes in excess of 5,800 feet. The jump zone used by SDAS overlaps the San Diego Traffic Control Area (TCA). Although the aircraft carrying the parachutists normally operate outside the TCA, the parachutists themselves are dropped through it. Thus, the air traffic controllers must approve each jump.

In July 1987, an air traffic controller in San Diego filed an Unsatisfactory Condition Report with the Federal Aviation Administration (FAA), complaining of the strain that parachuting was putting on the controllers and raising safety concerns. The report led to a staff study of parachute jumping within the San Diego TCA. This was followed by a letter in March 1988 from the FAA to SDAS, informing SDAS that ―[e]ffective immediately parachute jumping within or into the San Diego TCA in the Otay Reservoir Jump Zone will not be authorized.‖ The FAA stated that the letter was final and appealable. SDAS challenged the letter in federal court on grounds that it constituted rulemaking without compliance with required Administrative Procedure Act (APA) procedures. Who is correct in this dispute and why? [San Diego Air Sports Center, Inc. v. FAA, 887 F.2d 966 (9th Cir.)] Answer: Rule promulgation. The effect of the FAA letter was to promulgate a rule.

Although the FAA characterized the ban on parachutes as simply a safety issue, it was a new rule for operation in the air space around San Diego, and SDAS had the right to participate and be heard in the process that led to the letter. No process was followed here at all in terms of the release of the findings or a public comment period. The FAA was required to follow the same steps for this new rule and could not circumvent that process by labeling a fundamental change in the rules as simply an interpretation. [San Diego Air Sports Center, Inc. v. FAA, 887 F.2d 966 (9th Cir. 1989)] 15. The Endangered Species Act (ESA) charges the National Marine Fisheries Service (a federal agency) with the duty to ―ensure‖ that any proposed action does not ―jeopardize‖ any threatened or endangered species. The Steller sea lion is on the list of endangered species.

The agency developed a North Pacific marine fishery plan that permitted significant harvest of fish by commercial fisheries in the area. Greenpeace, an environmental group, challenged the agency on the grounds that the plan was not based on a sufficient number of biological studies on the impact of the allowed fishing on the Steller sea lion.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 7: Crimes

Greenpeace‘s biologic opinion concluded that the fishery plan would reduce the level of food for the sea lions by about 40 percent to 60 percent, if the juvenile fish were not counted in that figure. Greenpeace‘s expert maintained that counting juvenile fish was misleading because they were not capable of reproducing and the government agency‘s figure was, as a result, much lower at 22 percent. What would Greenpeace need to show to be successful in challenging the agency‘s fishery plan? [Greenpeace, American Oceans Campaign v. National Marine Fisheries Service, 237 F. Supp. 2d 1181 (W.D. Wash.)]

Answer: Challenges to rulemaking. Greenpeace would need to bring in experts to challenge the agency‘s findings on the numbers. One of the basis for challenging a rule is that it was not based on evidence. Greenpeace has data it needs to present to show the foundation for the rule might be flawed. [Greenpeace, American Oceans Campaign v.

National Marine Fisheries Service, 237 F.Supp.2d 1181 (W.D. Wash.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 7: Crimes

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 49 Questions and Case Problems ............................................................................................................ 49

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Bernard Flinn operated a business known as Harvey Investment Co., Inc./High Risk Loans.

Flinn worked as a loan broker, matching those who came to him with lenders willing to loan them money given their credit history and the amount involved. From 1982 through 1985, Flinn found loans for five people. Indiana requires that persons engaged in the business of brokering loans obtain a license from the state. Flinn was prosecuted for brokering loans without having a license. He raised the defense that he did not know that a license was required and that, accordingly, he lacked the criminal intent to broker loans without having a license. Does Flinn have a good defense? [Flinn v. Indiana, 563 N.E.2d

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536 (Ind.)] Answer: Criminal culpability. No, ignorance of the law is not an excuse. Flinn is still liable.

Before doing business, check the applicable laws. [Flinn v. Indiana, 563 N.E. 2d 536 (Ind.)] 2.

H. J., Inc., and other customers of Northwestern Bell Corp. alleged that Northwestern Bell had furnished cash and tickets for air travel, plays, and sporting events and had offered employment to members of the Minnesota Public Utilities Commission in exchange for favorable treatment in rate cases before the commission. A Minnesota statute makes it a felony to bribe public officials. H. J. and other customers brought suit against Northwestern for violating the criminal bribery statute. Can the customers bring a criminal action? [H. J., Inc. v. Northwestern Bell Corp., 420 N.W.2d 673 (Minn. App.)] Answer: Crime v. civil action. No, the customers cannot bring a criminal action because enforcement of laws is the responsibility of the state. Enforcement of rights under the laws can be done by individual citizens. If the citizens have experienced harm as a result of the activities, they can bring a civil suit, but they cannot bring a criminal action—only agents of the state can do so. [H.J., Inc. v. Northwestern Bell Corp., 420 N.W. 2d 673 (Minn. App.)]

3.

Baker and others entered a Walmart store shortly after 3:00 a.m. by cutting through the metal door with an acetylene torch. They had moved some of the merchandise in the store to the rear door, but the police arrived before the merchandise could be taken from the store. Baker was prosecuted for larceny. He raised the defense that he was not guilty of larceny because no merchandise had ever left the store. Is there enough intent and action for a crime? [Tennessee v. Baker, 751 S.W.2d 154 (Tenn. App.)] Answer: Larceny. Yes. Although some people regard shoplifting as not serious, it comes within the definition of larceny. It is a taking of personal property from the owner with the intent to deprive the owner of that property. Leaving the store is often proof of intent; but it is not the only proof. The use of the torch in this case shows intent. While there are separate statutes in most states that impose a lesser penalty for shoplifting than for larceny, these shoplifting statutes do not repeal the larceny statutes or remove shoplifting from the scope of the larceny statutes. Thus, an overlap of larceny and shoplifting occurs, and the district attorney has the discretion or choice of deciding for which crime a shoplifter should be prosecuted. The men were also convicted of possession of burglary tools. [Tennessee v. Baker, 751 S.W. 2d 154 (Tenn. App.)]

4.

Sergeant Kenneth Riley used videos of a fellow officer, not for training purposes, but for

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purposes of getting a fellow officer disciplined. He showed the videos to those within the department who would not have authorization to view them. Riley was indicted for unauthorized use of a computer and unauthorized access and disclosure of computer data. Riley moved to have the indictment dismissed. What should the court do with the case and why? [New Jersey v. Riley, 988 A.2d 1252 (N.J. 2009)] Answer: Computer crimes. Riley‘s access and use of computer data did not constitute the crime of unauthorized use of computers. The court held that what Riley did was a violation of workplace policies but did not fit within the criminal conduct intended to be covered by the statute. The judge was concerned about arbitrary definitions and enforcement and a criminal statute being used for retaliatory purposes. [New Jersey v. Riley, 988 A.2d 1252 (N.J. 2009)] 5.

Dr. Doyle E. Campbell, an ophthalmologist, established his practice in southern Ohio in 1971. Many of Dr. Campbell‘s patients are elderly people who qualify for federal Medicare benefits and state Medicaid benefits. Under the existing financing system, a doctor who treats a Medicare patient is required to submit a ―Medicare Health Insurance Claim Form‖ (HCFA Form 1500). The doctor is required to certify that ―the services shown on this form were medically indicated and necessary for the health of the patient and were personally rendered by me or were rendered incident to my professional service by my employees.‖ Claims Dr. Campbell submitted for his elderly patients ranged from $900 to $950, of which $530 to $680 were covered by the Medicare program. The government alleged that Dr. Campbell billed Medicare for several treatments that were either not performed or not necessary. Dr. Campbell was charged with fraud for the paperwork he submitted. Has he committed a crime? [United States v. Campbell, 845 F.2d 1374 (6th Cir.)] Answer: Fraud; criminal intent. Yes, the good doctor committed the crimes of fraud and mail fraud. He knew that he had not performed the services, yet he billed for them anyway.

The Medicare claim forms expressly required the doctor to certify that "the services shown on this form were medically indicated and necessary for the health of the patient." Thus, where a physician submits a Medicare claim to the government through an insurer, and the physician knows that the treatments performed were unnecessary or non-therapeutic, he or she is criminally liable. [United States v. Campbell, 845 F. 2d 1374 (6th Cir.)]

6.

In the late 1980s, Life Energy Resources, Ltd. (LER), a New York corporation, was a multilevel marketing network. LER‘s marketing plan provided that members of the general public could purchase its products only through an official LER distributor or by becoming LER distributors themselves. Each potential distributor had to be sponsored by an existing

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distributor and was required to sign a distributorship agreement with LER stating that he or she would not make medical claims or use unofficial literature or marketing aids to promote LER products.

Ballistrea and his partner Michael Ricotta were at the top of the LER distribution network.

Two products sold by LER were the REM SuperPro Frequency Generator (REM) and the Lifemax Miracle Cream (Miracle Cream). The REM, which sold for $1,350 to distributors, was a small box powered by electricity that ran currents through the feet and body of the user.

Ballistrea and Ricotta distributed literature and audiotapes to many potential downstream distributors and customers—some of whom were undercover government agents— touting the REM and the Miracle Cream. Other literature claimed that the Miracle Cream could alleviate the discomforts of premenstrual syndrome and reverse the effects of osteoporosis. The Food and Drug Administration charged Ballistrea and Ricotta with violating federal law for making medical claims concerning LER products. Their defense is that they never sold any of the products. They simply earned commissions as part of the marketing scheme and could not be held criminally liable on the charges. Are they correct? [United States v. Ballistrea, 101 F.3d 827 (2d Cir.)] Answer: Fraud; criminal intent. No, they are not correct. Convictions for conspiracy to defraud the Food and Drug Administration (FDA) were sustained by evidence that defendant and coconspirator, knowing their marketing scheme contravened the law, repeatedly instructed persons to whom they sent unauthorized literature touting medicinal powers of their products to conceal use and possession of this information to prevent FDA's discovery of their unlawful activities, and that defendant helped to organize and became distributor in new company selling same products after FDA began investigating old company's distribution of those products, which showed defendant's agreement to obstruct FDA's lawful function of regulating marketing and distribution of medical devices and drugs; showing of actual contact.

That defendant be legally responsible party was not required element of offense of causing unapproved medical devices and drugs to be introduced into interstate commerce when defendant's own conduct of causing unapproved products to be introduced into interstate commerce provided basis for prosecution. [United States v. Ballistrea, 101 F. 3d 827 (2d Cir.)] 7.

Carriage Homes, Inc. was a general contractor that built multifamily residential and land-

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development projects in Minnesota. John Arkell was Carriage Homes‘ chief executive officer, president, and sole shareholder. Carriage Homes built Southwinds, a condominium development of 38 residential units in Austin, Minnesota. The foundation elevations of some of the Southwinds units were lower than permitted under the State Building Code, causing storm water to pool in the units‘ driveways and garages. The city of Austin‘s development director sent Arkell a series of seven letters in 1999 and 2001 concerning the elevation problems, and Arkell gave the letters to the project managers, who failed to resolve the problems.

Minnesota makes a violation of the State Building Code a misdemeanor. On May 30, 2001, the state charged Carriage Homes and Arkell with three misdemeanor counts each, alleging a violation of the Uniform Building Code (UBC).

Carriage Homes pleaded guilty and was sentenced to a $1,000 fine. But Arkell pleaded not guilty, asserting that he could not be held criminally responsible for the violation. After a bench trial, the district court found Arkell guilty. He was sentenced to pay a fine, pay restitution to the condominium owners, and serve 90 days in jail, with 80 days stayed pending his compliance with sentencing conditions. Mr. Arkell appealed on the grounds that the employees and subcontractors had simply not followed his orders and he was not responsible for their failures. Is he correct? [State v. Arkell, 657 N.W.2d 883 (Minn. App.)] Answer: Criminal responsibility; corporate crime. Responsible-corporate-officer doctrine applied to impose misdemeanor criminal liability on president of corporate general contractor for the corporation's violation of state building code in providing inadequate foundation elevations, even if subcontractors on the construction project actually violated the code, where corporation pleaded guilty to same violation, president was sole shareholder and controlled corporation's policies and activities, city development director personally informed president in writing on several occasions that elevations violated building code, and president failed to ensure that violations were corrected. [State v.

Arkell, 657 N.W. 2d 883 (Minn. App.)] 8.

James Durham operates an art gallery. He has several paintings from unknown artists that he has listed for sale. The paintings always sell at his weekly auction for $20,000 to $50,000 above what James believes them to be worth. James learns that the bidders at the auctions are employed by an olive distributor located near the shipping yards of the city.

What concerns should Durham have about the art, the bidders, and the large purchase prices?

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Answer: Money laundering. Durham should be concerned that his gallery and auctions are being used to launder money. Remember that the Patriot Act extended liability for money laundering beyond just banks. The problem is a take-off on Mickey Blue Eyes, a movie in which Hugh Grant‘s art gallery is used for money laundering.

9.

Jennings operated a courier service to collect and deliver money. The contract with his customers allowed him a day or so to deliver the money that had been collected. Instead of holding collections until delivered, Jennings made short-term investments with the money. He always made deliveries to the customers on time, but because he kept the profit from the investments for himself, Jennings was prosecuted for embezzlement. Was he guilty? [New York v. Jennings, 504 N.E.2d 1079 (N.Y.)] Answer: Intent element of larceny. No. An intent to permanently deprive the owner of the owner‘s property is essential to the crime of larceny. This intent was apparently lacking, as Jennings had always made payment of the proper amounts when due, so no conduct indicated an intent to deprive the owners permanently of their property. Jennings made an unauthorized use of the property and kept the benefit for himself, but this did not constitute larceny. [New York v. Jennings, 504 N.E. 2d 1079 (N.Y.)]

10. In April 2006, a DC-9 aircraft landed in the port city of Ciudad del Carmen, located 500 miles east of Mexico City. When the plane‘s crew began directing security personnel away from the plane, the suspicious activity piqued the curiosity of local law enforcement officials. They decided to search the plane and found 128 suitcases packed with over 56 tons of cocaine. The cocaine was to have been delivered to Toluca, near Mexico City. In investigating the plane and individual involved, law enforcement agents discovered that the plane had been purchased with money that had been laundered through two U.S. banks, Wachovia Corp. and Bank of America Corp. Neither bank was actually aware that the money was being used to purchase a plane that would then be used for drug trafficking. Are the banks still criminally liable for breaking the rules? Explain why or why not. What if the banks were aware of large sums of money being run through particular customers‘ accounts? Would that knowledge make a difference?

Answer: Money laundering. The banks could be held liable if they were not following a money-laundering prevention program. Banks have to have programs that track such large transfers of cash in order to prevent the problems. Banks need not have actual knowledge of the use of the funds in order to be required to raise questions of customers about the large transfers.

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11. Grabert ran Beck‘s, an amusement center in Louisiana. He held a license for video gambling machines. Louisiana makes it illegal to allow a minor to play a video gambling machine. A mother came into Grabert‘s center carrying her 23-month-old baby in her arms. She sat at the video poker machine with her child on her lap and proceeded to play.

State troopers witnessed the baby pushing the buttons on the machine at least three times. The Department of Public Safety and Corrections revoked Grabert‘s video gaming license because a minor had been allowed to play the machines, and Grabert sought judicial review. The trial court reversed, and the department appealed. Has Grabert committed the crime of allowing a minor to engage in gaming? Is this the crime of allowing a minor to gamble? [Grabert v. Department of Public Safety & Corrections, 680 So. 2d 764 (La. App.) cert. denied; Grabert v. State through Dept. of Public Safety and Corrections, 685 So. 2d 126 (La.)] Answer: Actus reus. The court held that the revocation of the license was not justified because the toddler could not have the requisite mental intent to violate the gambling laws. Further, the actual act itself by the toddler was not a minor engaged in playing a slot machine but simply a small child interacting with noise, buttons, and colors. There was no criminal activity necessary to support the revocation of the license. [Grabert v. Department of Public Safety & Corrections, 680 So.2d 764 (La. App) cert. denied; Grabert v. State through Dept. of Public Safety and Corrections, 685 So. 2d 126 (La.)] 12. The Banco Central administered a humanitarian plan for the government of Ecuador.

Fernando Banderas and his wife presented false claims that the bank paid. After the fraud was discovered, the bank sued Banderas and his wife for damages for fraud and treble damages under the Florida version of RICO. Banderas and his wife asserted that they were not liable for RICO damages because there was no proof that they were related to organized crime and because the wrong they had committed was merely ordinary fraud.

They had not used any racketeering methods. Is involvement with organized crime a requirement for liability under RICO? [Banderas v. Banco Central del Ecuador, 461 So. 2d 265 (Fla. App.)] Answer: RICO. No, proof of a tie-in to organized crime is not required, on-going crime of fraud is sufficient. [Banderas v. Banco Central del Ecuador, 461 So. 2d 265 (Fla. App.)] 13. Kravitz owned 100 percent of the stock of American Health Programs, Inc. (AHP). To obtain the Philadelphia Fraternal Order of Police as a customer for AHP, Kravitz paid money bribes to persons who he thought were officers of that organization but who in fact were federal undercover agents. He was prosecuted for violating RICO. He was convicted, and

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the court ordered the forfeiture of all of Kravitz‘s shares of AHP stock. Can a forfeiture be ordered? [United States v. Kravitz, 738 F.2d 102 (3d Cir.)] Answer: RICO. The shares of stock were not the instrumentality of a crime but may have been property used in the pattern of racketeering. Yes, the court did have the discretion to seize the shares. [United States v. Kravitz, 738 F. 2d 102 (3d Cir.)] 14. Kathryn Erickson was the general manager of the Uintah Special Services District (USSD), an entity created to use federal-mineral-lease revenues for road projects. She, along with her secretary, Cheryl McCurdy, administered the USSD from a small office in Vernal, Utah.

Ms. Erickson‘s authority was limited and she was not permitted to enter into or modify contracts for or to expend more than $1,000 of USSD funds, without board approval.

Mitchell Construction was a major contractor for USSD. In 1998, USSD awarded Mitchell Construction a contract to haul gravel from a site called Hamaker Bottoms and another contract to carry out small asphalt-paving projects. Both contracts were to be completed within the 1998 construction year.

During 1999 and 2000 Mitchell Construction continued to perform work on the projects covered by its 1998 contracts with USSD, despite their expiration. It submitted invoices to USSD and was paid for this work.

In June 1999 a federal grand jury began to investigate contracting irregularities at USSD and the Uintah County Road Department and issued a subpoena duces tecum to USSD requesting copies of ―project contracts, invoices‖ between USSD and contractors.

While the office was preparing the response for the grand jury subpoena, Ms. McCurdy saw Ms. Erickson prepare a handwritten change order for the Hamaker Bottoms contract and saw Ms. Erickson and Gilman N. Mitchell both sign it. The change order, which was backdated to January 13, 1999, extended the contract through December 31, 2000.

Ms. McCurdy later discovered that two other change orders had been created and backdated. She spent a day copying documents for the grand jury and recording, on a handwritten list, all of the documents that she had copied. However, she left Ms. Erickson in the office while she was working on the list in order to go home for dinner. Ms. Erickson called her and told her not to come back because all the copying was done. Later, Ms. McCurdy found on Ms. Erickson‘s desk a photocopy of the grand jury document list and saw that two entries not in her handwriting had been added. These entries were for

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change orders for contracts between Mitchell Construction and USSD. Ms. McCurdy reported the change to the government.

Ms. Erickson and Mr. Mitchell were each indicted by a grand jury in the U.S. District Court for the District of Utah on three counts of obstruction of justice by knowingly falsifying a document with the knowledge and intent that the grand jury would rely on it. Are both the elements of mental intent (scienter) and action present for criminal convictions here? [U.S. v. Erickson, 561 F.3d 1150 (10th Cir.)] Answer: Criminal culpability. The jury returned a verdict of guilty against both Ms. Erickson and Mr. Mitchell on all three counts. The two appealed. The court affirmed the decision. There are three requirements for conviction of obstruction of justice: (1) There must be a pending judicial proceeding; (2) the defendant must have knowledge or notice of the pending proceeding; and (3) the defendant must have acted corruptly with the specific intent to obstruct or impede the administration of justice. The two had backdated the documents in order to cover up the fact that the contracts had expired. They had continued the contracts without authority and authorized or received payments above the $1,000 limit. They were responding to a grand jury subpoena and gave it false change orders. They did so in order to protect Ms. Erickson‘s job and Mr. Mitchell‘s company‘s contracts and relationship with USSD. [U.S. v. Erickson, 561 F. 3d 1150 (10th Cir.)] 15. Ahmad owns a Spin-N-Market in Texas, a convenience store and gas station. One of the Spin- N-Market‘s gasoline tanks developed a leak. Jewel McCoy of CIT Environmental Services inspected the tank and said it needed to be drained and then pumped. McCoy gave Ahmad the cost of draining, and he suggested he would do it himself despite McCoy‘s warning about violations of the law. Ahmad rented a pump at the local hardware store and pumped over 5,000 gallons into a manhole near his store (4,690 of those gallons were gasoline). The gasoline made its way to the storm sewer system and then a creek as well as the city sewage treatment center. While firemen were working to divert the gasoline, the treatment center and two nearby schools had to be evacuated. Ahmad was charged with violation of the Clean Water Act and was convicted of two charges. Ahmad raises the defense that he did not know that he was pumping gas, that he thought that he was pumping water. What issue is he raising as a defense? Is his defense valid? [United States v. Ahmad, 101 F.3d 386 (5th Cir. 1996)] Answer: Criminal intent. The appeals court held that Ahmad did not have the intent to violate the statute, the CWA, because he thought that he was discharging water, not gasoline. There is more knowledge required for CWA violations; it is a criminal statute and

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 8: Torts

there cannot be just strict liability—there still must be a showing of mental intent. [United States v. Ahmad, 101 F.3d 386 (5th Cir. 1996)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 8: Torts

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 58 Questions and Case Problems ............................................................................................................ 58

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Christensen Shipyards built a 155-foot yacht for Tiger Woods at its Vancouver, Washington, facilities. It used Tiger‘s name and photographs relating to the building of the yacht in promotional materials for the shipyard without seeking his permission. Was this a right of publicity tort because Tiger could assert that his name and photos were used to attract attention to the shipyard to obtain commercial advantage? Did the shipyard have a First Amendment right to present the truthful facts regarding its building of the yacht and the owner‘s identity as promotional materials? Does the fact that the yacht was named Privacy have an impact on this case? Would it make a difference as to the outcome of this case if the contract for building the yacht had a clause prohibiting the use of Tiger‘s name or photo without his permission?

Answer: Right-to-publicity tort. Tiger sued the shipyard under Right-to-Publicity and breach of contract theories. (The courts have struggled with the First Amendment right to express ―facts‖ such as a right of the builder to…). The courts have struggled with the issue of whether a Right-to-Publicity claim is nevertheless prohibited by the First Amendment; especially where the promotional materials were factual. Some courts have used a ―relatedness‖ test to allow for the use of the celebrity name. However, in this case, Tiger‘s attorneys anticipated the problem and had a clause in the construction contract that prohibited all publicity without permission. The case was settled with a $1.6 million

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payment to Tiger Woods.

2.

ESPN held its Action Sports and Music Awards ceremony in April, at which celebrities in the fields of extreme sports and popular music such as rap and heavy metal converged.

Well-known musicians Ben Harper and James Hetfield were there, as were popular rappers Busta Rhymes and LL Cool J. Famed motorcycle stuntman Evel Knievel, who is commonly thought of as the ―father of extreme sports,‖ and his wife, Krystal, were photographed. The photograph depicted Evel, who was wearing a motorcycle jacket and rose-tinted sunglasses, with his right arm around Krystal and his left arm around another young woman. ESPN published the photograph on its ―extreme sports‖ Web site with a caption that read ―Evel Knievel proves that you‘re never too old to be a pimp.‖ The Knievels brought suit against ESPN, contending that the photograph and caption were defamatory because they accused Evel of soliciting prostitution and implied that Krystal was a prostitute. ESPN contends that the caption was a figurative and slang usage and was not defamatory as a matter of law. Decide. [Knievel v. ESPN, 393 F.3d 1068 (9th Cir.)] Answer: Defamation. Although the word ―pimp‖ may be reasonably capable of a defamatory meaning when read in isolation, we agree with the district court‘s assessment that ―the term loses its meaning when considered in the context of this case where it appeared among other photos using loose, figurative slang language directed at a younger, lighthearted audience.‖ The term ―pimp‖ as used on the ESPN.com website was not intended as a criminal accusation, nor was it reasonably susceptible to such a literal interpretation. Ironically it was most likely intended as a compliment. But we need not definitively resolve that issue here because even if the photograph and caption are reasonably capable of a defamatory meaning, they are not actionable under the First Amendment. [Knievel v. ESPN, 393 F.3d 1068 (9th Cir.)]

3.

While snowboarding down a slope at Mammoth Mountain Ski Area (Mammoth), 17-yearold David Graham was engaged in a snowball fight with his 14-year-old brother. As he was ―preparing to throw a snowball‖ at his brother, David slammed into Liam Madigan, who was working as a ski school instructor for Mammoth, and injured him. Madigan sued Graham for damages for reckless and dangerous behavior. The defense contended that the claim was barred under the doctrine of assumption of the risk, applicable in the state, arising from the risk inherent in the sport that allows for vigorous participation and frees a participant from a legal duty to act with due care. Decide. [Mammoth Mountain Ski Area v.

Graham, 38 Cal. Rptr. 3d 422 (Cal. App.)] Answer: Assumption of the risk not applicable where reckless conduct is involved. It is true

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that collisions between snowboarders are one of the risks inherent in the sport of snowboarding, and if this case were brought on a negligence theory related to an ordinary collision the defense would be successful. However, the plaintiff‘s case is pursued under the heightened burden of proof on the part of the plaintiff asserting reckless conduct.

Snowboarding downhill at a fast rate of speed while engaged in a snowball fight is dangerous activity, and the court concluded that there was a [triable] issue of fact whether David‘s conduct was so reckless that it was totally outside the range of ordinary activity of the sport of snowboarding. [Mammoth Mountain Ski Area v. Graham, 38 Cal. Rptr. 3d 422 (Cal. App.)] 4.

Following a visit to her hometown of Coalinga, Cynthia wrote ―An Ode to Coalinga‖ (Ode) and posted it in her online journal on MySpace.com. Her last name did not appear online.

Her page included her picture. The Ode opens with ―The older I get, the more I realize how much I despise Coalinga‖ and then proceeds to make a number of extremely negative comments about Coalinga and its inhabitants. Six days later, Cynthia removed the Ode from her journal. At the time, Cynthia was a student at UC Berkeley, and her parents and sister were living in Coalinga. The Coalinga High School principal, Roger Campbell, submitted the Ode to the local newspaper, the Coalinga Record, and it was published in the Letters to the Editor section, using Cynthia‘s full name. The community reacted violently to the Ode, forcing the family to close its business and move. Cynthia and her family sued Campbell and the newspaper on the right-of-privacy theory of public disclosure of private facts. What are the essential elements of this theory? Was Cynthia and her family‘s right of privacy violated? [Moreno v. Hanford Sentinel, Inc., 91 Cal. Rptr. 3d 858 (Cal. App.)] Answer: Invasion of privacy. Judgment against both Cynthia and her family. The essential elements of the ―public disclosure of private facts‖ theory are public disclosure of private facts. A matter that is already public or has become part of the public domain is not private. While Cynthia expected a limited audience, by posting the article on MySpace.com for six days, Cynthia opened the article to the public at large. The potential audience was vast. The right to privacy is purely personal and cannot be asserted by her parents and sister. [Moreno v. Hanford Sentinel, Inc., 91 Cal. Rptr. 3d 858 (Cal. App.)]

5.

Catherine Bosley worked as a television news anchor for WKBN Channel 27 in Youngstown, Ohio. While on vacation with her husband in Florida she participated in a ―wet t-shirt‖ contest, which was videotaped without her consent by DreamGirls, Inc. and licensed to Marvad Corp., which runs a Web site for adult entertainment through a subscription service on the Internet. Marvad used depictions of her in advertisements to

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promote the materials and services it markets. Web site searches related to Catherine Bosley in 2004 were the most popular search on the World Wide Web. Due to the publicity, she resigned from her position at WKBN. Bosley sought an injunction against the defendants from using her image in any manner that promotes the sale of their goods or services. The defendants contend that an injunction would violate their First Amendment rights. What legal theory did Bosley rely on to seek the injunction? Would an injunction be in violation of the defendant‘s First Amendment‘s rights? Decide. [Bosley v. Wildwett.com, 310 F. Supp. 2d 914 (N.D. Ohio)] Answer: Right of publicity. Bosley pursued the injunction under the right of publicity tort theory. Judgment for Bosley. The First Amendment does not immunize defendants from damages for infringement of the right of publicity. No significant editorial comment or artistic expression involving First Amendment protections applies in this case. If any ―speech‖ interest is involved it is commercial speech. At its core the defendants are selling Bosley‘s image for a profit without her consent. It is in violation of her right of publicity, which protects one‘s right to be free from the appropriation of one‘s persona. The injunction sought was granted. [Bosley v. Wildwett.com, 310 F. Supp. 2d 914 (N.D. Ohio)] 6.

Juanita DeJesus was seriously injured when hit on the head by a foul ball at a minor league baseball game and sued the stadium operators for negligence and premises liability. The case progressed to the Indiana Supreme Court where the Indianapolis Indians urged the State Supreme Court to dispose of the premises liability and negligence claims in one fell swoop by adopting the so-called Baseball Rule, which provides that: a ballpark operator that provides screening behind home plate sufficient to meet ordinary demand for protected seating has fulfilled its duty with respect to screening and cannot be subjected to liability for injuries resulting to a spectator by an object leaving the playing field.

Should the court adopt this clear and unambiguous rule for the national pastime? Does the court have authority to make such a ruling? How would you decide her negligence claim? [South Shore Baseball, LLC v. DeJesus, 11 N.E.3d 903 (Ind.)] Answer: Negligence: Assumption of Risk. The State Supreme Court declined to adopt the Baseball Rule stating: Under our system of limited government, the legislative branch is entrusted with decisions of public policy. Judges and Justices are servants of the law, not the other way around.

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Judges are like umpires. Umpires don‘t make the rules, they make sure everybody plays by the rules, but it is a limited role. Nobody ever went to a ball game to see the umpire.

Charles Fried, Balls and Strikes, 61 Emory L.J. 641, 642 (2012), quoting the Confirmation Hearing on the Nomination of John G. Roberts, Jr. to be Chief Justice of the United States: Should the General Assembly wish to adopt the Baseball Rule in statutory form, of course, it is free to do so; indeed, four other state legislatures have done just that. Ms. DeJesus was unsuccessful in her premises liability and negligence claims. [South Shore Baseball, LLC v. DeJesus, 11 N.E.3d 903 (Ind.)] 7.

Mallinckrodt produces nuclear and radioactive medical pharmaceuticals and supplies.

Maryland Heights Leasing, an adjoining business owner, claimed that low-level radiation emissions from Mallinckrodt damaged its property and caused a loss in earnings. What remedy should Maryland Heights have? What torts are involved here? [Maryland Heights Leasing, Inc. v. Mallinckrodt, Inc., 706 S.W.2d 218 (Mo. App.)] Answer: Trespass. Damage to property by entry with the emissions; this is a trespass.

[Maryland Heights Leasing, Inc. v. Mallinckrodt, Inc., 706 S.W. 2d 218 (Mo. App.)]

8.

An owner abandoned his van in an alley in Chicago. In spite of repeated complaints to the police, the van was allowed to remain in the alley. After several months, it was stripped of most of the parts that could be removed. Jamin Ortiz, age 11, was walking down the alley when the van‘s gas tank exploded. The flames from the explosion set fire to Jamin‘s clothing, and he was severely burned. Jamin and his family brought suit against the city of Chicago to recover damages for his injuries. Could the city be held responsible for injuries caused by property owned by someone else? Why or why not? [Ortiz v. Chicago, 398 N.E.2d 1007 (Ill. App.)] Negligence; duty. The court held that the spontaneous explosion of the abandoned van‘s gas tank was not reasonably foreseeable, and the city owed no duty to protect the boy who was playing nearby. The city was not negligent in its failure to tow the van. In determining whether there was a legal duty on the part of the city, the question to be answered is whether the occurrence (explosion) was reasonably foreseeable. Liability cannot be based on surmise or conjecture. [Ortiz v. Chicago, 398 N.E. 2d 1007 (Ill. App.)]

9.

Carrigan, a district manager of Simples Time Recorder Co., was investigating complaints of mismanagement of the company‘s Jackson office. He called at the home of Hooks, the secretary of that office, who expressed the opinion that part of the trouble was caused by

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the theft of parts and equipment by McCall, another employee. McCall was later discharged and sued Hooks for slander. Was she liable? [Hooks v. McCall, 272 So. 2d 925 (Miss.)]

Answer: Qualified privilege; defamation. The circumstances of the investigation, the relevance of the matter to the employer‘s business, and the fact that the statement was privately told to a superior led to the conclusion that Hooks did not make the statement with malice. Because the statements were nonmalicious and were made to the employer regarding a matter within the range of corporate business, Hooks was protected by a qualified privilege from liability for slander. [Hooks v. McCall, 272 So. 2d 925 (Miss.)]

10. Moore and Beye had an altercation after a public meeting regarding airport expansion.

Moore owned a ranch near the airport and staunchly opposed expansion. Beye owned a flying service and avidly supported expansion. Moore and Beye exchanged unpleasantries while leaving the meeting. Beye then punched Moore on the left side of the jaw. Moore stumbled, but caught himself before falling. He then exclaimed to the crowd, ―You saw that. You are my witnesses. I‘ve been assaulted. I want that man arrested.‖ Ravalli County deputies took Beye into custody and the state charged him with misdemeanor assault.

Moore visited the hospital complaining of back and neck pain two days later and contended that he injured his back while reeling from Beye‘s punch. He filed a civil complaint against Beye for damages. Moore‘s evidence mostly concerned his alleged back injury. Beye did not contest that he punched Moore. His evidence countered that Moore‘s back problems existed before the altercation. The judge instructed the jury that Beye had committed a battery as a matter of law and directed that they answer the question ―Was Moore damaged as a result of the battery?‖ The jury voted 11 to 1 that the battery did not injure Moore. Contending that he presented compelling evidence that he was in fact injured by the battery, Moore appealed. Decide. [Moore v. Beye 122 P.3d 1212 (Mont.

2005)] Answer: Battery. Beye presented the testimony of several eyewitnesses and a medical expert that Moore had sustained no damages. Although Moore presented considerable evidence to the contrary, it was not the court‘s function to agree or disagree with the verdict. Beye

presented sufficient evidence to uphold the jury‘s verdict. [Moore v. Beye,

122 P.3d 1212 (Mont. 2005)] 11. Carl Kindrich‘s father, a member of the Long Beach Yacht Club before he died, expressed a wish to be ―buried at sea.‖ The Yacht Club permitted the Kindrich family the use of one of its boats, without charge, for the ceremony, and Mr. Fuller—a good friend of Carl‘s

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father—piloted the boat. Portable stairs on the dock assisted the attendees in boarding.

Upon returning, Fuller asked for help to tie up the boat. The steps were not there, and Carl broke his leg while disembarking to help tie up the boat. Carl sued the Yacht Club for negligence in failing to have someone on the dock to ensure that the portable steps were available. The Yacht Club contended that it was not liable because Carl made the conscious decision to jump from the moving vessel to the dock, a primary assumption of risk in the sport of boating. The plaintiff contended that he was not involved in the sport of boating, and at most his actions constituted minimal comparative negligence, the type that a jury could weigh in conjunction with the defendant‘s negligence in assessing damages. Decide. [Kindrich v. Long Beach Yacht Club, 84 Cal. Rptr. 3d 824 (Cal. App.)] Answer: Primary assumption of the risk; comparative negligence. The appeals court decided that the doctrine of primary assumption of the risk did not apply to the facts of this case. Such a doctrine is a complete defense. Carl was not engaged in the sport of boating when he was injured. He may well have been comparatively negligent in jumping off the moving vessel to help tie up the boat, which could be compared to the negligence of the Yacht Club by a jury in determining responsibility and apportioning damages.

Primary assumption of the risk is a complete bar to the recovery of damages. [Kindrich v.

Long Beach Yacht Club, 84 Cal. Rptr. 3d 824 (Cal. App.)] 12. Hegyes was driving her car when it was negligently struck by a Unjian Enterprises truck.

She was injured, and an implant was placed in her body to counteract the injuries. She sued Unjian, and the case was settled. Two years later Hegyes became pregnant. The growing fetus pressed against the implant, making it necessary for her doctor to deliver the child 51 days prematurely by Cesarean section. Because of its premature birth, the child had a breathing handicap. Suit was brought against Unjian Enterprises for the harm sustained by the child. Was the defendant liable? [Hegyes v. Unjian Enterprises, Inc., 286 Cal. Rptr. 85 (Cal. App.)] Answer: Negligence; duty. The driver who collided with the motorist owed no duty of care to the yet unconceived child who later was delivered prematurely due to pressure from the motorist‘s lumbo-peritoneal shunt. There was no duty to the infant. [Hegyes v. Unjian Enterprises, Inc., 286 Cal. Rptr. 85 (Cal. App.)] 13. Kendra Knight took part in a friendly game of touch football. She had played before and was familiar with football. Michael Jewett was on her team. In the course of play, Michael bumped into Kendra and knocked her to the ground. He stepped on her hand, causing injury to a little finger that later required its amputation. She sued Michael for damages.

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He defended on the ground that she had assumed the risk. Kendra claimed that assumption of risk could not be raised as a defense because the state legislature had adopted the standard of comparative negligence. What happens if contributory negligence applies? What happens if the defense of comparative negligence applies?

Answer: Comparative negligence statutes; assumption of risk. Kendra was not negligent in taking part in the game. There was nothing in the fact of participation in the game that would have alerted a reasonable person to the fact that such an injury was foreseeable. By taking part in the game, she voluntarily assumed risks of normal harm that could reasonably be associated with the game. Her experience with the game showed that she knew what could be expected, and there was no proof that the defendant acted recklessly or caused harm intentionally. That is, nothing went beyond the reasonable expectations of a reasonable person. Therefore, there was no problem of allocating degree of fault; thus, the comparative negligence statute did not apply, and Kendra was barred by her assumption of risk.

For an advanced class, it may be noted that there is confusion in the law as to the relationship of contributory negligence to assumption of risk. This typically results from failing to distinguish between whether the plaintiff was negligent in acting as the plaintiff acted or whether the defendant was at fault. Justice Frankfurter of the U.S. Supreme Court has commented on this confusion: ―The phrase ‗assumption‘ is an excellent illustration of the extent to which uncritical use of words bedevils the law. A phrase begins life as a literary expression; its felicity leads to its lazy repetition; and repetition soon establishes it as a legal formula, undiscriminatingly used to express different and sometimes contradictory ideas.‖ Tiller v Atlantic Coast Line RR Co., 318 US 54, 68, 87 L Ed 610, 143 ALR 967 (1943), concurring opinion.

14. Lawrence Hardesty is an over-the-road tractor-trailer truck driver who picked up a load of stadium seating equipment for the NFL stadium under construction in Baltimore. The equipment was packaged in large corrugated cardboard boxes weighing several hundred pounds. The shipper, American Seating Co., loaded the trailer while Hardesty remained in the cab of his truck doing ―paperwork‖ and napping. Considerable open space existed between the boxes and the rear door of the trailer. The evidence showed that Hardesty failed to properly examine the load bars used to secure the boxes from movement during transit. When Hardesty arrived at the Baltimore destination, he opened the rear trailer door and boxes at the end of trailer fell out and injured him. Hardesty brought a personal injury negligence action against the shipper contending it improperly loaded the trailer.

American Seating Co. responded that Hardesty was contributorily negligent, thus barring

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his negligence claim. [Hardesty v. American Seating Co.194 F.Supp.2d 447 (D. Md. 2002)] Answer: Defenses to negligence; contributory negligence. Maryland is a contributory negligence state. Judgment for American Seating Co., because the claim is barred by Hardesty‘s contributory negligence. His decision to ignore the loading process by remaining in his truck, oblivious to the manner and means of the loading of the trailer, coupled with his own failure to examine the load bars sufficiently to confirm that they would ―adequately secure‖ the cargo, together with his decision to open the doors of the trailer upon his arrival in Baltimore while standing within the zone of danger created by the possibility of injury from cargo falling out of the trailer, cohered to rise to the level of a cognizable breach of duty—contributory negligence. [Hardesty v. American Seating Co., 194 F.Supp.2d 447 (D. Md. 2002)] 15. Blaylock was a voluntary psychiatric outpatient treated by Dr. Burglass, who became aware that Blaylock was violence prone. Blaylock told Dr. Burglass that he intended to do serious harm to Wayne Boynton, Jr., and shortly thereafter he killed Wayne. Wayne‘s parents then sued Dr. Burglass on grounds that he was liable for the death of their son because he failed to give warning or to notify the police of Blaylock‘s threat and nature. Was a duty breached here? Should Dr. Burglass be held liable? [Boynton v. Burglass, 590 So. 2d 446 (Fla. App.)] Answer: Requirement of duty for tort liability. The court held that there was no liability because there was no duty to communicate any warning. The court reached this result on the grounds that psychiatry is not such a precise science that the doctor would know that a real danger existed, and it would tend to undermine the confidentiality of the psychiatrist-patient relationship if the psychiatrist were required to give warnings.

A dissenting opinion points out that the majority of the court first decided that it desired that there be no liability and then worked backward to justify that result by saying that there was no duty. It can be pointed out that in many situations, it is obvious that a court makes up its mind as to the desired result, then works backward to explain that result in a way that looks logical. One is reminded of the cynic‘s definition of a statistician: ―A [person] who draws a mathematically straight line from an unwarranted assumption to a foregone conclusion.‖ The Florida statutes were amended in 1988 to protect the psychiatrist who concludes that a threat made by his patient will be carried out. The statutes now provide that ―the psychiatrist may disclose patient communications to the extent necessary to warn any

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 9: Intellectual Property Rights and the Internet

potential victim or to communicate the threat to a law enforcement agency. No civil or criminal action shall be instituted, and there shall be no liability on account of disclosure of otherwise confidential communications by a psychiatrist in disclosing a threat pursuant to this section [of the statute].‖ [Boynton v. Burglass, 590 So. 2d 446 (Fla. App.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 9: Intellectual Property Rights and the Internet

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 67 Questions and Case Problems ............................................................................................................ 67

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

In 2017, Hulu, the well-known streaming platform sent a cease-and-desist letter to Humu, a human resources startup. In 2019, Humu sought a declaratory judgment, arguing that the trademark is neither infringing nor diluting Hulu‘s trademark rights. What factors would a court consider in determining whether the Humu mark infringes Hulu‘s mark?

What would a court consider in determining whether Humu dilutes Hulu‘s mark?

Answer: Trademark infringement and dilution. This problem offers an opportunity to discuss declaratory judgment as well as the fact that trademark owners will often claim both infringement and dilution. Hulu also sought to block registration by the USPTO. After receiving the cease-and-desist letter in 2017, Humu decided to confront the threat of litigation head on by filing a preemptive lawsuit. Humu proposes to use artificial intelligence to solve workplace problems. Humu named the company after a fish native to Hawaii, where the idea for the company was conceived, and because it evokes the word ―human.‖ Students should recognize that likelihood of confusion is the key to prevailing in a trademark infringement case. This is a good case to look at the factors courts consider to determine whether they favor Hulu or Humu. For example, Hulu is a strong mark, as it is arbitrary or fanciful. The marks are similar, as only one letter is different. Nevertheless, the

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two companies offer very different services to different customers. Humu serves large business organizations while Hulu is offered to consumers through a monthly subscription.

Using likelihood of confusion factors, a court is likely to give substantial weight to the fact that the services and customers are different. Also, Humu‘s clients would be sophisticated in making a business choice whether to engage the company‘s services. Hulu could prevail in a dilution suit even if there is no likelihood of confusion. In a dilution case, Hulu could argue successfully that it is a famous mark. Students‘ opinions may differ on whether or not the Humu mark would blur the distinctiveness of the Hulu mark. The case was filed in the Northern District of California.

2.

Booking.com applied to register BOOKING.COM as a service mark for online hotel reservation services. The USPTO denied the registration on the grounds that combining a generic term like ―booking‖ with a generic top-level domain name like ―.com‖ merely communicates to consumers that the business offers online hotel reservations.

Booking.com argued that adding the ―.com‖ resulted in a descriptive term that could be registered if it acquired secondary meaning. Booking.com introduced evidence that showed that a majority of consumers recognized BOOKING.COM as a brand name rather than a product category. Should BOOKING.COM be registered as a trademark? Or is the term generic and therefore incapable of trademark protection? [United States PTO v.

Booking.com, 2020 U.S. LEXIS 3517 (June 30, 2020)] Answer: Trademarks. The United States Patent and Trademark Office refused to register the mark ―Booking.com,‖ stating that it is generic. The Supreme Court rejected that conclusion. In a unanimous decision, the Supreme Court held that a term styled ―generic.com‖ is a generic name for a class of goods or services only if it has that meaning to consumers. The Court concluded that consumers do not perceive the term ―Booking.com‖ to signify online hotel-reservation services as a lass. Thus, the term is not generic and it is eligible for federal trademark registration. [United States PTO v.

Booking.com, 140 S. Ct. 1492 (2020)]

3.

ComicMix published a book titled ―Oh, the Places You‘ll Boldly Go.‖ The book is a mash-up of Dr. Seuss‘s book, ―Oh, the Places You‘ll Go!‖ and Star Trek. The estate of Dr. Seuss sued for copyright infringement. A trial judge ruled the new book was entitled to the fair use defense because it was highly transformative. On appeal, Dr. Seuss claimed the book exploited the fame of the existing two works and did not comment on, criticize or teach about Seuss or Star Trek. The publisher maintains that the new work combines the two old works for new purposes to ―contrast and critique the starkly egocentric, winner-take-all motif‖ of Dr. Seuss‘s book. How should the court rule? [ Seuss Enterprises, LP v. ComicMix

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LLC et al., 2019 U.S. Dist. LEXIS 58073 (9th Cir.)] Answer: Fair use in copyright law. As this book went to press, the case was on appeal to the Ninth Circuit Court of Appeal. The trial judge analyzed each element of the fair use defense and concluded although the defendants borrowed liberally from Seuss‘s work, it tailored it to Star Trek fans; illustrations were infused with a unique Star-Trek viewpoint; and the new work had a different market function. The court noted that Seuss could not prove market harm. Dr. Seuss‘s ―Oh, The Places You‘ll Go‖ is frequently given to students as a graduation gift and the Seuss estate suggested that the new Star Trek themed book could compete with it in this market. The court dismissed this argument as speculative.

[Seuss Enterprises, LP v. ComicMix LLC et al., 372 F. Supp. 3d 1101 (S.D. Cal.)] 4.

The NCAA filed suit when an e-cigarette company applied for the mark MARSH MADNESS for an e-liquid containing nicotine. The NCAA owns the trademark MARCH MADNESS. What would the NCAA have to prove in a case for trademark dilution?

Answer: Trademark infringement and dilution. In a trademark dilution case, the NCAA would have to prove that its mark is famous and that the proposed trademark MARSH MADNESS blurs or tarnishes its reputation. The NCAA does not have to prove likelihood of confusion. The NCAA opposed the registration at the Trademark Trial and Appeal Board in 2019. The problem is presented as a hypothetical.

5.

Sara Bostwick hired Christian Oth, Inc., to be her wedding photographer. The parties‘ written contract granted ownership of the copyright in all images created to Oth. Oth posted the wedding photos on its Web site. Bostwick e-mailed Oth to remove the photos from the Web site. Oth failed to do so and Bostwick sued, claiming that she had the sole and exclusive right to control her own wedding photos. Is she correct? [Bostwick v.

Christian Oth, Inc. 936 N.Y.S.2d 176 (A.D.)] Answer: Copyrights and contracts. Bostwick is incorrect. The contract of the parties unambiguously granted the photographer ownership of the photos. The authority was unrestricted. Even though Bostwick hired the photographer and paid for the service, the contract giving the copyright to the photographer is controlling.

Authors’ Note: As you get ready to study the law of contracts in subsequent chapters, you will learn that the courts apply the terms of a contract, as written. You will also learn that it is important to read with care each contract. Printed language on the photographer‘s standard form contract giving the photographer the copyright to all images, should have

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been stricken from the proposed contract by Bostwick. It is highly unlikely that the photographer would turn down the job and income because the bride insisted on owning the copyright to her wedding photos. [Bostwick v. Christian Oth, Inc., 936 N.Y. S. 2d 176 (A.D.)] 6.

Sullivan sold t-shirts with the name Boston Marathon and the year of the race imprinted on them. The Boston Athletic Association (BAA) sponsors and administers the Boston Marathon and has used the name Boston Marathon since 1917. The BAA registered the name Boston Marathon on the Principal Register. In 1986, the BAA entered into an exclusive license with Image, Inc., to use its service mark on shirts and other apparel.

Thereafter, when Sullivan continued to sell shirts imprinted with the name Boston Marathon, the BAA sought an injunction. Sullivan‘s defense was that the general public was not being misled into thinking that his shirts were officially sponsored by the BAA. Without this confusion of source, he contended, no injunction should be issued. Decide.

[Boston Athletic Ass’n v. Sullivan, 867 F.2d 22 (1st Cir.)] Answer: Injunction against improper use of mark. Judgment for BAA. A person who has the right to use a mark may enjoin a competitor from imitating the mark. Sullivan‘s shirts were designed to take advantage of the Boston Marathon and to benefit from its goodwill.

Sullivan was getting a ―free ride‖ at the BAA‘s expense. The fact that Sullivan did not say his product was ―officially sponsored‖ does not lessen the general public‘s confusion or alter the outcome of the case. [Boston Athletic Ass'n v. Sullivan, 867 F. 2d 22 (1st Cir.)]

7.

The Greenwich Bank & Trust Co. (GB&T) opened in 1998 and by 2008 had expanded to a total of four branches in the Greenwich, Connecticut, community of 62,000 residents. A competitor using the name Bank of Greenwich (BOG) opened in December 2006. GB&T‘s parent entity sued BOG for trademark violation under the Lanham Act. BOG argued that GB&T‘s service mark is generic and is simply not entitled to Lanham Act protection because it combines the generic term ―bank‖ and the geographic term ―Greenwich.‖ GB&T asserted that it had been the only bank in Greenwich using the word Greenwich in its name and had done so exclusively for nine years. It asserted that a geographic term is entitled to protection if it acquires secondary meaning. GB&T introduced evidence regarding its advertising expenditures, sales success, and length of exclusivity of use along with evidence of actual consumer confusion. Decide. [Connecticut Community Bank v. The Bank of Greenwich, 578 F. Supp. 2d 405 (D. Conn.)]

Answer: Trademarks; secondary meaning. Judgment for Greenwich Bank & Trust. The Bank of Greenwich is incorrect in its assertion that GB&T service mark is generic and not entitled

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to trademark protection. A ―geographic‖ term is capable of Lanham Act protection if it attains secondary meaning. GB&T‘s evidence of record supported a finding of secondary meaning. The court issued injunction relief to GB&T permanently expiring it from using the name ―The Bank of Greenwich‖ and awarded nominal damages of $1.00. [Connecticut Community Bank v. The Bank of Greenwich, 578 F. Supp. 2d 405 (D. Conn.)]

8.

The U.S. Polo Association (USPA) is a not-for-profit corporation that is the governing body of the sport of polo in the United States. It has been in existence since 1890 and derives the majority of its revenue from royalties obtained from licensing its trademarks. It owns more than 900 trademarks worldwide, including marks bearing the words ―U.S. Polo Assn.‖ with the depiction of two polo players for licensees on products sold in the apparel category. In 2009 it produced 10,000 units of a men‘s fragrance using packaging featuring its logo as used on apparel. Since 1978 PRL (Polo Ralph Lauren) and its licensee of PRL trademarks, L‘Oreal, have used the mark known as the ―Polo Player‖ logo on men‘s fragrances with its logo containing one player. The fragrance has been sold for 32 years and it was voted into the industry‘s Hall of Fame. PRL sued USPA. What must PRL establish to prevail in an action for trademark infringement? How would you decide this case?

[United States Polo Assn. v. PRL USA Holdings, Inc., 800 F. Supp. 2d 515 (S.D.N.Y.)] Answer: Trademark infringement. In order to prevail in an action for trademark infringement, a party must establish that it possesses a valid, legally protectable trademark and that the junior user‘s mark is likely to cause confusion as to the origin or sponsorship of the product. PRL proved it had a valid, legally protected trademark. Surveys conducted

by PRL were suggestive of actual confusion. The court determined that USPA adopted its mark with the intention of capitalizing on PRL‘s reputation and goodwill. As a result of the likelihood of consumer confusion the public interest would be served by the issuance of permanent injunction prohibiting USPA from using the ―U.S. POLO ASSN.‖ name in conjunction with the double horseman mark in men‘s fragrances. [United States Polo Assn. v. PRL USA Holdings, Inc., 800 F. Supp. 2d 515 (S.D. N.Y.)]

9.

Diehr devised a computerized process for curing rubber that was based on a well-known mathematical formula related to the cure time, and he devised numerous other steps in his synthetic rubber-curing process. The patent examiner determined that because abstract ideas, the laws of nature, and mathematical formulas are not patentable subject matter, the process in this case (based on a known mathematical formula) was also not patentable. Diehr contended that all of the steps in his rubber-curing process were new and not obvious to the art of rubber curing. He contended also that he did not seek an exclusive patent on the mathematical formula, except for its use in the rubber-curing

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process. Decide. [Diamond v. Diehr, 450 U.S. 175] Answer: Patents. Diehr can‘t patent the math formula, he can only patent a unique curing process. To the extent that Diehr can establish a curing process distinct from current processes and not tied solely to timing and formulas, he can obtain a patent. [Diamond v.

Diehr, 450 U.S. 175] 10. Aries Information Systems, Inc., develops and markets computer software specifically designed to meet the financial accounting and reporting requirements of such public bodies as school districts and county governments. One of Aries‘s principal products is the POBAS III accounting program. Pacific Management Systems Corporation was organized

by Scott Dahmer, John Laugan, and Roman Rowan for marketing a financial accounting and budgeting system known as FAMIS. Dahmer, Laugan, and Rowan were Aries employees before, during, and shortly after they organized Pacific. As employees, they each gained access to Aries‘s software materials (including the POBAS III system) and had information about Aries‘s existing and prospective clients. Proprietary notices appeared on every client contract, source code list, and magnetic tape. Dahmer, Laugan, and Rowan signed an Employee Confidential Information Agreement after beginning employment with Aries. While still employees of Aries, they submitted a bid on behalf of Pacific to Rock County and were awarded the contract. Pacific‘s FAMIS software system is substantially identical to Aries‘s proprietary POBAS III system. Aries sued Pacific to recover damages for misappropriation of its trade secrets. Pacific‘s defense was that no ―secrets‖ were misappropriated because many employees knew the information in question. Decide.

[Aries Information Systems, Inc. v. Pacific Management Systems Corp., 366 N.W.2d 366 (Minn. App.)] Answer: Trade secrets; proprietary information. It is not always controlling that many employees knew the information—it is a question of whether Aries kept the information proprietary. In this case, Aries had taken appropriate steps to keep the information within the company. The use by Pacific was an appropriation. [Aries Information Systems, Inc. v.

Pacific Management Systems Corp., 366 N.W. 2d 366 (Minn. App.)] 11. The plaintiff, Herbert Rosenthal Jewelry Corporation, and the defendant, Kalpakian, manufactured jewelry. The plaintiff obtained a copyright registration of a jeweled pin in the shape of a bee. Kalpakian made a similar pin. Rosenthal sued Kalpakian for infringement of copyright registration. Kalpakian raised the defense that he was only copying the idea, not the way the idea was expressed. Was he liable for infringement of the plaintiff‘s copyright? [Herbert Rosenthal Jewelry Corp. v. Kalpakian, 446 F.2d 738 (9th

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Cir.)] Answer: Copyright distinction between an idea and the mode of expressing the idea.

Judgment was for the defendant. Unlike a patent, a copyright protects only the expression of the idea, not the idea itself.The line between idea and expression is not always easy to draw. If the idea of a jeweled bee pin can be copied by another, the copy expressing the idea of a jeweled bee pin will look very much like the original expression of the idea. That is, it is impossible to copy the idea without paralleling or duplicating the original expression of the idea.

If the similarity of the subsequent expression bars the copying of the original idea, the net result is that the subsequent copying of the idea would be prohibited. This in effect would give a patent protection to something to which Congress did not intend that patent protection be given. Therefore, it is held that when copying of the expression is inseparable from copying of the idea, the copyright law does not provide any protection against copying. [Herbert Rosenthal Jewelry Corp. v. Kalpakian, 446 F. 2d 738 (9th Cir.)] 12. Mineral Deposits, Ltd. (MD, Ltd.), an Australian company, manufactures the Reichert Spiral, a device used for recovering gold particles from sand and gravel. The spiral was patented in Australia, and MD, Ltd., had applied for a patent in the United States. Theodore Zigan contacted MD, Ltd., stating that he was interested in purchasing up to 200 devices for use in his gravel pit. MD, Ltd., agreed to lend Zigan a spiral for testing its efficiency. Zigan made molds of the spiral‘s components and proceeded to manufacture 170 copies of the device. When MD, Ltd., found out that copies were being made, it demanded the return of the spiral. MD, Ltd., also sought lost profits for the 170 spirals manufactured by Zigan.

Recovery was sought on a theory of misappropriation of trade secrets. Zigan offered to pay for the spiral lent him by MD, Ltd. He argued that trade secret protection was lost by the public sale of the spiral. What ethical values are involved? Was Zigan‘s conduct a violation of trade secret law? [Mineral Deposits, Ltd. v. Zigan, 773 P.2d 609 (Colo. App.)] Answer: Trade secrets; ethics and modern law. This case involves the ethical principles of integrity, fairness, and doing no harm. The device was loaned to Zigan for the limited purpose of testing. Zigan was not acting ethically when he used the product for something other than the purpose for which it was loaned. In addition to the ethical aspects of the case, Zigan‘s conduct violated trade secrecy law. Using the Spiral to make copies was an unauthorized use, sufficient to make Zigan liable for damages for misappropriation of trade secrets. One of the policies behind trade secret law is the maintenance of standards of commercial ethics.

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From the viewpoint of social forces, as discussed in Chapter 2, note how the social forces of protection of property and protection from exploitation require that society have laws protecting trade secrets. Students may be asked to look at Figure 2-1 and comment on the complex interactions of social forces, ethics, and the law in the context of this case problem. The development of patent protection, in this case for the benefit of Mineral Deposits Ltd., ensures a monopoly on the manufacture of the product and those who would act as Theodore Zigan did. [Mineral Deposits, Ltd. v. Zigan, 773 P. 2d 609 (Colo.

App.)] 13. The American Geophysical Union and 82 other publishers of scientific and technical journals brought a class-action lawsuit against Texaco, claiming that Texaco‘s unauthorized photocopying of articles from their journals constituted a copyright infringement. Texaco‘s defense was that the copying was fair use under Section 107 of the Copyright Act of 1976. To avoid extensive discovery, the parties agreed to focus on one randomly selected Texaco scientist, Dr. Donald Chickering, who had photocopies of eight articles from the Journal of Catalysis in his files. The trial court judge held that the copying of the eight articles did not constitute fair use, and Texaco appealed. [American Geophysical Union v. Texaco, Inc., 60 F.3d 913 (2d Cir.)] Answer: Fair use in copyright law. Judgment for the publishers. Applying the four statutory standards to determine whether Texaco‘s photocopying of the scientific journal articles was fair use, three of the four factors favor the publishers. The first factor, purpose and character of use, favors the publishers because the purpose of Texaco‘s use was to multiply the number of copies for the benefit of its scientists, which is the same purpose for which additional subscriptions are normally sold. The second factor, the nature of the copyrighted work, which in this case is scientific articles, favors Texaco. The third factor, the amount and substantiality of the portion used, favors the publishers because Texaco copied the works in their entirety. The fourth factor, the effect on the potential market or value of the work, favors the publishers because they have shown substantial harm due to lost licensing revenue and lost subscription revenue. The Aggregate assessment is that the photocopying was not fair use. [American Geophysical Union v. Texaco Inc., 60 F. 3d 913 (2d Cir.)] 14. The Column is a sculpture of 19 stainless steel statues depicting a squad of soldiers on patrol; it is a key part of the Korean War Veterans Memorial on the National Mall in Washington, D.C. The Column was created by sculptor and World War II veteran Frank Gaylord. In January 1996, John Alli, an amateur photographer, visited the Memorial during

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 10: The Legal Environment of International Trade

a heavy snowstorm and photographed The Column. In 2002, the United States Postal Service issued a stamp commemorating the fiftieth anniversary of the Korean War armistice. The Postal Service selected Mr. Alli‘s photograph for the stamp face and paid Mr. Alli a one-time fee of $1,500 for the right to use the photo. The Postal Service did not have permission from Mr. Gaylord to feature his sculpture. Do you think that Gaylord would prevail in a copyright infringement suit? If so, how would you determine damages?

[Gaylord v. United States, 777 F.3d 1363 (Fed. Cir.)] Answer: Copyright infringement; derivative work; damages. The court found that the government was liable to Mr. Gaylord for copyright infringement because it did not have his permission to use his work. The photograph was a derivative of The Column under 17 U.S.C. § 106(2). The court then had to determine the fair market value of a license for Mr. Gaylord‘s work. The court used a hypothetical negotiation between the parties to determine damages. The court considered three categories of infringing goods: (1) stamps used to send mail; (2) commercial merchandise featuring an image of the stamp; and (3) unused stamps purchased by collectors. The parties agreed that no damages would be awarded for stamps used to send mail and that a per-unit royalty was appropriate for the commercial merchandise; a rate of 10% of revenue to produce a merchandise award of $33,000.

The parties disputed the award on the third category—unused stamps. The Postal Service received $5.4 million in revenue on unused stamps, as pure profit (from collectors). The court determined that a 10% per-unit royalty was appropriate to calculate damages for stamps purchased by collectors, awarding Mr. Gaylord $540,000. On appeal, the court affirmed the award. [Gaylord v. United States, 777 F. 3d 1363 (Fed. Cir.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 10: The Legal Environment of International Trade

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 76 Questions and Case Problems ............................................................................................................ 76

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Answers to the End-of-Chapter Questions Questions and Case Problems 1.

How does the selling of subsidized foreign goods in the United States adversely affect free trade?

Answer: Antidumping laws and export subsidies. Subsidized goods of foreign countries are usually sold in the United States at less than their fair market value. The Trade Agreement Act of 1979 permits the United States to respond to such ―dumping‖ by imposing countervailing duties on such goods.

2.

Able Time Inc. imported a shipment of watches into the United States. The watches bore the mark ―TOMMY,‖ which is a registered trademark owned by Tommy Hilfiger. U.S. Customs seized the watches pursuant to the Tariff Act, which authorizes seizure of any ―merchandise bearing a counterfeit mark.‖ Tommy Hilfiger did not make or sell watches at the time of the seizure. Able argued that because Tommy Hilfiger did not make watches at the time of the seizure, the watches it imported were not counterfeit, and the civil penalty imposed by Customs was unlawful. The government argued that the mark was counterfeit and that the Tariff Act does not require the owner of the registered mark to make the same type of goods as those bearing the offending mark. Decide. [U.S. v. Able Time, Inc., 545 F.3d 824 (9th Cir.)] Answer: Counterfeit goods § 5(a). The Tariff Act does not contain an identity of goods or services requirement. Customs may impose a civil penalty pursuant to the Tariff Act upon an importer of merchandise bearing a counterfeit mark, even though the owner of the registered mark does not manufacture or sell the same type of merchandise. The district court‘s order granting Able Time‘s motion for summary judgment was reversed. [U.S. v.

Able Time, Inc., 545 F. 3d 824 (9th Cir.)]

3.

Ronald Sadler, a California resident, owned a helicopter distribution company in West Germany, Delta Avia. This company distributed U.S.-made Hughes civilian helicopters in western Europe. Sadler‘s German firm purchased 85 helicopters from Hughes Aircraft Co. After export licenses were obtained in reliance on the purchaser‘s written assurance that the goods would not be disposed of contrary to the export license, the helicopters were exported to Germany for resale in western Europe. Thereafter, Delta Avia exported them to North Korea, which was a country subject to a trade embargo by the United States. The helicopters were converted to military use. Sadler was charged with violating the Export

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Administration Regulations. In Sadler‘s defense, it was contended that the U.S. regulations have no effect on what occurs in the resale of civilian helicopters in another sovereign country. Decide.

Answer: Criminal sanctions for export administration violations. North Korea is a Country Group 2 and is subject to a trade embargo by the United States. A helicopter has a military application, and it is in the national security interest of the United States not to provide arms to North Korea. Delta Avia‘s statement as to the end-use and end-users of the helicopters was relied on and served as the basis for the issuance of the validated export licenses. Sadler violated the Export Administration regulations by specifying false end-use and end-users. On February 10, 1988, he was sentenced to three years in prison and fined $10,000 for his role in the illegal export of the helicopters.

4.

United Overseas, Ltd. (UOL), is a U.K. firm that purchases and sells manufacturers‘ closeouts in Europe and the Middle East. UOL‘s representative, Jay Knox, used stationery listing a UOL office in New York to solicit business from Revlon, Inc., in New York. On April 1, 1992, UOL faxed a purchase order from its headquarters in England to Revlon‘s New York offices for the purchase of $4 million worth of shampoo. The purchase order on its face listed six conditions, none of which referred to a forum selection clause. When Revlon was not paid for the shampoo it shipped, it sued UOL in New York for breach of contract.

UOL moved to dismiss the complaint because of a forum selection clause, which it stated was on the reverse side of the purchase order and provided that ―the parties hereby agree to submit to the jurisdiction of the English Courts disputes arising out of the contract.‖ The evidence did not show that the reverse side of the purchase order had been faxed with the April 1992 order. Should the court dismiss the complaint based on the ―forum selection clause‖? Read Chapter 29 on letters of credit and advise Revlon how to avoid similar litigation in the future. [Revlon, Inc. v. United Overseas, Ltd., 1994 WL 9657 (S.D.N.Y)] Answer: CISG. The case involves a classic ―battle of the forms‖ issue between merchants. A forum selection clause is a material addition to a contract and although Revlon and UOL had a contract, the addition of the forum selection clause (particularly when not faxed) would not be a part of the contract. The complaint should not be dismissed on the basis of the clause. However, the issue then becomes whether the N.Y. courts can take jurisdiction over UOL. A letter of credit allows the seller to avoid payment hassles by tying shipment and release of the goods to the payment by the bank. Once the seller presents the required documents under the letter of credit terms, payment must be made or the goods can‘t be released. [Revlon, Inc. v. United Overseas, Ltd., 1994 WL 9657 (S.D. N.Y.)]

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5.

Reebok manufactures and sells fashionable athletic shoes in the United States and abroad.

It owns the federally registered Reebok trademark and has registered this trademark in Mexico as well. Nathan Betech is a Mexican citizen residing in San Diego, California, with business offices there. Reebok believed that Betech was in the business of selling counterfeit Reebok shoes in Mexican border towns, such as Tijuana, Mexico. It sought an injunction in a federal district court in California ordering Betech to cease his counterfeiting activity and to refrain from destroying certain documents. It also asked the court to freeze Betech‘s assets pending the outcome of a Lanham Act lawsuit. Betech contended that a U.S. district court has no jurisdiction or authority to enter the injunction for the activities allegedly occurring in Mexico. Decide. [Reebok Int’l, Ltd. v. Marnatech Enterprises, Inc., 970 F.2d 552 (9th Cir.)] Answer: Protection of trademarks from counterfeiting extraterritorial jurisdiction. This district court properly relied on the Timberlane Lumber Co. precedent, a case dealing with the extraterritorial reach of U.S. Antitrust laws, to establish that it had jurisdiction in this case. While the alleged counterfeiting activity took place in Mexico, counterfeit shoes were taken back to the United States regularly by purchasers and the sale of counterfeit shoes decreased the sale of genuine shoes in Mexico. This adversely affected American foreign commerce, and that effect was sufficiently great to be considered an injury under the Lanham Act. The court has inherent equitable powers to freeze assets pending the outcome of Lanham Act litigation. The court determined that Reebok was likely to succeed on the merits of the case, and the defendant might hide its ill-gotten gains if the assets were not frozen. Reebok is entitled to treble damages if successful in its Lanham Act suit.

[Reebok Int'l, Ltd. v. Marnatech Enterprises, Inc., 970 F. 2d 552 (9th Cir.)]

6.

A complaint was filed with the U.S. Commerce Department‘s ITA by U.S. telephone manufacturers AT&T, Comidial Corp., and Eagle Telephones, Inc., alleging that 12 Asian manufacturers of small business telephones, including the Japanese firms Hitachi, NEC, and Toshiba and the Taiwanese firm Sun Moon Star Corp. were dumping their small business phones in the U.S. market at prices that were from 6 percent to 283 percent less than those in their home markets. The U.S. manufacturers showed that the domestic industry‘s market share had dropped from 54 percent in 1985 to 33 percent in 1989. They asserted that it was doubtful if the domestic industry could survive the dumping. Later, in a hearing before the ITC, the Japanese and Taiwanese respondents contended that their domestic industry was basically sound and that the U.S. firms simply had to become more efficient to meet worldwide competition. They contended that the United States was using the procedures before the ITA and ITC as a nontariff barrier to imports. How should the ITC decide the case? [American Telephone and Telegraph Co. v. Hitachi, 6 I.T.C. 1511]

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Answer: Relief mechanisms for economic injuries caused by foreign trade. The ITC decided the matter against the Asian manufacturers. The ITA found that the manufacturers were dumping business phones at LTFV in the U.S. market. The evidence showed that domestic manufacturers lost 21 percent of the domestic market from 1985 to l989. The ITC considered this to be injurious to the domestic industry. Thus, offsetting antidumping duties were assessed against the named foreign manufacturers.

Students may be asked for the pros and cons of allowing all firms, both domestic and foreign, to sell their products in the United States at the prices the individual firms choose.

Under the Trade Agreement Act of 1979, foreign firms may not sell below LTFV if such selling causes injury to the domestic industry. Often the LTFV selling does not cause injury to the domestic industry, and such pricing is therefore legal. The evidence did not show that the United States was using its antidumping laws as a nontariff barrier to imports.

[American Telephone and Telegraph Co. v. Hitachi, 6 ITC 1511] 7.

Tivo‘s Rovi Corporation owns numerous U.S. patents. Comcast had licensing agreements with Rovi to use its patents, but those licenses lapsed in 2016. When Comcast stopped paying licensing fees, Rovi sued to stop the importation of Comcast products that infringed its patents. Which court should decide this case? What remedies would Rovi seek? [Comcast v. ITC, 951 F.3d 1301 (Fed. Cir.)] Answer: Section 337 unfair trade practices regarding import of item infringing patent. As in the TianRui case, the International Trade Commission decided this case. Section 337 prohibits import of products that infringe a valid U.S. patent. The ITC banned import of the digital video receivers and related components. It found that Comcast violated Section 337 of the Tariff Act of 1930. This is just one of several cases in which courts have found that Comcast infringed Rovi‘s patents. The Federal Circuit upheld the ITC‘s findings. Comcast v.

ITC, 951 F.3d 1301(Fed. Cir. 2020). Comcast appealed to the United States Supreme Court arguing that the ITC has exceeded its power. [Comcast v. ITC, 951 F.3d 1301 (Fed. Cir.)]

8.

National Computers, Inc., a U.S. firm, entered into a joint venture with a Chinese computer manufacturing organization, TEC. A dispute arose over payments due the U.S. firm under the joint venture agreement with TEC. The agreement called for disputes to be arbitrated in China, with the arbitrator being chosen from a panel of arbitrators maintained by the Beijing arbitration institution, Cietac. What advantages and disadvantages exist for the U.S. firm under this arbitration arrangement? Advise the U.S. firm on negotiating future arbitration agreements with Chinese businesses.

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Answer: International arbitration. One advantage to National would be that the dispute would be resolved quickly, without the significant expenses associated with pretrial discovery common in judicial proceedings. Also, the decision is usually final and binding on the parties, eliminating the uncertainty and expenses associated with judicial appeals.

On the other hand, the arbitrator will be Chinese, and the attorneys presenting the case must also be Chinese. The Chinese attorneys may not fully understand the nuances of National‘s case; communication problems may occur; and cultural and bias factors may cloud the arbitrator‘s decision. Moreover, no appeal is allowed to Chinese courts. It is suggested that National and TEC concur, as part of any future joint venture agreement, that disputes be arbitrated in a neutral country. For a dispute resolution procedure to work, it must be fair to all parties. Insisting on such a neutral country in all likelihood should not jeopardize the formation of the joint venture.

9.

Sensor, a Netherlands business organization wholly owned by Geosource, Inc., of Houston, Texas, made a contract with C.E.P. to deliver 2,400 strings of geophones to Rotterdam by September 20, 1982. The ultimate destination was identified as the USSR. Thereafter, in June 1982, the president of the United States prohibited shipment to the USSR of equipment manufactured in foreign countries under license from U.S. firms. The president had a foreign policy objective of retaliating for the imposition of martial law in Poland, and he was acting under regulations issued under the Export Administration Act of 1979.

Sensor, in July and August 1982, notified C.E.P. that as a subsidiary of a U.S. corporation, it had to respect the president‘s embargo. C.E.P. filed suit in a district court of the Netherlands asking that Sensor be ordered to deliver the geophones. Decide. [Compagnie Européenne des Pétroles v. Sensor Nederland, 22 I.L.M. 66] Answer: Export controls as instruments of foreign policy. Judgment for C.E.P. Sensor‘s reliance on the American embargo as a defense for not fulfilling its contract is not compatible with international law. While it is the universally accepted rule of international law that in general, it is not permissible for a state to exercise jurisdiction over acts performed outside its borders, an exception exists under the so-called ―nationality principle.‖ The nationality principle allows a state to exercise jurisdiction over the acts of companies outside its borders, when the companies are organized under that state‘s laws.

The nationality of a business entity is determined primarily by the place of the incorporation. Also considered are other links to a particular jurisdiction, including the location of the registered office, accounts and share register; the place where its board meetings are held; and its listings in the tax records of a jurisdiction. Nationality is not determined by who owns or controls the entity. Because Sensor, though owned by a U.S.

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corporation, was a Netherlands business corporation, it did not have to respect the American embargo. [Compagnie Européenne des Pétroles v. Sensor Nederland, 22 ILM 66] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 11: The Nature and Sources of Law

Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 81 Questions and Case Problems ............................................................................................................ 81 End of Chapter: CPA Questions and Answers ................................................................................... 88 Answers to AICPA Questions .............................................................................................................. 89

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

What is a contract?

Answer: Definition of a contract. A contract is a binding agreement. This means that the contract can be enforced, or damages awarded for the breach of the contract. A contract is a set of promises for the breach of which the law gives a remedy.

2.

Fourteen applicants for a city of Providence, Rhode Island, police academy training class each received from the city a letter stating that it was a ―conditional offer of employment‖ subject to successful completion of medical and psychological exams. The 14 applicants passed the medical and psychological exams. However, these applicants were replaced by others after the city changed the selection criteria. Can you identify an offer and acceptance in this case? Can you make out a bilateral or unilateral contract? [Ardito et al. v.

City of Providence, 213 F. Supp. 2d 358 (D.R.I.)] Answer: Unilateral Contract. The letter which conveyed the message that applicants would be admitted to the police academy upon passing the medical and psychological exams was an ―offer‖ to enter a unilateral contract. The ―acceptance‖ occurred when they passed

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the two exams. A binding contract was accordingly formed. The applicants therefore had a legitimate claim of entitlement to admission to the police academy. [Ardito, et al. v. City of Providence, 213 F. Supp. 2d 358 (D. R.I.)] 3.

Compare an implied contract with a quasi contract.

Answer: Implied contracts and quasi contracts. Both implied contracts and quasi contracts share the characteristic that there is no express agreement between the parties. However, in the case of the implied contract, there is a contract that in fact is based on the conduct of the parties. From the conduct, it is clear that the parties have actually agreed, and it is merely a question of how they have communicated or manifested that agreement. In effect, the agreement is expressed by conduct rather than by words.

In the case of the quasi contract, there is no agreement. The contract of the parties does not express or manifest any agreement and in fact ordinarily negates or precludes the existence of an agreement. However, instead of declaring that there is no contractual obligation because there is no binding agreement, the law imposes a duty on one party just as though there had been a contract. In order to make it clear that there is in fact no contract, the obligation is described as a quasi contract.

In summary, an implied contract is a contract based on the actual agreement of the parties, but a quasi contract is a fictional contract that is imposed on a party in order to prevent injustice in a particular situation.

4.

The Jordan Keys law firm represented the Greater Southeast Community Hospital of Washington, D.C., in a medical malpractice suit against the hospital. The hospital was selfinsured for the first $1,000,000 of liability and the St. Paul Insurance Co. provided excess coverage up to $4,000,000. The law firm was owed $67,000 for its work on the malpractice suit when the hospital went into bankruptcy. The bankruptcy court ordered the law firm to release its files on the case to St. Paul to defend under the excess coverage insurance, and the Jordan Keys firm sued St. Paul for its legal fees of $67,000 expended prior to the bankruptcy under an ―impliedin- fact contract‖ because the insurance company would have the benefit of all of its work. Decide. [Jordan Keys v. St. Paul Fire, 870 A.2d 58 (D.C.)] Answer: Implied-in-fact contracts. The requirements for recovery under a contract impliedin-fact are: (1) valuable services were rendered; (2) for the person sought to be charged; (3) which services were accepted by the person sought to be charged, used, or enjoyed by him or her; and (4) under such circumstances as reasonably notified the person sought to

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be charged that the person rendering the services expected to be paid by him or her.

While the law firm may be able to make arguments that the first three elements are present, their [case] lost on the fourth element. When Jordan Keys provided legal services to the hospital, St. Paul insurance was not on notice that the firm expected to be paid by St. Paul. Rather, the firm contracted to be paid by the hospital. No implied agreement exists obligating that [broke] St. Paul insurance pay the law firm. [Jordan Keys v. St. Paul Fire, 870 A. 2d 58 (D.C.)] 5.

Beck was the general manager of Chilkoot Lumber Co. Haines sold fuel to the company.

To persuade Haines to sell on credit, Beck signed a paper by which he promised to pay any debt the lumber company owed Haines. He signed this paper with his name followed by ―general manager.‖ Haines later sued Beck on this promise, and Beck raised the defense that the addition of ―general manager‖ showed that Beck, who was signing on behalf of Chilkoot, was not personally liable and did not intend to be bound by the paper. Was Beck liable on the paper? [Beck v. Haines Terminal and Highway Co., 843 P.2d 1229 (Alaska)] Answer: Form of contract. The form of a signature on a contract controls primary and secondary liability, but not the intent to form a contract. The language used controls, not how a signature appears. Beck may be liable depending upon the signature, but he cannot claim no contract based solely on the form of his signature. [Beck v. Haines Terminal and Highway Co., 843 P. 2d 1229 (Alaska)]

6.

In May 2014, Tony Hardt, as general contractor for a construction project in Liberty Hill, Texas, contracted with Thomas Kam to perform engineering services for the project for a fee of $2,500. Kam did so. Karedia, the owner of the project, paid Hardt $350,000, the entire amount owed under the construction contract. Hardt disappeared without paying the engineer. The engineer, Mr. Kam, sued the owner, Karedia, for unjust enrichment. What defenses, if any, would you raise on behalf of Karedia? Decide. [Kam v. Karedia, 2019 Tex. App. LEXIS 10819] Answer: Unjust enrichment. Kam was not in privity of contract with Karedia and Hardt and cannot sue on their contract. Kam would not succeed on quantum meruit because if an express contract covers the services at issue, recovering under quantum meruit generally is prohibited. Unjust enrichment applies when a person has obtained a benefit by fraud, duress or taking of unfair advantage. ―Unjust enrichment‖ does not apply when a valid, express contract covers the subject matter of the parties‘ dispute—the Karedia-Hardt contract, which the owner fully paid for. [Kam v. Karedia, 2019 WL 6831551 (Tex. App.)]

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7.

Edward Johnson III, the CEO and principal owner of the world‘s largest mutual fund company, Fidelity Investments, Inc., was a longtime tennis buddy of Richard Larson. In 1995, Johnson asked Larson, who had construction experience, to supervise the construction of a house on Long Pond, Mount Desert Island, Maine. Although they had no written contract, Larson agreed to take on the project for $6,700 per month plus lodging.

At the end of the project in 1997, Johnson made a $175,000 cash payment to Larson, and he made arrangements for Larson to live rent-free on another Johnson property in the area called Pray‘s Meadow in exchange for looking after Johnson‘s extensive property interests in Maine. In the late summer of 1999, Johnson initiated a new project on the Long Pond property. Johnson had discussions with Larson about doing this project, but Larson asked to be paid his former rate, and Johnson balked because he had already hired a project manager. According to Johnson, at a later date he again asked Larson to take on the ―shop project‖ as a favor and in consideration of continued rent-free use of the Pray‘s Meadow home. Johnson stated that Larson agreed to do the job ―pro bono‖ in exchange for the use of the house, and Johnson acknowledged that he told Larson he would ―take care‖ of Larson at the end of the project, which could mean as much or as little as Johnson determined. Larson stated that Johnson told him that he would ―take care of ‖ Larson if he would do the project and told him to ―trust the Great Oracle‖ (meaning Johnson, the highly successful businessperson). Larson sought payment in March 2000 and asked Johnson for ―something on account‖ in April. Johnson offered Larson a loan. In August during a tennis match, Larson again asked Johnson to pay him. Johnson became incensed, and through an employee, he ended Larson‘s participation in the project and asked him to vacate Pray‘s Meadow. Larson complied and filed suit for payment for work performed at the rate of $6,700 per month. Did Larson have an express contract with Johnson? What legal theory or theories could Larson utilize in his lawsuit? How would you decide this case if you believed Larson‘s version of the facts? How would you decide the case if you believed Johnson‘s version of the facts? [Larson v. Johnson, 196 F. Supp. 2d 38 (D. Me. 2002)] Answer: Express contracts; implied-in-fact contracts; unjust enrichment. To have an express contract, the terms of the agreement of the parties must be manifested by their words, either spoken or written. To establish a legally binding agreement, the terms must be sufficiently definite to enable the court to determine the meaning and fix exactly the legal liabilities of the parties. Do the phrases "I will take care of you" and "trust the Great Oracle" amount to a commitment to pay Larson a specific amount of money, $6,700 per month? The jury did not find that the above quoted language formed such an express contract. The jury apparently believed the agreement was as expressed by Johnson, that of rent-free housing in exchange for services. Larson's version of the facts does not provide a

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basis for an express commitment to pay $6,700 per month. An implied-in-fact contract would be a possible theory for Larson. A valid implied-in-fact claim consists of (1) services rendered to the defendant by the plaintiff (2) with the knowledge or consent of the defendant and (3) under circumstances that make it reasonable for the plaintiff to expect payment. The first two elements are satisfied. Was it reasonable to expect payment because of Johnson's statements under the third element? The trial judge left this matter up to the jury, and the jury concluded that no additional money was owed Larson above his rent-free housing in Pray's Meadow.

Larson also could pursue an unjust enrichment claim, where there is no contractual relationship between the parties, but the defendant accepts a benefit under such circumstances that it would be unjust to retain the benefit without payment. The jury considered this theory and decided against Larson. The jury apparently believed Johnson's version of the facts, believing that the rent-free housing arrangement was in fact the contractual arrangement for the benefits performed for Johnson by Larson.

As reported in a local newspaper, after the verdict against Larson he stated in part: "I'm not bitter…it's just that I worked for nearly nine months for one of the richest men in the world and didn't get a penny.‖ Larson said he plans to write a book about his experiences with Johnson. [Larson v. Johnson, 196 F. Supp. 2d 38 (D. Me. 2002)] 8.

While Clara Novak was sick, her daughter Janie helped her in many ways. Clara died, and Janie then claimed that she was entitled to be paid for the services she had rendered her mother. This claim was opposed by three brothers and sisters who also rendered services to the mother. They claimed that Janie was barred because of the presumption that services rendered between family members are gratuitous. Janie claimed that this presumption was not applicable because she had not lived with her mother but had her own house. Was Janie correct? [In re Estate of Novak, 398 N.W.2d 653 (Minn. App.)] Answer: Objective intent as essential to contract. No. The services were rendered under circumstances such that a reasonable person would regard them as a gift and not expect to be paid for them.

Accordingly, no contract to compensate for the services would be implied by the law; and because no express contract had been made, no recovery could be allowed. [In re Estate of Novak, 398 N.W. 2d 653 (Minn. App.)]

9.

Dozier and his wife, daughter, and grandson lived in the house Dozier owned. At the

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request of the daughter and grandson, Paschall made some improvements to the house.

Dozier did not authorize these, but he knew that the improvements were being made and did not object to them. Paschall sued Dozier for the reasonable value of the improvements, but Dozier argued that he had not made any contract for such improvements. Was he obligated to pay for such improvements?

Answer: Quasi contracts. Yes. When a homeowner permits repairs to be made with knowledge that they are being made by a stranger who would expect to be paid for such repairs, there is a quasi-contractual duty to pay for the reasonable value of the improvements to avoid the homeowner‘s unjust enrichment at the expense of the person making the repairs.

10. When Harriet went away for the summer, Landry, a house painter, painted her house. He had a contract to paint a neighbor‘s house but painted Harriet‘s house by mistake. When Harriet returned from vacation, Landry billed her for $3,100, which was a fair price for the work. She refused to pay. Landry claimed that she had a quasi-contractual liability for that amount. Was he correct?

Answer: Limitations on quasi-contractual liability. No. Harriet was not liable in quasi contract because she did not know that Landry was painting her house and had done nothing to cause him to paint the house. Therefore, the fact that she benefited by the painting was not regarded as unjust enrichment, and no quasi-contractual liability existed.

11. Margrethe and Charles Pyeatte, a married couple, agreed that she would work so that he could go to law school and that when he finished, she would go back to school for her master‘s degree. After Charles was admitted to the bar and before Margrethe went back to school, the two were divorced. She sued Charles, claiming that she was entitled to quasicontractual recovery of the money that she had paid for Charles‘s support and law school tuition. He denied liability. Was she entitled to recover for the money she spent for Charles‘s maintenance and law school tuition? [Pyeatte v. Pyeatte, 661 P.2d 196 (Ariz.

App.)] Answer: Quasi-contractual liability when the agreement is not binding. Yes. Margrethe had furnished Charles with certain financial benefits in the expectation that she would receive a benefit at some future time. Because of the divorce, she would receive no future benefit. It would be inequitable or unjust to allow Charles to have the benefit of the payments made

by Margrethe without her receiving anything in return. Margrethe could therefore recover the payments in quasi contract. [Pyeatte v. Pyeatte, 661 P. 2d 196 (Ariz. App.)]

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12. Carriage Way was a real estate development of approximately 80 houses and 132 apartments. The property owners were members of the Carriage Way Property Owners Association. Each year, the association would take care of certain open neighboring areas, including a nearby lake, that were used by the property owners. The board of directors of the association would make an assessment or charge against the property owners to cover the cost of this work. The property owners paid these assessments for a number of years and then refused to pay any more. In spite of this refusal, the association continued to take care of the areas in question. The association then sued the property owners and claimed that they were liable for the benefit that had been conferred on them. Were the owners liable? [Board of Directors of Carriage Way Property Owners Ass’n v. Western National Bank, 487 N.E.2d 974 (Ill. App.)] Answer: Rejection of benefit as bar to quasi-contractual liability. No. The owners made it clear to the plaintiff that they did not want a continuation of the benefits; therefore, they could not be required to pay for them when the plaintiff continued to render the services no longer desired. While the property owners benefited by those services, this benefit was not an unjust enrichment when the person providing the benefits knew that they were not wanted and would not be paid for. [Board of Directors of Carriage Way Property Owners Ass'n v. Western National Bank, 487 N.E. 2d 974 (Ill. App.)] 13. When improvements or buildings are added to real estate, the real estate tax assessment is usually increased to reflect the increased value of the property. Frank Partipilo and Elmer Hallman owned neighboring tracts of land. Hallman made improvements to his land, constructing a new building and driveway on the tract. The tax assessor made a mistake about the location of the boundary line between Partipilo‘s and Hallman‘s land and thought the improvements were made on Partipilo‘s property. Instead of increasing the taxes on Hallman‘s land, the assessor wrongly increased the taxes on Partipilo‘s land.

Partipilo paid the increased taxes for three years. When he learned why his taxes had been increased, he sued Hallman for the amount of the increase that Partipilo had been paying.

Hallman raised the defense that he had not done anything wrong and that the mistake had been the fault of the tax assessor. Decide. [Partipilo v. Hallman, 510 N.E.2d 8 (Ill. App.)] Answer: Unjust enrichment. Judgment for Partipilo. Because the improvements were made to Hallman‘s land, Hallman should be the one to pay the tax increase. When Partipilo paid it, Hallman received a benefit to which he was not entitled. This was an unjust enrichment.

Therefore, Partipilo could recover the amount of the increased taxes without regard to the fact that Hallman was free of any fault and that the only fault in the case was the fault of

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the tax assessor. [Partipilo v. Hallman, 510 N.E. 2d 8 (Ill. App.)] 14. When a college student complained about a particular course, the vice president of the college asked the teacher to prepare a detailed report about the course. The teacher did and then demanded additional compensation for the time spent in preparing the report.

He claimed that the college was liable to provide compensation on an implied contract.

Was he correct? [Zadrozny v. City Colleges of Chicago, 581 N.E.2d 44 (Ill. App.)] Answer: Implied contracts. No. The circumstances under which the report was requested and prepared would not make a reasonable person in the position of the teacher believe that the report was being prepared for the benefit of the college and that it would be paid for. A reasonable person would have recognized that the report was being prepared for the teacher‘s own defense and not to benefit the college. [Zadrozny v. City Colleges of Chicago, 581 N.E. 2d 44 (Ill. App.)] 15. Smith made a contract to sell automatic rifles to a foreign country. Because the sale of such weapons to that country was illegal under an act of Congress, the U.S. government prosecuted Smith for making the contract. He raised the defense that because the contract was illegal, it was void and there is no binding obligation when a contract is void; therefore, no contract for which he could be prosecuted existed. Was he correct?

Answer: Contrast between civil law and criminal law. The rule that an illegal contract does not exist (void) is true only as between the parties to the illegal contract. As between the government that declared the contract illegal and the parties making the illegal contract, the law looks only at the fact that the contract was made. The fact is not erased, even though no one can enforce the contract because it‘s illegal. Smith is liable for making the contract under the criminal law. Note, however, that the contract, although legally formed, is void. [return to top] End of Chapter: CPA Questions and Answers Correct answer in boldface.

1.

Kay, an art collector, promised Hammer, an art student, that if Hammer could obtain certain rare artifacts within two weeks, Kay would pay for Hammer‘s postgraduate education. At considerable effort and expense, Hammer obtained the specified artifacts

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 12: Formation of Contracts: Offer and Acceptance

within the two-week period. When Hammer requested payment, Kay refused. Kay claimed that there was no consideration for the promise. Hammer would prevail against Kay based on: a.

Unilateral contract

b.

Unjust enrichment

c.

Public policy

d.

Quasi contract

[return to top] Answers to AICPA Questions 1. Kay, an art collector, promised Hammer, an art student, that if Hammer could obtain certain rare artifacts within two weeks, Kay would pay for Hammer‘s postgraduate education. At considerable effort and expense, Hammer obtained the specified artifacts within the twoweek period. When Hammer requested payment, Kay refused. Kay claimed that there was no consideration for the promise. Hammer would prevail against Kay based on: a.

Unilateral contract

b.

Unjust enrichment

c.

Public policy

d.

Quasi contract

(a) The offeror made a promise for an act. When the act was performed, a unilateral contract was created, and the offeror is bound to pay. Answer (b) is incorrect because unjust enrichment is generally considered only if there was no contract and the court wishes to provide an ―equitable solution.‖ Answer (c) is incorrect because there are no public policy issues involved. Answer (d) is incorrect because a quasicontract arises only if there was no contract to begin with and the law implies one to prevent an unjust enrichment. Since there was a unilateral contract, there can be no quasi-contract. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 12: Formation of Contracts: Offer and Acceptance

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Table of Contents Answers to the End-of-Chapter Questions ........................................................................................................ 90 Questions and Case Problems ............................................................................................................ 90 End of Chapter: CPA Questions and Answers ................................................................................... 97 Answers to AICPA Questions .............................................................................................................. 98

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Bernie and Phil‘s Great American Surplus store placed an ad in the Sunday Times stating, ―Next Saturday at 8:00 a.m. sharp, 3 brand new mink coats worth $5,000 each will be sold for $500 each! First come, first served.‖ Marsha Lufklin was first in line when the store opened and went directly to the coat department, but the coats identified in the ad were not available for sale. She identified herself to the manager and pointed out that she was first in line in conformity with the store‘s advertised offer and that she was ready to pay the $500 price set forth in the store‘s offer. The manager responded that a newspaper ad is just an invitation to negotiate and that the store decided to withdraw ―the mink coat promotion.‖ Review the text on unilateral contracts in the section titled ―Bilateral and Unilateral Contracts‖ in Chapter 11. Decide.

Answer: Newspaper ads—invitation to negotiate. While newspaper ads generally are considered invitations to negotiate, this ad was specifically constructed to invite an offeree to take specific action, be among the first three customers in line in order to qualify to purchase the coat. One reason why newspaper ads are considered invitations to negotiate is that a merchant cannot possibly have sufficient goods to supply all person who might see the ad with the item in question. Since the number of coats available are specified at 3, overacceptance is not at issue. A unilateral contract was formed when Marsha was first in line and offered payment for the coat. This case problem was developed from the classic case of Lefkowitz v. Great Minneapolis Surplus Store, 86 N.W.2d 689 (Minn. 1957).

2.

Brown made an offer to purchase Overman‘s house on a standard printed form.

Underneath Brown‘s signature was the statement: ―ACCEPTANCE ON REVERSE SIDE.‖ Overman did not sign the offer on the back but sent Brown a letter accepting the offer.

Later, Brown refused to perform the contract, and Overman sued him for breach of contract. Brown claimed there was no contract because the offer had not been accepted in the manner specified by the offer. Decide. [Overman v. Brown, 372 N.W.2d 102 (Neb.)]

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Answer: Acceptance; intent to contract. The parties clearly intended to contract, and a contract can be evidenced by papers grouped together; it need not all be on one form. ―ACCEPTANCE ON REVERSE SIDE‖ does not convey a mandatory condition, but rather only a convenient method for acceptance. The letter accomplishes the same purpose.

[Overman v. Brown, 372 N.W.2d 102 (Neb.)] 3.

Katherine mailed Paul an offer with definite and certain terms and that was legal in all respects stating that it was good for 10 days. Two days later she sent Paul a letter by certified mail (time stamped by the Postal Service at 1:14 p.m.) stating that the original offer was revoked. That evening Paul e-mailed acceptance of the offer to Katherine. She immediately phoned him to tell him that she had revoked the offer that afternoon, and that he would surely receive it in tomorrow‘s mail. Was the offer revoked by Katherine?

Answer: Communication of revocation. No. A revocation is not effective until it is communicated to the offeree. In the case of a mailed revocation, this requires actual receipt by the offeree of the revoking letter. Unlike a letter of acceptance, the letter of revocations is not effective when mailed.

4.

Nelson wanted to sell his home. Baker sent him a written offer to purchase the home.

Nelson made some changes to Baker‘s offer and wrote him that he, Nelson, was accepting the offer as amended. Baker notified Nelson that he was dropping out of the transaction.

Nelson sued Baker for breach of contract. Decide. What social forces and ethical values are involved? [Nelson v. Baker, 776 S.W.2d 52 (Mo. App.)] Answer: Counteroffer by offeree. Judgment for Baker. When Nelson made changes to Baker‘s offer, his action had the effect of rejecting the offer and proposing a counteroffer to Baker, even though Nelson purported to be accepting the original offer. Baker was not willing to buy under the terms stated by Nelson. This decision involves the social forces of freedom of personal action and enforcement of intent. It also involves the ethical value of fairness. You may wish to discuss Uniform Commercial Code § 2-207, under which it could be possible for a contract to arise between parties based on the original terms of the offer, with additional terms added by the offeree. [Nelson v. Baker, 776 S.W.2d 52 (Mo. App.)]

5.

While riding her motorcycle Amy Kemper was struck by a vehicle driven by Brown. She suffered serious injuries and Brown was charged with DUI. Kemper sent a demand letter to Brown‘s insurance claim‘s administrator Statewide, which stated in part:

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Please send all the insurance money that Mr. Brown had under his insurance policy. In exchange, I will agree to sign a limited release.

The release must not have any language saying that I will have to pay Mr. Brown or his insurance company any of their incurred costs. …If you fail to meet my demand, I will be forced to hire an attorney and sue Mr. Brown and your company. Please do not contact me, or my friends[,] as this demand is very simple.

Statewide sent a letter to Kemper agreeing to settle her claims for the limits of Brown‘s liability insurance. Attached to the letter was a $25,000 check and a two-page limited liability release form. The letter stated in part, [i]n concluding the settlement, we are entrusting that you place money in an escrow account in regards to any and all liens pending, This demand is being asserted to protect the lien’s interest[.]

Ms. Kemper rejected Statewide‘s ―counteroffer‖ and filed suit. Brown filed a motion to enforce the ―settlement agreement.‖ Decide. [Kemper v. Brown, 754 S.E.2d 141 (Ga. App.)] Answer: Counteroffer by Offeree. Judgment for Kemper. To establish a contract the offer must be accepted unequivocally and without variance of any sort. Statewide demanded that Kemper place the settlement funds into an escrow account to protect against any pending liens. Its response was a counteroffer rather than an unconditional and unequivocal acceptance. No binding settlement agreement was formed. [Kemper v. Brown, 754 S.E.2d 141 (Ga. App.)] 6.

Willis Music Co. advertised a television set at $22.50 in the Sunday newspaper. Ehrlich ordered a set, but the company refused to deliver it on the grounds that the price in the newspaper ad was a mistake. Ehrlich sued the company. Was it liable? Why or why not?

[Ehrlich v. Willis Music Co, 113 N.E.2d 252 (Ohio App.)] Answer: Invitation to negotiate. No. Apart from the question of whether there had been a mistake or the question of the effect of a mistake, 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. [Ehrlich v. Willis Music Co., 113 N.E.2d 252 (Ohio App.)]

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7.

When a movement was organized to build Charles City College, Hauser and others signed pledges to contribute to the college. At the time of signing, Hauser inquired what would happen if he should die or be unable to pay. The representative of the college stated that the pledge would then not be binding and that it was merely a statement of intent. The college failed financially, and Pappas was appointed receiver to collect and liquidate the assets of the college corporation. He sued Hauser for the amount due on his pledge.

Hauser raised the defense that the pledge was not a binding contract. Decide. What ethical values are involved? [Pappas v. Hauser, 197 N.W.2d 607 (Iowa)] Answer: Contractual intent. Judgment for Hauser. The statements of the representative of the college made it clear that Hauser‘s pledge had not been intended by the parties as a binding contract.

The case involves the ethical values of promise keeping, truthfulness, and fairness.

Questions for student discussion might include the following: Was the pledge solicitor being truthful in representing the pledge as a mere statement of intent? Did Hauser regard his pledge as merely a declaration of intent only if he should die or be unable to pay? Apparently, nothing was said at the time of the solicitation of the pledge with respect to the college‘s failure. Is the decision fair from the standpoint of Hauser? Is the decision fair from the standpoint of the unpaid creditors of the college? [Pappas v. Hauser, 197 N.W.2d 607 (Iowa)]

8.

Maria Cantu was a special education teacher under a one-year contract with the San Benito School district for the 1990–1991 school year. On Saturday, August 18, just weeks before fall-term classes were to begin, she hand delivered a letter of resignation to her supervisor. Late Monday afternoon the superintendent put in the mail a properly stamped and addressed letter to Cantu accepting her offer of resignation. The next morning at 8:00, before the superintendent‘s letter reached her, Cantu hand delivered a letter withdrawing her resignation. The superintendent refused to recognize the attempted rescission of the resignation. Decide. [Cantu v. Central Education Agency, 884 S.W.2d 563 (Tex. App.)] Answer: Mailbox rule. The resignation became binding when the acceptance of the resignation was mailed. The fact that the offer to resign had been delivered by hand did not require that the offer be accepted by a hand delivery of the acceptance. The use of mail was reasonable under the circumstances, and therefore the mailing of the acceptance made it effective. [Cantu v. Central Education Agency, 884 S.W. 2d 563 (Tex. App.)]

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9.

A. H. Zehmer discussed selling a farm to Lucy. After a 40-minute discussion of the first draft of a contract, Zehmer and his wife, Ida, signed a second draft stating: ―We hereby agree to sell to W. O. Lucy the Ferguson farm complete for $50,000 title satisfactory to buyer.‖ Lucy agreed to purchase the farm on these terms. Thereafter, the Zehmers refused to transfer title to Lucy and claimed they had made the contract for sale as a joke. Lucy brought an action to compel performance of the contract. The Zehmers claimed there was no contract. Were they correct? [Lucy v. Zehmer, 84 S.E.2d 516 (Va. App.)] Answer: Existence of contractual intent. There was a binding contract. Because it appeared to a reasonable person, 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. [Lucy v. Zehmer, 84 S.E.2d 516 (Va. App.)]

10. Wheeler operated an automobile service station, which he leased from W. C. Cornitius, Inc. The lease ran for three years. Although the lease did not contain any provision for renewal, it was in fact renewed six times for successive three-year terms. The landlord refused to renew the lease for a seventh time. Wheeler brought suit to compel the landlord to accept his offer to renew the lease. Decide. [William C. Cornitius, Inc. v. Wheeler, 556 P.2d 666 (Or.)] Answer: Unconscionability; formation. The court held that there was no obligation to renew the lease and the absence of a renewal clause in the lease was not unconscionable.

Where lessee had leased service station from lessor under series of three-year leases, with changes only in rental terms, but there was no lease provision which entitled lessee to such periodic renewal, following lessor's sale of service station and assurances made by lessor and purchaser of station that sale of station would not result in change in business practice or business relationships, purchaser of station was not obligated to renew lease on reasonable terms.

Although periodic renewals of a lease may give rise to expectations by the tenant that renewal is likely in the future, this is insufficient to create an obligation to renew. [William C. Cornitius, Inc. v. Wheeler, 556 P.2d 666 (Or.)] 11. Buster Cogdill, a real estate developer, made an offer to the Bank of Benton to have the bank provide construction financing for the development of an outlet mall, with funds to

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be provided at prime rate plus two percentage points. The bank‘s president Julio Plunkett thanked Buster for the proposal and said, ―I will start the paperwork.‖ Did Cogdill have a contract with the Bank of Benton? [Bank of Benton v. Cogdill, 454 N.E.2d 1120 (Ill. App.)] Answer: Necessity of clear intention to accept. No. There was no acceptance of Cogdill‘s offer because there was no clear statement that the offer was being accepted. There was no acceptance when the offeree stated that I would ―start the paperwork,‖ as this could have meant that (a) the offer was accepted by the offeree or (b) the offeree was not acting on the offer, but was interested in it and would undertake the various investigations necessary to make a decision. [Bank of Benton v. Cogdill, 454 N.E.2d 1120 (Ill. App.)] 12. Ackerley Media Group, Inc., claimed to have a three-season advertising Team Sponsorship Agreement (TSA) with Sharp Electronics Corporation to promote Sharp products at all Seattle Supersonics NBA basketball home games. Sharp contended that a valid agreement did not exist for the third season (2000–2001) because a material price term was missing, thus resulting in an unenforceable ―agreement to agree.‖ The terms of the TSA for the 2000–2001 third season called for a base payment of $144,200 and an annual increase ―not to exceed 6% [and] to be mutually agreed upon by the parties.‖ No ―mutually agreed‖ increase was negotiated by the parties. Ackerley seeks payment for the base price of $144,200 only. Sharp contends that since no price was agreed upon for the season, the entire TSA is unenforceable, and it is not obligated to pay for the 2000–2001 season. Is Sharp correct? [Ackerley Media Group, Inc. v. Sharp Electronics Corp., 170 F. Supp. 2d 445 (S.D.N.Y.)] Answer: Definiteness; agreement to make a contract at a future date. Sharp is incorrect in its assertion that no price was mutually agreed upon. A base price of $144,200 had been agreed upon in the TSA. The parties were unable to agree on the amount set forth in the escalator clause not to exceed a 6 percent increase. No increase over the base price was thus in order. Sharp's position that a material price term was missing making the contract unenforceable is devoid of merit. [Ackerley Media Group, Inc. v. Sharp Electronics Corp.,170 F.Supp.2d 445 (S.D. N.Y.)] 13. L. B. Foster invited Tie and Track Systems Inc. to submit price quotes on items to be used in a railroad expansion project. Tie and Track responded by e-mail on August 11, 2006, with prices for 9 items of steel ties. The e-mail concluded, ―The above prices are delivered/Terms of Payment—to be agreed/ Delivery—to be agreed/We hope you are successful with your bid. If you require any additional information please call.‖ Just 3 of the 9 items listed in Tie and Track‘s price quote were ―accepted‖ by the project. L. B. Foster

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demanded that Tie and Track provide the items at the price listed in the quote. Tie and Track refused. L. B. Foster sued for breach of contract. Did the August 11 e-mail constitute an offer, acceptance of which could bind the supplier to a contract? If so, was there a valid acceptance? [L. B. Foster v. Tie and Track Systems, Inc., 2009 WL 900993 (N.D. Ill.)] Answer: Price quotes as offers [§ 12]; nature of acceptance [§13]. The price quotation e-mail lacked essential payment and delivery terms and could not have induced the bidder to reasonably believe that its acceptance could bind the supplier to a contract. Moreover, even if the e-mail had been an offer, no contract was formed because the bidder did not accept the offer‘s terms when it purported to accept only three items; the bidder instead made a counteroffer that the supplier rejected. [L.B. Foster v. Tie and Track Systems, Inc., 2009 WL 900993 (N.D. Ill.)] 14. On August 15, 2003, Wilbert Heikkila signed an agreement with Kangas Realty to sell eight parcels of Heikkila‘s property. On September 8, 2003, David McLaughlin met with a Kangas agent who drafted McLaughlin‘s offer to purchase three of the parcels. McLaughlin signed the offer and gave the agent checks for each parcel. On September 9 and 10, 2003, the agent for Heikkila prepared three printed purchase agreements, one for each parcel. On September 14, 2003, David‘s wife, Joanne McLaughlin, met with the agent and signed the agreements. On September 16, 2003, Heikkila met with his real estate agent. Writing on the printed agreements, Heikkila changed the price of one parcel from $145,000 to $150,000, the price of another parcel from $32,000 to $45,000, and the price of the third parcel from $175,000 to $179,000. Neither of the McLaughlins signed an acceptance of Heikkila‘s changes to the printed agreements before Heikkila withdrew his offer to sell. The McLaughlins learned that Heikkila had withdrawn his offer on January 1, 2004, when the real estate agent returned the checks to them. Totally shocked at Heikkila‘s conduct, the McLaughlins brought action to compel specific performance of the purchase agreement signed by Joanne McLaughlin on their behalf. Decide. [McLaughlin v. Heikkila, 697 N.W.2d 231 (Minn. App.)] Answer: Rejection, counteroffer, revocation. The purchase and sale agreements signed by Joanne McLaughlin were offers, even though they were drafted by the seller‘s real estate agent. Heikkila‘s alteration of the purchase agreements constituted a rejection of the offers and served as counteroffers. Although a long period of time transpired between September 2003 and January 2004, Heikkila withdrew the counteroffers before the McLaughlins provided written acceptance, as Heikkila was entitled to do. An offeror may withdraw an offer prior to acceptance.

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This case is an example of the ―mirror image rule‖ in analyzing acceptance as offers. Under this rule, an acceptance must be coextensive with the offer and may not introduce additional terms or conditions. Only a written acceptance by the McLaughlins of the written terms proposed by Heikkila on the purchase agreements would have created a binding contract for the sale of the land. [McLaughlin v. Heikkila, 697 N.W.2d 231 (Minn.

App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Able Sofa, Inc., sent Noll a letter offering to sell Noll a custom-made sofa for $5,000. Noll immediately sent a telegram to Able purporting to accept the offer. However, the telegraph company erroneously delivered the telegram to Abel Soda, Inc. Three days later, Able mailed a letter of revocation to Noll, which was received by Noll. Able refused to sell Noll the sofa. Noll sued Able for breach of contract. Able: a.

Would have been liable under the deposited acceptance rule only if Noll had accepted by mail.

2.

b.

Will avoid liability since it revoked its offer prior to receiving Noll‘s acceptance.

c.

Will be liable for breach of contract.

d.

Will avoid liability due to the telegraph company‘s error (Law, #2, 9911).

On September 27, Summers sent Fox a letter offering to sell Fox a vacation home for $150,000. On October 2, Fox replied by mail agreeing to buy the home for $145,000.

Summers did not reply to Fox. Do Fox and Summers have a binding contract? a.

No, because Fox failed to sign and return Summers‘s letter.

b.

No, because Fox’s letter was a counteroffer.

c.

Yes, because Summers‘s offer was validly accepted.

d.

Yes, because Summers‘s silence is an implied acceptance of Fox‘s letter (Law, #2, 0462).

3.

On June 15, Peters orally offered to sell a used lawn mower to Mason for $125. Peters specified that Mason had until June 20 to accept the offer. On June 16, Peters received an offer to purchase the lawn mower for $150 from Bronson, Mason‘s neighbor. Peters accepted Bronson‘s offer. On June 17, Mason saw Bronson using the lawn mower and was told the mower had been sold to Bronson. Mason immediately wrote to Peters to accept

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the June 15 offer. Which of the following statements is correct? a.

Mason‘s acceptance would be effective when received by Peters.

b.

Mason‘s acceptance would be effective when mailed.

c.

Peters’s offer had been revoked and Mason’s acceptance was ineffective.

d.

Peters was obligated to keep the June 15 offer open until June 20 (Law, #13, 3095).

[return to top] Answers to AICPA Questions 1.

Able Sofa, Inc., sent Noll a letter offering to sell Noll a custom-made sofa for $5,000. Noll immediately sent a telegram to Able purporting to accept the offer. However, the telegraph company erroneously delivered the telegram to Abel Soda, Inc. Three days later, Able mailed a letter of revocation to Noll, which was received by Noll. Able refused to sell Noll the sofa. Noll sued Able for breach of contract. Able: a.

Would have been liable under the deposited acceptance rule only if Noll had accepted by mail.

b.

Will avoid liability since it revoked its offer prior to receiving Noll‘s acceptance.

c.

Will be liable for breach of contract.

d.

Will avoid liability due to the telegraph company‘s error (Law, #2, 9911).

(c) If sent by a mode of communication expressly or impliedly authorized by the offeror (e.g., mail or telegram), acceptance of an offer is normally effective on dispatch, even if subsequently delayed or lost. Noll‘s telegram was an effective acceptance of the offer by Able. The rule applies to any situation in which acceptance is made in a manner expressly or impliedly authorized. This can include telegraph or telephone as well as mail in most circumstances. In this situation the acceptance was effective on dispatch, before Able‘s attempted revocation.

2.

On September 27, Summers sent Fox a letter offering to sell Fox a vacation home for $150,000. On October 2, Fox replied by mail agreeing to buy the home for $145,000.

Summers did not reply to Fox. Do Fox and Summers have a binding contract? a.

No, because Fox failed to sign and return Summers‘s letter.

b.

No, because Fox’s letter was a counteroffer.

c.

Yes, because Summers‘s offer was validly accepted.

d.

Yes, because Summers‘s silence is an implied acceptance of Fox‘s letter (Law, #2, 0462).

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 13: Capacity and Genuine Assent

(b) Common law applies to this contract because it involves real estate. In this situation, Fox‘s reply on October 2 is a counteroffer and terminates Summers‘ original offer made on September 27. The acceptance of an offer must conform exactly to the terms of the offer under common law. By agreeing to purchase the vacation home at a price different from the original offer, Fox is rejecting Summers‘ offer and is making a counteroffer. Answer (a) is incorrect because the fact that Fox failed to return Summers‘ letter is irrelevant to the formation of a binding contract. Fox‘s reply constitutes a counteroffer as Fox did not intend to accept Summers‘ original offer.

Answer (c) is incorrect because Summers‘ offer was rejected by Fox‘s counteroffer.

Answer (d) is incorrect because with rare exceptions, silence does not constitute acceptance.

3.

On June 15, Peters orally offered to sell a used lawn mower to Mason for $125. Peters specified that Mason had until June 20 to accept the offer. On June 16, Peters received an offer to purchase the lawn mower for $150 from Bronson, Mason‘s neighbor. Peters accepted Bronson‘s offer. On June 17, Mason saw Bronson using the lawn mower and was told the mower had been sold to Bronson. Mason immediately wrote to Peters to accept the June 15 offer. Which of the following statements is correct? a.

Mason‘s acceptance would be effective when received by Peters.

b.

Mason‘s acceptance would be effective when mailed.

c.

Peters’s offer had been revoked and Mason’s acceptance was ineffective.

d.

Peters was obligated to keep the June 15 offer open until June 20 (Law, #13, 3095).

(c) Peters‘ offer had been revoked. Since revocation notice can be received either directly or indirectly, Mason, in effect, received the revocation notice when he was told the mower had been sold to Bronson; and therefore, Mason‘s acceptance was ineffective, even though the specified time of the oral contract had not expired.

Peters‘ offer had been revoked prior to Mason‘s acceptance. There was no obligation on the part of Peters to keep the offer open since there was no consideration for him to do so. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 13: Capacity and Genuine Assent

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Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 100 Questions and Case Problems .......................................................................................................... 100 End of Chapter: CPA Questions and Answers ................................................................................. 109 Answers to AICPA Questions ............................................................................................................ 109

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Lester purchased a used automobile from MacKintosh Motors. He asked the seller if the car had ever been in a wreck. The MacKintosh 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 been no wreck. When Lester learned the truth, he sued MacKintosh Motors and the salesperson for damages for fraud. They raised the defense that the salesperson did not know the statement was false and had not intended to deceive Lester. Did the conduct of the salesperson constitute fraud?

Answer: Mental state necessary to 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. This reckless indifference as to the truth of a statement satisfies the mental state element of fraud. The salesperson was therefore guilty of fraud.

2.

Helen, age 17, wanted to buy a Harley-Davidson ―Sportster‖ motorcycle. She did not have the funds to pay cash but persuaded the dealer to sell the cycle to her on credit. The dealer did so partly because Helen said that she was 22 and showed the dealer an identification card that falsely stated her age as 22. Helen drove the motorcycle away. A few days later, she damaged it and then returned it to the dealer and stated that she disaffirmed the contract because she was a minor. The dealer said that she could not because (1) she had misrepresented her age and (2) the motorcycle was damaged. Can she avoid the contract?

Answer: Avoidance of minor’s contract after damage to consideration; effect of

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misrepresentation of age. Yes. In a state that follows the common law rule, neither the damage to the property nor Helen‘s misrepresentation of her age will prevent her from avoiding the contract. Some states would hold that because of the misrepresentation of age, Helen must pay for the damage that she has done, but she can avoid the contract. A few states would hold that Helen cannot avoid the contract because she misrepresented her age.

3.

Paden signed an agreement dated May 28 to purchase the Murrays‘ home. The Murrays accepted Paden‘s offer the following day, and the sale closed on June 27. Paden and his family moved into the home on July 14, 1997. Paden had the home inspected prior to closing. The report listed four minor repairs needed by the home, the cost of which was less than $500. Although these repairs had not been completed at the time of closing, Paden decided to go through with the purchase. After moving into the home, Paden discovered a number of allegedly new defects, including a wooden foundation, electrical problems, and bat infestation. The sales agreement allowed extensive rights to inspect the property. The agreement provided: Buyer . . . shall have the right to enter the property at Buyer’s expense and at reasonable times … to thoroughly inspect, examine, test, and survey the Property…. Buyer shall have the right to request that Seller repair defects in the Property by providing Seller within 12 days from Binding Agreement Date with a copy of inspection report(s) and a written amendment to this agreement setting forth the defects in the report which Buyer requests to be repaired and/or replaced. . . . If Buyer does not timely present the written amendment and inspection report, Buyer shall be deemed to have accepted the Property ―as is.‖ Paden sued the Murrays for fraudulent concealment and breach of the sales agreement. If Mr. Murray told Paden on May 26 that the house had a concrete foundation, would this be fraud? Decide. [Paden v. Murray, 523 S.E.2d 75 (Ga. App.)] Answer: Nondisclosure; fraudulent concealment; fraud. The initial fact pattern does not fit any of the exceptions to the general rule of nonliability for non-disclosure. There was no serious defect unlikely to be discovered by Paden and no "active concealment" nondisclosure. Rather the sales contract called for Paden to examine the property, and since Paden did not identify these defects in the written report to the seller, as required by the sales agreement, he took the property "as is". Moreover, with regard to the existence of a wooden foundation, electrical problems, and bat infestation, these defects could have easily been discerned by Paden upon a diligent inspection of the property prior to closing.

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Were Mr. Murray to have stated the home had a concrete foundation prior to the sale when the foundation was actually made of wood, such may not have amounted to fraud even though such a statement was a material misstatement of fact. A key element of fraud is "reliance", and such may have been missing in this case, if a reasonable inspector would be expected to discover and report such a defect. The sales agreement called for inspection or to take the property "as is". Paden had the home inspected for any defects and accepted the house as inspected. Paden relied on the inspection report when he closed on the sale and not on any statements by Murray. If a wooden foundation were not considered a defect by reasonable inspectors, the statement would amount to fraud, however. [Paden v. Murray, 523 S.E. 2d 75 (Ga. App.)] 4.

Wilcox Manufacturing Group, Inc. did business under the name of Superior Automation Co., and Howard Wilcox served as Superior‘s president. As part of a loan ―lease agreement‖ of $50,000 executed on December 5, 2000, Superior was to repay Marketing Services of Indiana (MSI) $67,213.80 over the course of 60 months. Wilcox gave a personal guarantee for full and prompt payment. Wilcox had been a patient of psychiatrist Dr. Shaun Wood since May 21, 1999, and was diagnosed as suffering from bipolar disorder during the period from June 2000 to January 2001. On June 9, 2000, Wilcox told Dr. Wood he was having problems functioning at work, and Dr. Wood determined that Wilcox was experiencing lithium toxicity, which lasted for 10 months, during which time he suffered from impaired cognitive functions that limited his capacity to understand the nature and quality of his actions and judgments. Superior made monthly payments through to October 28, 2003, and the balance owed at that time was $33,031.37. MSI sued Wilcox personally and the corporation for breach of contract. The defendants raised the defense of lack of capacity and contended that they were not liable on the loan signed by the corporate president when he was incapacitated. Decide. [Wilcox Manufacturing, Inc. v.

Marketing Services of Indiana, Inc. 832 N.E.2d 559 (Ind. App.)] Answer: Effect of Incompetency. Judgement for MSI. The acts or deeds of a person of unsound mind whose condition has not been judicially ascertained and who is not under guardianship are voidable and not absolutely void. The acts are subject to ratification or disaffirmance on removal of the disability. The latest Wilcox could have been experiencing the effects of lithium toxicity was October 2001. Wilcox thus regained his capacity by that date. No attempt was made to disaffirm the contract. Rather, monthly payments continued to be made for a year and one-half before the payments ceased. The contract was thus ratified by the conduct of the president of Superior after he recovered his ability to understand the nature of the contract. [Wilcox Manufacturing, Inc. v. Marketing Services of

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Indiana, Inc., 832 N.E.2d 559 (Ind. App.)] 5.

Thomas Bell, a minor, went to work in the Pittsburgh beauty parlor of Sam Pankas and agreed that when he left the employment, he would not work in or run a beauty parlor business within a 10-mile radius of downtown Pittsburgh for a period of two years.

Contrary to this provision, Bell and another employee of Pankas‘s opened a beauty shop three blocks from Pankas‘s shop and advertised themselves as Pankas‘s former employees.

Pankas sued Bell to stop the breach of the noncompetition, or restrictive, covenant. Bell claimed that he was not bound because he was a minor when he had agreed to the covenant. Was he bound by the covenant? [Pankas v. Bell, 198 A.2d 312 (Pa.)] Answer: Contracts that minors cannot avoid. Bell could avoid his contract of employment and free himself from the obligation of working for Pankas. This right is given to the minor to protect him. However, the minor should not be allowed to exercise his right in such a way as to harm Pankas. Therefore, he would not be allowed to compete with Pankas.

[Pankas v. Bell, 198 A. 2d 312 (Pa.)]

6.

Aldrich and Co. sold goods to Donovan on credit. The amount owed grew steadily, and finally Aldrich refused to sell any more to Donovan unless Donovan signed a promissory note for the amount due. Donovan did not want to but signed the note because he had no money and needed more goods. When Aldrich brought an action to enforce the note, Donovan claimed that the note was not binding because it had been obtained by economic duress. Was he correct? [Aldrich & Co. v. Donovan, 778 P.2d 397 (Mont.)]

Answer: What constitutes economic duress. No. Aldrich had a right to insist on execution of the note to protect his claim. The fact that Donovan felt compelled to sign the note was a result of Donovan‘s own financial circumstances and not the result of undue economic duress created by Aldrich. [Aldrich & Co. v. Donovan, 778 P. 2d 397 (Mont.)]

7.

Francesco and Jane Secchi, the owners of Italian Cowboy Partners, Ltd., leased a building from Prudential Insurance Co. through the property management director Fran Powell, who told the Secchis the building never had any problems and was a perfect restaurant site. The lease contained the following language: Tenant acknowledges that neither Landlord nor Landlord’s agents, employees or contractors have made any representations or promises with respect to the Site, the Shopping Center or this lease except as expressly set forth herein.

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When a sewer gas smell could not be remedied, the Secchis closed the restaurant. The manager of the restaurant that previously leased the building told the Secchis that the property manager herself had personally experienced a sewer gas odor in the prior tenant‘s restaurant she described as ―almost unbearable‖ and ―ungodly.‖ The Secchis sued Prudential for fraud. Prudential defended that the lease disclaimed any reliance. Decide.

[Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am. 341 S.W.3d 323, (Tex.)] Answer: Justified Reliance on Statements of Property Manager. In a split decision of the Texas Supreme Court, it determined that the contract language was not a disclaimer of reliance to negate the ―justifiable reliance‖ element of a fraud claim. The court determined that the property manager‘s representations to the future tenant that the building was problem free; no problems had been experienced by the prior tenant; and the building was a perfect restaurant site were false statements of fact known to be false when made.

The Texas Court of Appeals had held that the lease disclaimed any reliance. Under the Texas Supreme Court decision, it now requires the contracting parties to disclaim reliance only by ―clear and unequivocal‖ language. To do so in this case, would the following additional language protect the landlord? ―Tenant acknowledges that landlord and its agents, employees or contractors made no warranty whatsoever regarding the functioning of the kitchen and building, its structure, ventilation, drains, stoves, and appliances.‖ Would you be willing to lease a building under such terms? [Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323 (Tex.)] 8.

Willingham proposed to obtain an investment property for the Tschiras at a ―fair market price,‖ lease it back from them, and pay the Tschiras a guaranteed return through a management contract. Using a shell corporation, The Wellingham Group bought a commercial property in Nashville for $774,000 on December 14, and the very same day sold the building to the Tschiras for $1,985,000. The title insurance policy purchased for the Tschiras property by Willingham was for just $774,000. Willingham believes that the deal was legitimate in that they ―guaranteed‖ a return on the investment. The Tschiras disagree. In a lawsuit against Willingham, what theory will the Tschiras rely on? Decide.

[Tschiras v. Willingham, 133 F.3d 1077 (6th Cir.)] Answer: Fraud. The Tschiras‘ relied on Willingham‘s statement that he would obtain an investment property at a ―fair market price‖. The fair market price was $774,000 as determined by the price paid by Willingham on the initial purchase; as well as the actual dollar value of the title insurance placed on the sale to the Tschiras. The statement was thus a material misrepresentation of fact, because a jury could conclude that they actually

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paid $1,214,000 over the fair market price of the property. The Tschiras relied on the representations and suffered damages as a result of that reliance. Punitive damages of $1,750,000 were assessed in addition to actual damages. [Tschiras v. Willingham, 133 F. 3d 1077 (6th Cir.)] 9.

Blubaugh was a district manager of Schlumberger Well Services. Turner was an executive employee of Schlumberger. Blubaugh was told that he would be fired unless he chose to resign. He was also told that if he would resign and release the company and its employees from all claims for wrongful discharge, he would receive about $5,000 in addition to his regular severance pay of approximately $25,000 and would be given jobrelocation counseling. He resigned, signed the release, and received about $40,000 and job counseling. Some time thereafter, he brought an action claiming that he had been wrongfully discharged. He claimed that the release did not protect the defendants because the release had been obtained by economic duress. Were the defendants protected by the release? [Blubaugh v. Turner, 842 P.2d 1072 (Wyo.)] Answer: Duress. Agreements such as these between departing employers and employees have come under increasing scrutiny. The agreements will be struck down unless: (a) employee given sufficient time to consider; (b) employee permitted to have outside counsel and (3) severance pay not held as an issue. Otherwise, the contract is one under duress, as in this case. [Blubaugh v. Turner, 842 P. 2d 1072 (Wyo.)]

10. Sippy was thinking of buying Christich‘s house. He noticed watermarks on the ceiling, but the agent showing the house stated that the roof had been repaired and was in good condition. Sippy was not told that the roof still leaked and that the repairs had not been able to stop the leaking. Sippy bought the house. Some time later, heavy rains caused water to leak into the house, and Sippy claimed that Christich was liable for damages.

What theory would he rely on? Decide. [Sippy v. Christich, 609 P.2d 204 (Kan. App.)] What constitutes a false statement. Yes. The statement that the roof had been repaired would suggest to the ordinary person that the repairs had been successful. This conclusion was reinforced by the statement that the roof was ―in good condition.‖ The net result was that what was said and what was not said had the effect of stating what was not true, misleading Sippy and causing him to be harmed. Because this was done with knowledge of the true facts, Christich committed fraud. [Sippy v. Christich, 609 P. 2d 204 (Kan. App.)] Answer: Authors’ Comment: You can change the facts to show active concealment by the sellers. Ask the students whether the sellers would have had to disclose the history of the

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leaky roof if it had been raining when Sippy had looked at the house and the leaky roof had been visible. What would happen if the leaky roof had been visible, but Sippy had been so excited when he first walked into the house that he had purchased it without inspecting the rest of the premises and such inspection would have shown the leaky roof?

Develop a discussion on the topic of whether an inspection should be required and how much should by disclosed to a person who supposedly can see things for himself or herself.

11. CEO Bernard Ellis sent a memo to shareholders of his Internet-related services business some four days before the expiration of a lock-up period during which these shareholders had agreed not to sell their stock. In the memo, he urged shareholders not to sell their stock on the release date because in the event of a massive sell-off ―our stock could plummet.‖ He also stated, ―I think our share price will start to stabilize and then rise as our company’s strong performance continues.‖ Based on Ellis‘ ―strong performance‖ statement, a major corporate shareholder did not sell. The price of the stock fell from $40 a share to 29 cents a share over the subsequent nine-month period. The shareholder sued Ellis for fraud, seeking $27 million in damages. Analyze the italicized statement to see if it contains an actionable misrepresentation of fact and a basis of fraud liability. [New Century Communications v. Ellis, 318 F.3d 1023 (11th Cir.)] Answer: Fraud: statement of opinion or value. The court held that the first half of the sentence in question was formed as a mere opinion as to future events, and thus nonactionable; and as to the characterization of its performance as ―strong‖, such a selfcongratulatory comment constituted mere puffery on which no reasonable investor would rely. [New Century Communications v. Ellis, 318 F. 3d 1023 (11th Cir.)] 12. Office Supply Outlet, Inc., a single-store office equipment and supply retailer, ordered 100 model RVX-414 computers from Compuserve, Inc. A new staff member made a clerical error on the order form and ordered a quantity that was far in excess of what Office Supply could sell in a year. Office Supply realized the mistake when the delivery trucks arrived at its warehouse. Its manager called Compuserve and explained that it had intended to order just 10 computers. Compuserve declined to accept the return of the extra machines. Is the contract enforceable? What additional facts would allow the store to avoid the contract for the additional machines?

Answer: Unilateral mistake. Because Office Supply's mistake was unilateral, the contract for the 100 machines in enforceable. If, however, a regular Compuserve salesperson called on Office Supply and knew of Office Supply's policy not to stock more than 10 model

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RVX-414 machines at any one period of time and the order for 100 machines was placed through this regular salesperson, Office Supply could avoid the contract for the additional 90 machines because Compuserve knew or should have known a mistake had been made.

13. The Printers International Union reached agreement for a new three-year contract with a large regional printing company. As was their practice, the union negotiators then met with Sullivan Brothers Printers, Inc., a small specialty shop employing 10 union printers, and Sullivan Brothers and the union agreed to follow the contractual pattern set by the union and the large printing company. That is, Sullivan Brothers agreed to give its workers all of the benefits negotiated for the employees of the large printing company. When the contract was typed, a new benefit of 75 percent employer-paid coverage for a dental plan was inadvertently omitted from the final contract the parties signed. The mistake was not discovered until six months after the contract took effect. Sullivan Brothers Printers, Inc., is reluctant to assume the additional expense. It contends that the printed copy, which does not cover dental benefits, must control. The union believes that clear and convincing evidence shows an inadvertent typing error. Decide.

Answer: Mistake in printing of contract: reformation. Based on the clear and convincing evidence of a practice of following the contractual pattern set by the large printer and Sullivan‘s assent to again follow the pattern, a court or arbitrator will reform the contract.

14. The city of Salinas entered into a contract with Souza & McCue Construction Co. to construct a sewer. City officials knew unusual subsoil conditions (including extensive quicksand) existed that would make performance of the contract unusually difficult. This information was not disclosed when city officials advertised for bids. The advertisement for bids directed bidders to examine carefully the site of the work and declared that the submission of a bid would constitute evidence that the bidder had made an examination.

Souza & McCue was awarded the contract, but because of the subsoil conditions, it could not complete on time and was sued by Salinas for breach of contract. Souza & McCue counterclaimed on the basis that the city had not revealed its information on the subsoil conditions and was thus liable for the loss. Was the city liable? [City of Salinas v. Souza & McCue Construction Co., 424 P.2d 921 (Cal. App. 3d)] Answer: Liability for nondisclosure. Judgment for contractor. An owner is liable for not informing the contractor of unusual difficulties known to the owner that the contractor will encounter in the performance of a contract when such difficulties are not known to the contractor. Because the city knew that the contractor would base its bid on incomplete information, the city misled the contractor by such nondisclosure and was liable to the

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contractor for the loss caused thereby. The provision as to the examination of the Awork site@ did not alter this conclusion because nothing in that provision would call to the contractor‘s attention the conditions that would be encountered or that disclaimed liability for concealed subsoil conditions. [City of Salinas v. Souza & McCue Construction Co., 424 P. 2d 921 (Cal. App. 3d)] 15. Vern Westby inherited a ―ticket‖ from Anna Sjoblom, a survivor of the sinking of the Titanic, which had been pinned to the inside of her coat. He also inherited an album of postcards, some of which related to the Titanic. The ticket was a one-of-akind item in good condition. Westby needed cash and went to the biggest antique dealer in Tacoma, operated by Alan Gorsuch and his family, doing business as Sanford and Sons, and asked about the value of these items. Westby testified that after Alan Gorsuch examined the ticket, he said, ―It‘s not worth nothing.‖ Westby then inquired about the value of the postcard album, and Gorsuch advised him to come back later. On Westby‘s return, Gorsuch told Westby, ―It ain‘t worth nothing.‖ Gorsuch added that he ―couldn‘t fetch $500 for the ticket.‖ Since he needed money, Westby asked if Gorsuch would give him $1,000 for both the ticket and the album, and Gorsuch did so.

Six months later, Gorsuch sold the ticket at a nationally advertised auction for $110,000 and sold most of the postcards for $1,200. Westby sued Gorsuch for fraud. Testimony showed that Gorsuch was a major buyer in antiques and collectibles in the Puget Sound area and that he would have had an understanding of the value of the ticket. Gorsuch contends that all elements of fraud are not present since there was no evidence that Gorsuch intended that Westby rely on the alleged representations, nor did Westby rely on such. Rather, Gorsuch asserts, it was an arm‘s-length transaction and Westby had access to the same information as Gorsuch. Decide. [Westby v. Gorsuch, 50 P.3d 284 (Wash. App.)] Answer: Elements of fraud. Judgment for Westby. All of the elements of fraud are present in this case. Gorsuch misrepresented the material fact of the general value of the ticket as ―worth nothing‖ and ―couldn‘t fetch $500‖ and the album as ―worth nothing.‖ These representations were false. He intended that Westby rely on the statement; Westby did in fact rely on the statements and he suffered damages. As a dealer in antiques who was sought out for his special knowledge of the general value of these items, he cannot raise a defense that what took place was an arms length transaction. Both parties did not have equal competence as to the value of the items, and what could be an opinion among persons of equal competence, became actionable fraud in the context of this case. [Westby v. Gorsuch, 50 P. 3d 284 (Wash. App.)]

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[return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

A building subcontractor submitted a bid for construction of a portion of a high-rise office building. The bid contained material computational errors. The general contractor accepted the bid with knowledge of the errors. Which of the following statements best represents the subcontractor‘s liability? a.

Not liable, because the contractor knew of the errors.

b.

Not liable, because the errors were a result of gross negligence.

c.

Liable, because the errors were unilateral. Liable, because the errors were material (5/95, Law, #17, 5351).

d.

2.

Liable, because the errors were material (5/95, Law, #17, 5351).

Egan, a minor, contracted with Baker to purchase Baker‘s used computer for $400. The computer was purchased for Egan‘s personal use. The agreement provided that Egan would pay $200 down on delivery and $200 thirty days later. Egan took delivery and paid the $200 down payment. Twenty days later, the computer was damaged seriously as a result of Egan‘s negligence. Five days after the damage occurred and one day after Egan reached the age of majority, Egan attempted to disaffirm the contract with Baker. Egan will: a.

Be able to disaffirm despite the fact that Egan was not a minor at the time of disaffirmance.

b.

Be able to disaffirm only if Egan does so in writing.

c.

Not be able to disaffirm because Egan had failed to pay the balance of the purchase price.

d.

Not be able to disaffirm because the computer was damaged as a result of Egan‘s negligence (11/93, Law, #21, 4318).

[return to top] Answers to AICPA Questions 1.

A building subcontractor submitted a bid for construction of a portion of a high-rise office building. The bid contained material computational errors. The general contractor accepted the bid with knowledge of the errors. Which of the following statements best

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represents the subcontractor‘s liability? a.

Not liable, because the contractor knew of the errors.

b.

Not liable, because the errors were a result of gross negligence.

c.

Liable, because the errors were unilateral. Liable, because the errors were material (5/95, Law, #17, 5351).

d.

Liable, because the errors were material (5/95, Law, #17, 5351).

(a) Where a mistake is made by only one party (a unilateral mistake), the rule is that the mistaken party is bound by the contract unless the nonmistaken party knew of the mistake or should have known of the mistake. In this question, the nonmistaken party knew of the mistake; thus, the mistaken party is not bound by the contract.

Whether the mistake was a result of gross negligence is irrelevant.

2.

Egan, a minor, contracted with Baker to purchase Baker‘s used computer for $400. The computer was purchased for Egan‘s personal use. The agreement provided that Egan would pay $200 down on delivery and $200 thirty days later. Egan took delivery and paid the $200 down payment. Twenty days later, the computer was damaged seriously as a result of Egan‘s negligence. Five days after the damage occurred and one day after Egan reached the age of majority, Egan attempted to disaffirm the contract with Baker. Egan will: a.

Be able to disaffirm despite the fact that Egan was not a minor at the time of disaffirmance.

b.

Be able to disaffirm only if Egan does so in writing.

c.

Not be able to disaffirm because Egan had failed to pay the balance of the purchase price.

d.

Not be able to disaffirm because the computer was damaged as a result of Egan‘s negligence (11/93, Law, #21, 4318).

(a) Answer (b) is incorrect because a disaffirmance need not be in writing. Answer (c) is incorrect because a minor can disaffirm at any time during minority or for a reasonable time thereafter regardless of payment. Answer (d) is incorrect because a minor need only return whatever consideration he/she has, even if damaged or lost.

Answer (a) is correct because it is still a reasonable time after majority. [return to top]

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 14: Consideration

Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 14: Consideration

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 111 Questions and Case Problems .......................................................................................................... 111

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Sarah‘s house caught on fire. Through the prompt assistance of her neighbor Odessa, the fire was quickly extinguished. In gratitude, Sarah promised to pay Odessa $1,000. Can Odessa enforce this promise?

Answer: Moral obligation as consideration. No. The fact that a person is under a moral obligation to pay for a particular service does not constitute consideration so as to make binding a promise to pay for the service.

2.

William E. Story agreed to pay his nephew, William E. Story II, a large sum of money (roughly equivalent to $75,000 in 2016 dollars) ―if he would refrain from drinking liquor, using tobacco, swearing, and playing cards or billiards for money until he should come to be 21 years of age.‖ William II had been using tobacco and occasionally drank liquor but refrained from using these stimulants over several years until he was 21 and also lived up to the other requirements of his uncle‘s offer. Just after William II‘s 21st birthday, Story acknowledged that William II had fulfilled his part of the bargain and advised that the money would be invested for him with interest. Story died, and his executor, Sidway, refused to pay William II because he believed the contract between Story and William II was without consideration. Sidway asserted that Story received no benefit from William II‘s performance and William II suffered no detriment (in fact, by his refraining from the use of liquor and tobacco, William II was not harmed but benefited, Sidway asserted). Is there any theory of consideration that William II can rely on? How would you decide this case?

[Hamer v. Sidway, 124 N.Y. 538] Answer: Forbearance as consideration. This classic case was decided in 1891. William II assigned his rights in this matter to an individual named Hamer who brought the lawsuit against the executor of the estate of Mr. Story, an individual named Sidway. The amount

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of the actual promise in the late 1800s was $5,000. The court stated: ―. . .the promisee used tobacco, occasionally drank liquor, and he had a legal right to do so. That right he abandoned for a period of years upon the strength of the promise of the testator that for such forbearance he would give him five thousand dollars . . . .‖ Consideration then may also consist of forbearance, which is refraining from doing an act that one has a legal right to do. Thus, Mr. Story‘s promise to William II was enforceable.

[Hamer v. Sidway, 124 N.Y. 538] 3.

Dale Dyer, who was employed by National By- Products, Inc., was seriously injured at work as the result of a job-related accident. He agreed to give up his right to sue the employer for damages in consideration of the employer‘s giving him a lifetime job. The employer later claimed that this agreement was not binding because Dyer‘s promise not to sue could not be consideration for the promise to employ on the ground that Dyer in fact had no right to sue. Dyer‘s only remedy was to make a claim under workers‘ compensation.

Was the agreement binding? [Dyer v. National By-Products, Inc., 380 N.W.2d 732 (Iowa)] Answer: Adequacy of consideration. Yes. Ordinarily, the law is not concerned with the value or quantity of consideration that the promisor demands and receives for the promise.

Therefore, the employment contract was binding, even if the compensation to be paid was in fact low. [Dyer v. National By-Products, Inc., 380 N.W. 2d 732 (Iowa)] Authors’ Comment: Certain exceptions exist to the rule that the courts will not consider the adequacy of consideration. Of these, the most important, because of the contemporary rise of consumer protectionism, is the concept of unconscionability.

4.

Charles Sanarwari retained Stan Gissel to prepare his income tax return for the year 2014.

The parties agreed on a fee of $400. Charles had done a rough estimate based on last year‘s return and believed he would owe the IRS approximately $2,000. When Stan‘s work was completed, it turned out that Charles would receive a $2,321 tax refund. Charles paid for Stan‘s services and was so pleased with the work that he promised to pay Stan an additional $400 for the excellent job on the tax return when he received his tax refund.

Thereafter, Charles had a falling out with Stan over a golf tournament snub. Stan was not paid the $400 promised for doing an excellent job on the tax return, and he sued Charles as a matter of principle. Decide.

Answer: Past Consideration. The general rule is that past consideration is no consideration.

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In this case, Stan prepared Charles‘s tax return and was paid for his work. The subsequent promise of an additional $400 for doing an excellent job is unenforceable because it is unsupported by consideration. The benefit conferred, an excellent job on the tax return, was completed before the promise to pay the additional $400 was made (the benefit was completed in the past). ―Past consideration is no consideration.‖ 5.

Medistar is a real estate development company specializing in the development of medical facilities. Dr. Schmidt, the team physician for the San Antonio Spurs basketball team, sought to develop ―The Texas Center for Athletes‖ medical center next to the Spurs facility and urged Medistar to obtain the real estate and develop the project on his group‘s behalf. Medistar spent more than $1 million and thousands of man-hours on the project from 2000 to July 12, 2004, when Dr. Schmidt‘s new group of investors purchased the property next to the Spur‘s facility for the project; subsequently, Medistar was informed that it would have no role in the project. Medistar asserts that it relied on Dr. Schmidt‘s assurances that it would be the developer of the project—and after four years and the $1 million in time and expenses it spent, it is unconscionable to be excluded from the project.

Dr. Schmidt and associates contend that Medistar has presented no contractual agreement tying it to any legal obligation to Medistar. Is there a viable legal theory available to Medistar? If so what is the remedy? [Medistar v. Schmidt, 267 S.W.3d 150 (Tex. App.)] Answer: Promissory estoppel. A basis existed for the jury to find that Dr. Schmidt‘s: (1) ―assured‖ Medistar that it would be the developer of the project, even though Medistar and Schmidt did not bargain out final terms and conditions of the arrangement, (2) Schmidt intended that Medistar would rely on the assurance, (3) Medistar did rely on the assurance and expended time and money on the project, and (4) some relief is necessary to avoid injustice. The damages recoverable are not the profits Medistar expected for developing the project, but the amount necessary to restore Medistar to the position it would have been in if it had not relied on the promise. In this case the jury awarded $418,069 in damages not the $1 million claimed. [Medistar v. Schmidt, 267 S.W. 3d 150 (Tex. App.)]

6.

While on a fishing trip, Tom Snyder met an elderly couple living in near-destitute conditions in a rural area of Texas. He returned to the area often, and he regularly purchased groceries for the couple and paid for their medical needs. Some two years later, the couple‘s son, David, discovered what Tom had been doing and promised to reimburse Snyder for what he had furnished his parents. He failed to do so and Tom sued David for breach of his promise to reimburse Snyder. Tom has receipts for most of the purchases.

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What defense, if any, does David have? Decide.

Answer: Past consideration; moral obligation. David may raise the defense of past consideration and moral obligation. A promise based on a party‘s past performance of purchasing goods and services for aged parents lacks consideration. Past consideration is no consideration.

A son has a moral obligation to support his parents; but a provision based on moral obligation also lacks consideration and is unenforceable.

7.

The Aqua Drilling Company made a contract to drill a well for the Atlas Construction Company. It was expected that this would supply water for a home being constructed by Atlas. Aqua did not make any guarantee or warranty that water would be produced. Aqua drilled the well exactly as required by the contract, but no water was produced. Atlas refused to pay. It asserted that the contract was not binding on the theory that there had been a failure of consideration because the well did not produce water. Was the contract binding? [Atlas Construction Co., Inc. v. Aqua Drilling Co., 559 P.2d 39 (Wyo.)] Answer: Adequacy of consideration. The contract was binding. Atlas obtained the exact performance required by the contract. While Atlas had expected that water would be obtained, Aqua did not make any guarantee or warranty that this would be so. Hence, there was no failure of consideration. [Atlas Construction Co., Inc. v. Aqua Drilling Co., 559 P. 2d 39 (Wyo.)]

8.

Sears, Roebuck and Co. promised to give Forrer permanent employment. Forrer sold his farm at a loss to take the job. Shortly after beginning work, he was discharged by Sears, which claimed that the contract could be terminated at will. Forrer claimed that promissory estoppel prevented Sears from terminating the contract. Was he correct? [Forrer v. Sears, Roebuck & Co., 153 N.W.2d 587 (Wis.)] Answer: Relation of promissory estoppel to contract termination. No. Promissory estoppel did not prevent Sears from terminating the contract. Because Sears had actually employed Forrer, there was no breach of its promise to employ him; therefore, it was unnecessary to apply the concept of promissory estoppel to enforce the promise to employ. Instead, the question was merely what the obligation was under a ―permanent employment‖ contract.

Here, the court held that such a contract is terminable at the will of the employer in the absence of a consideration that would benefit the employer other than the rendition of the contemplated service. [Forrer v. Sears, Roebuck & Co., 153 N.W. 2d 587 (Wis.)]

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Authors’ Comment: This case illustrates the fact that in spite of the ―reform‖ currents of the twentieth century, courts will not always protect a plaintiff from hardship. This in turn emphasizes the importance of preventive law. Undoubtedly, Forrer thought that ―permanent employment‖ meant just that. He therefore needed legal advice so that he would have known that he could be discharged the next day.

Note that the decision of this case cannot be minimized on the theory that the court is opposed to promissory estoppel because this court had adopted already the Restatement concept of promissory estoppel in Hoffman v. Red Owl Stores, Inc., 26 Wis. 2d 683, 133 N.W. 2d 267 (1965). Also, note that the court could have held the contract not binding because it was too indefinite. Nothing in the phrase ―permanent employment‖ would in any way indicate the nature of the work to be done or the compensation to be paid for the work.

9.

Kemp leased a gas filling station from Baehr. Kemp, who was heavily indebted to Penn-OTex Oil Corp., transferred to it his right to receive payments on all claims. When Baehr complained that the rent was not paid, he was assured by the corporation that the rent would be paid to him. Baehr did not sue Kemp for the overdue rent but later sued the corporation. The defense was raised that there was no consideration for the promise of the corporation. Decide. [Baehr v. Penn-O-Tex Corp., 104 N.W.2d 661 (Minn.)]

Answer: A promise as consideration. The promise of the corporation was not binding because there was no consideration for it. While the concept of consideration developed as a way of determining which agreements were serious and intended by the parties to be binding, the converse doesn't follow that every serious agreement is binding. It is necessary in every case to find that the promisor received the required price of his or her promise. Although Baehr‘s not suing Kemp could have been specified by the corporation as the price of its promise to pay Kemp‘s obligation, the corporation hadn't done so; therefore, no consideration existed. The decision can be criticized because the corporation didn't receive a benefit from its promise to pay Kemp‘s rent to Baehr, and that was a continued payment to the corporation on the assigned claims by Kemp. Had Baehr evicted Kemp, the corporation would have received nothing. Apparently, what the court requires is the formality of Baehr saying that in consideration for the promise to pay him the rent that Kemp owes, he will not evict Kemp. [Baehr v. Penn-O-Tex Corp., 104 N.W. 2d 661 (Minn.)]

10. John Blackwell was seriously injured in an auto accident. His wife was Korean and spoke little English and needed help communicating with Blackwell‘s doctor. The Blackwells hired

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Choi as an interpreter in 1997 and over time Mr. Choi assisted with the family finances and other matters. In 2010 Blackwell‘s wife fired Choi and later the parties signed an agreement agreeing to pay Choi $450,000 ―for the work Choi had done for Blackwell.‖ Choi sued to obtain payment. Was he successful? [Lee v. Choi, 754 S.E.2d 371 (Ga. App.)] Answer: Past consideration. The agreement to pay Choi for work he had already done is unenforceable. Past consideration cannot support the existence of a contract. [Lee v. Choi, 754 S.E. 2d 371 (Ga. App.)] 11. Kelsoe worked for International Wood Products, Inc., for a number of years. One day Hernandez, a director and major stockholder of the company, promised Kelsoe that the corporation would give her 5 percent of the company‘s stock. This promise was never kept, and Kelsoe sued International for breach of contract. Had the company broken its contract? [Kelsoe v. International Wood Products, Inc., 588 So. 2d 877 (Ala.)] Answer: Preexisting obligation. No, the company had not broken a promise because Kelsoe already worked for the company and there was no detriment on her part in exchange for the promise of the stock. [Kelsoe v. International Wood Products, Inc., 588 So. 2d 877 (Ala.)] 12. Kathy left her classic 1978 Volkswagen convertible at Freddie‘s Service Station, requesting a ―tune-up.‖ When she returned that evening, Freddie‘s bill was $374. Kathy stated that Firestone and Sears advertise tune-ups for $70, and she asked Freddie, ―How can you justify this bill?‖ Freddie responded, ―Carburator work.‖ Kathy refused to pay the bill and left. That evening, when the station closed, she took her other set of keys and removed her car, after placing a check in the station‘s mail slot. The check was made out to Freddie‘s Service Station for $200 and stated on its face: ―This check is in full payment of my account with you regarding the tune-up today on my 1978 Volkswagen convertible.‖ Freddie cashed the check in order to meet his business expenses and then sued Kathy for the difference owed. What result?

Answer: Part payment by check. Judgment for Kathy. The parties had a good-faith dispute about the amount properly owed for the engine tune-up. Kathy offered $200 as a compromise settlement of the dispute. The cashing of the ―full payment‖ check serves as acceptance of the offer to compromise and discharges the entire debt.

13. On the death of their mother, the children of Jane Smith gave their interests in their mother‘s estate to their father in consideration of his payment of $1 to each of them and

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his promise to leave them the property on his death. The father died without leaving them the property. The children sued their father‘s second wife to obtain the property in accordance with the agreement. The second wife claimed that the agreement was not a binding contract because the amount of $1 and future gifts given for the children‘s interests were so trivial and uncertain. Decide.

Answer: Irrelevance of adequacy of consideration. Judgment for children. The promises between the father and the children created a binding agreement. It was against the objection that it was not binding because the children received very little from the father.

The only thing the children received was the one dollar and the chance that when the father died, there would be something in his estate that could be left to them. The argument of the second wife was rejected because the law will not consider the adequacy of consideration unless some element of fraud exists.

14. Radio Station KSCS broadcast a popular music program. It announced that it would pay $25,000 to any listener who detected that it did not play three consecutive songs. Steve Jennings listened to and heard a program in which two songs were followed by a commercial program. He claimed the $25,000. The station refused to pay on the ground that there was no consideration for its promise to pay that amount. Was the station liable?

[Jennings v. Radio Station KSCS, 708 S.W.2d 60 (Tex. App.)] Answer: Forbearance as consideration. The obvious purpose of the radio station‘s offer was to increase its listening audience. The station purchased conduct—a person listening to that station as opposed to another station—by its promise. Jennings gave up a legal right to listen to any other radio station as a result of the station‘s promise. The conduct of Jennings in listening to the program was thus consideration for the station‘s promise to pay the $25,000 if the listener satisfied the specified condition. The station was bound by a unilateral contract to pay the money to Jennings when he detected that the station did not play three consecutive songs, and the consideration to support the contract was his listening to this particular music program. [Jennings v. Radio Station KSCS, 708 S.W. 2d 60 (Tex. App.)] 15. Hoffman wanted to acquire a franchise for a Red Owl grocery store. (Red Owl was a corporation that maintained a system of chain stores.) An agent of Red Owl informed Hoffman and his wife that if they would sell their bakery in Wautoma, acquire a certain tract of land in Chilton (another Wisconsin city), and put up $6,000, they would be given a franchise. In reliance on the agent‘s promise, Hoffman sold his business and acquired the land in Chilton, but he was never granted a franchise. He and his wife sued Red Owl. Red

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Owl raised the defense that there had been only an assurance that Hoffman would receive a franchise, but because there was no promise supported by consideration, there was no binding contract to give him a franchise. [Hoffman v. Red Owl Stores, Inc., 133 N.W.2d 267 (Wis.)] Answer: Promissory estoppel. Judgment for the Hoffmans. Injustice would result under the circumstances of the case if the Hoffmans were not granted relief. The plaintiffs had acted in reliance on a promise made by Red Owl‘s authorized agent. They would be harmed substantially if the promise were not held binding. [Hoffman v. Red Owl Stores, Inc., 133 N.W.2d 267 (Wis.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 15: Legality and Public Policy

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 118 Questions and Case Problems .......................................................................................................... 118 End of Chapter: CPA Questions and Answers ................................................................................. 128 Answers to AICPA Questions ............................................................................................................ 129

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

When are the parties to an illegal agreement in pari delicto?

Answer: Unconscionability. Parties are in pari delicto when both are equally guilty of a violation of a law.

2.

John Iwen sued U.S. West Direct because of a negligently constructed yellow pages advertisement. U.S. West Direct moved to stay litigation and compel arbitration under the yellow pages order form, which required advertisers to resolve all controversies through arbitration, but allowed U.S. West (the publisher) to pursue judicial remedies to collect amounts due it. Under the arbitration provision, Iwen‘s sole remedy was a pro rata

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reduction or refund of the cost of the advertisement. The order form language was drafted

by U.S. West Direct on a take-it-or-leave-it basis and stated in part: Any controversy or claim arising out of or relating to this Agreement, or breach thereof, other than an action by Publisher for the collection of amounts due under this Agreement, shall be settled by final, binding arbitration in accordance with the Commercial Arbitration rules of the American Arbitration Association.

If forced to arbitration, Iwen would be unable to recover damages for the negligently constructed yellow pages ad, nor could he recover damages for infliction of emotional distress and punitive damages related to his many efforts to adjust the matter with the company, which were ignored or rejected. Must Iwen have his case resolved through arbitration rather than a court of law? [Iwen v. U.S. West Direct, 977 P.2d 989 (Mont.)]

Answer: Unconscionability. No, the U.S. West contract was a contract of adhesion. There was lack of mutuality. The arbitration clause is one-sided. A contract must not unreasonably favor the drafter. [Iwen v. U.S. West Direct, 977 P. 2d 989 (Mont.)]

3.

Sutcliffe Banton, dba Nemard Construction, furnished labor and materials (valued at $162,895) for improving Vicky Deafeamkpor‘s New York City residential property. She paid only $41,718, leaving $121,987 unpaid. Banton sued her, and the jury awarded $90,000 in damages. Deafeamkpor moved for an order setting aside the jury‘s verdict because Banton was not properly licensed by New York City. Under NYC Code an unlicensed contractor may neither enforce a home improvement contract against an owner nor recover in quantum meruit. The jury heard all the evidence regarding the materials and labor expended on Deafeamkpor‘s residence and concluded that the plaintiff performed satisfactory work valued at $90,000 for which he was not paid. Should the court allow the owner to take advantage of Banton and his employees and suppliers? What public policy would support such an outcome? Decide. [Nemard Construction Corp. v. Deafeamkpor, 863 N.Y.S.2d 846] Answer: Licensed callings or dealing § 11. Judgment for Deafeamkpor setting aside the $90,000 verdict. The licensing requirement of this city, even when work is satisfactory, is strictly enforced to protect consumers from unqualified contractors. Public policy bars enforcement of the contract in this case. However, this does not mean that Vicky Deafeamkpor is a good person. [Nemard Construction Corp. v. Deafeamkpor, 863 N.Y. S.2d 846]

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4.

Eugene McCarthy left his position as director of sales for Nike‘s Brand Jordan division in June 2003 to become vice president of U.S. footwear sales and merchandising at Reebok, one of Nike‘s competitors. Nike sought a preliminary injunction to prevent McCarthy from working for Reebok for a year, invoking a noncompete agreement McCarthy had signed in Oregon in 1997 when Nike had promoted him to his earlier position as a regional footwear sales manager. The agreement stated in pertinent part: During EMPLOYEE’S employment by NIKE. . . and for one (1) year thereafter, (―the Restriction Period‖), EMPLOYEE will not directly or indirectly . . . be employed by, consult for, or be connected in any manner with, any business engaged anywhere in the world in the athletic footwear, athletic apparel or sports equipment and accessories business, or any other business which directly competes with NIKE or any of its subsidiaries or affiliated corporations.

McCarty contends that such a contract is a restraint of trade and should not be enforced.

Nike contends that the agreement is fair and should be enforced. Decide. [Nike, Inc. v.

McCarthy, 379 F.3d 576 (9th Cir.)] Answer: Noncompete agreements. Even if the covenant not to compete is not void…it is a contract in restraint of trade that must meet three requirements under Oregon common law to be enforceable: (1) it must be restricted in its operation in respect either to time or place; (2) it must be on some good consideration; and (3) it must be reasonable, that is, it should afford only a fair protection to the interests of the party in whose favor it is made, and must not be so large in its operation as to interfere with the interests of the public.

McCarthy did not contest the geographic scope or duration, nor does he claim it lacked consideration. The potential use of confidential information by McCarthy in his new position with Reebok is sufficient to justify enforcing the Noncompete Agreement. [Nike, Inc. v. McCarthy, 379 F. 3d 576 (9th Cir.)]

5.

Ewing was employed by Presto-X-Co., a pest exterminator. His contract of employment specified that he would not solicit or attempt to solicit customers of Presto-X for two years after the termination of his employment. After working several years, his employment was terminated. Ewing then sent a letter to customers of Presto-X stating that he no longer worked for Presto-X and that he was still certified by the state. Ewing set forth his home address and phone number, which the customers did not previously have. The letter ended with the statement, ―I thank you for your business throughout the past years.‖ Presto-X brought an action to enjoin Ewing from sending such letters. He raised the defense that he was prohibited only from soliciting and there was nothing in the letters

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that constituted a seeking of customers. Decide. What ethical values are involved? [PrestoX-Co. v. Ewing, 442 N.W.2d 85 (Iowa)] Answer: What constitutes a solicitation prohibited by a restrictive covenant. This letter was a solicitation. Although it did not expressly seek customers, a person receiving such letter would regard it as a statement that Ewing was available, licensed, and qualified to do pest control work. The supplying of the address and phone number that the customers did not previously have was clearly an indication that Ewing was willing to be contacted at that address and number. Because he was no longer employed by Presto-X, there would be no reason for customers to use the address or phone number Ewing provided if they were trying to reach Presto-X, only if they were trying to reach Ewing. Therefore, the letter was a solicitation of pest control work. The ethical values of promise keeping and doing no harm are involved in this case. Obviously, Ewing was seeking customers for himself. Note the lack of reason of Ewing‘s thanking the customers for their prior business. Presto-X was the party that had been receiving the benefit from such prior business. The ―thanking‖ sentence increases the implication that Ewing is saying to the customers, ―I hope you will continue to do business with me in the future, and here is my address and phone number to assist you.‖ Because Ewing no longer worked for Presto-X, there was no reason for him to write those thanking statements and no reason to write the customers on behalf of Presto-X. The letters were clearly an attempt by Ewing to solicit business without appearing to solicit. The decision of the court furthers the value of making Ewing live up to his agreement and thereby causing no economic harm to his former employer. [Presto-XCo. v. Ewing, 442 N.W. 2d 85 (Iowa)] 6.

Alessia McIntosh is the parent of a minor child who attends Flint Hill School. The Enrollment Contract with the school, which she signed online by automatic signature, stated in relevant part: ―We (I) agree to pay all attorney‘s fees and costs incurred by Flint Hill School in any action arising out of or relating to this Enrollment Contract.‖ Ms. McIntosh contends that the contract is unconscionable because she will be obligated to pay the attorney‘s fees and costs of the school regardless of which party is ultimately victorious. The school disagrees. Is the contract a contract of adhesion? If so, does that fact establish procedural unconscionability? Is the contract substantively unconscionable?

[McIntosh v. Flint Hill School, 2018 Va. Cir. LEXIS 321] Answer: Unconscionable clauses. The contract is one of adhesion and procedurally unconscionable and it is substantively unconscionable. ―A contract of adhesion is a standard form contract, prepared by one party and presented to a weaker party—usually, a consumer—who has no bargaining power and little or no choice about the terms.‖ A

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contract of adhesion may suggest that a degree of procedural unconscionability exists.

However, a contract of adhesion is not in itself enough to establish procedural unconscionability. Paragraph 16 of the Enrollment Contract, however, does rise to such a level. Parents are presented with the contract in order to have their children enrolled in Flint Hill School. Assent to the contract‘s terms is done by online electronic signature leaving no room for bargaining. What makes the contract‘s terms substantively unconscionable is that the parents are subject to attorneys‘ fees and costs if they litigate with success against the School or are sued by the School and yet prevail, and without regard to whether the attorneys‘ fees and costs are ―reasonable.‖ [McIntosh v. Flint Hill School, 2018 WL 9393020 (Va.)] 7.

Siddle purchased a quantity of fireworks from Red Devil Fireworks Co. The sale was illegal, however, because Siddle did not have a license to make the purchase, which the seller knew because it had been so informed by the attorney general of the state. Siddle did not pay for the fireworks, and Red Devil sued him. He defended on the ground that the contract could not be enforced because it was illegal. Was the defense valid? [Red Devil Fireworks Co. v. Siddle, 648 P.2d 468 (Wash. App.)] Answer: Illegality; public policy; unjust enrichment. The agreement for the sale of fireworks violated state fireworks law. The equitable principle of unjust enrichment did not permit fireworks supplier‘s recovery of fair value of dangerous fireworks delivered and accepted pursuant to an agreement in violation of state fireworks law where supplier and buyer were aware of buyer‘s lack of a proper license and where Attorney General‘s office informed parties that sale would be illegal. [Red Devil Fireworks Co. v. Siddle, 648 P. 2d 468 (Wash. App.)]

8.

Justin Shaffer, while an employee of the Home Paramount Pest Control Companies Inc., signed an employment agreement providing that: The Employee will not engage directly or indirectly or concern himself/herself in any manner whatsoever in the carrying on or conducting the business of exterminating, pest control, termite control and/ or fumigation services as an owner, agent, servant, representative, or employee, and/or as a member of a partnership and/or as an officer, director or stockholder of any corporation, or in any manner whatsoever, in any city, cities, county or counties in the state(s) in which the Employee works and/ or in which the Employee was assigned during the two (2) years next preceding the termination of the Employment Agreement and for a period of two (2) years from and after the date upon which he/ she shall cease for any reason whatsoever to be an employee of [Home

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Paramount].

Shaffer resigned from Home Paramount and became an employee of Connor‘s Termite and Pest Control Inc. Home Paramount sued Shaffer and Connor‘s, claiming that Shaffer‘s employment by Connor‘s violated the contract. The defendants contended that the provision was overboard and unenforceable. Decide. [Home Paramount Pest Control Companies, Inc. v. Shaffer, 718 S.E.2d 762 (Va.)] Answer: Agreements not-to-compete. The provision prohibits Shaffer from working for any other business in the pest control industry in any capacity. It bars him from engaging even indirectly, or concerning himself in any manner whatsoever, in the pest control business, even as a passive stockholder of a publicly traded international conglomerate with a pest control subsidiary. The clear over breadth of the function here cannot be saved by the narrow tailoring of geographic scope and duration. The provision is overly broad and therefore unenforceable. [Home Paramount Pest Control Companies, Inc. v. Shaffer, 718 S.E. 2d 762 (Va.)] 9.

Illinois Attorney General Lisa Madigan filed a lawsuit on June 8, 2016, against Jimmy John‘s Sandwich Shops seeking injunctive and other equitable relief contending: … that Jimmy John’s use of non-compete agreements for at-will, low wage workers limits the ability of employees to find new employment, … hinders upward mobility of workers looking for higher wages or advancement with new employment using skills obtained in their current employment, and suppresses wages for employees who have limited negotiating power with both current and potential new employers when they are limited by a non-competition agreement. …

All store employees are employees at-will, and all store employees in Illinois were required to sign a noncompetition covenant, which stated in part: Non-Competition Covenant. Employee covenants and agrees that, during his or her employment with Employer and for a period of two (2) years after… he or she will not have any direct or indirect interest in or perform services for (whether as an owner, partner, investor, director, officer, representative, manager, employee, principal, agent, advisor, or consultant) any business which derives more than ten percent (10%) of its revenue from selling submarine, hero type, deli-style, pita and/or wrapped or rolled sandwiches and which is located within three (3) miles of either (1) ________ [Insert address of employment], or (2) any such other JIMMY JOHN’S Sandwich Shop operated by

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JJF, one of its authorized franchisees, or any of JJF’s affiliates . . . .

Costs and Attorney’s Fees. Employee agrees to reimburse Employer and JJF for all costs and expenses, including attorney’s fees, that Employer or JJF incur to enforce this Agreement against Employee.

Speculate on what counter-assertions you would make if you represented a sandwich shop employer like Jimmy John‘s Sandwich Shops in this situation such as the hypothetical employer stating it never enforces these noncompete agreements; it pays full market wage rates; and it provides a fun no hassle working environment. Now, assuming the role as judge, deny or grant an injunction similar to that sought by Attorney General Madigan.

Answer: Non-compete agreements for low wage workers. On December 7, 2016 the parties, Jimmy John‘s and the State of Illinois, announced a settlement in which the company agreed to notify all current and former employees that their non-compete agreements are unenforceable and Jimmy John‘s does not intend to enforce them. And, as set forth in the text effective January 1, 2017 the Illinois Freedom to Work Act banned the use of non-compete agreements for those earning less than $13.50 per hour.

As to how most states would handle the non-compete clause language of two years, it is quite likely to be considered an unreasonably long time to restrict a sandwich maker or delivery person from these classifications of work. The restrictive language on sandwich makers or delivery persons restricting them from doing work not previously part of their work assignments, such as being an officer, manager, principal, or agent would be considered ―overbroad‖ and unenforceable in most states.

The threat of ―costs and attorney fees‖ is very impactful on a working person who may not know that such a clause is now unlawful in Illinois for a person earning less than $13.50 per hour.

10. All new employees of Circuit City Stores were required to sign a Dispute Resolution Agreement (DRA) mandating that employees submit all employment- related disputes to arbitration. Under the DRA, Circuit City was not obligated to arbitrate its claims against employees and may bring lawsuits against employees. Remedies are limited under the DRA, including a one-year back pay limit and a two-year front pay limit, with cap on punitive damages of an amount up to the greater of the amount of back pay and front pay awarded or $5,000. In a civil lawsuit under state law a plaintiff is entitled to all forms of relief. The DRA requires that employees split the cost of the arbitrator‘s fees with the

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employer. An individual is not required to pay for the services of a judge. Adams filed a sexual harassment case against his employer in state court. Circuit City filed a petition in federal court to compel arbitration. Decide. [Circuit City Stores, Inc. v. Adams, 274 F.3d 889 (9th Cir.)] Answer: Arbitration requirements; unconscionable clauses. Judgment for Adams. The arbitration provision is unenforceable. The DRA is procedurally unconscionable because it is a contract of adhesion drafted by the party with superior bargaining power, which relegated to the other party the option of either adhering to its terms without modification or rejecting the contract entirely.

The DRA is substantively unconscionable because employees must arbitrate ―any and all employment-related claims‖ while Circuit City was not obligated to arbitrate its claims against employees and may bring lawsuits against employees, thus depriving the DRA of any modicum of bilaterality. Moreover, the remedies were limited under the DRA, including one year back pay limit and a two-year front pay limit, with cap on punitive damages of an amount up to the greater of the amount of back pay and front pay awarded or $5,000. The DRA required that the employee split the cost of the arbitrator‘s fees with the employer while an individual would not be required to pay half of the cost of a judge. [Circuit City Stores, Inc. v. Adams, 274 F.3d 889 (9th Cir.)] 11. Vodra was employed as a salesperson and contracting agent for American Security Services. As part of his contract of employment, Vodra signed an agreement that for three years after leaving this employment, he would not solicit any customer of American. Vodra had no experience in the security field when he went to work for American. To the extent that he became known to American‘s customers, it was because of being American‘s representative rather than because of his own reputation in the security field. After some years, Vodra left American and organized a competing company that solicited American‘s customers. American sued him to enforce the restrictive covenant. Vodra claimed that the restrictive covenant was illegal and not binding. Was he correct? [American Security Services, Inc. v. Vodra, 385 N.W.2d 73 (Neb.)] Answer: Validity of anticompetitive contract. No. American had a legitimate interest in protecting its goodwill by preventing Vodra from soliciting its customers. The three-year restraint imposed by the contract was not unreasonable and did not go beyond what was reasonably necessary for the protection of the legitimate interest of the employer. The restriction was therefore valid. [American Security Services, Inc. v. Vodra, 385 N.W. 2d 73 (Neb.)]

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12. Potomac Leasing Co. leased an automatic telephone system to Vitality Centers. Claudene Cato signed the lease as guarantor of payments. When the rental was not paid, Potomac Leasing brought suit against Vitality and Cato. They raised the defense that the rented equipment was to be used for an illegal purpose—namely, the random sales solicitation by means of an automatic telephone in violation of state statute; that this purpose was known to Potomac Leasing; and that Potomac Leasing could therefore not enforce the lease. Was this defense valid? [Potomac Leasing Co. v. Vitality Centers, Inc., 718 S.W.2d 928 (Ark.)] Answer: Knowledge of illegal purpose of other contracting party. No. The plaintiff has not in any way participated in the commission of a crime. The mere act of leasing the goods did not constitute a crime, and the transaction was not made illegal because of the lessor‘s knowledge of the lessee‘s intent to use the property in an unlawful manner. This was so because the contemplated crime was not a major crime, and therefore, the lessor would be allowed to enforce the terms of the lease and to obtain payment. The court indicated that the lessor would not be allowed to do so if the contemplated crime had been a major crime. [Potomac Leasing Co. v. Vitality Centers, Inc., 718 S.W. 2d 928 (Ark.)] 13. The English publisher of a book called Cambridge gave a New York publisher permission to sell that book any place in the world except in England. The New York publisher made several bulk sales of the book to buyers who sold the book throughout the world, including England. The English publisher sued the New York publisher and its customers for breach of the restriction prohibiting sales in England. Decide.

Answer: Narrow construction of restrictive covenants. The restrictive covenant only prohibited the New York publisher from selling the book in England. The customers of the New York publisher were therefore not bound by the sales contract. The New York publisher sold to its customers without requiring them to agree to comply with the restriction that the English publisher had imposed on the New York firm. The New York publisher was not required by its contract to impose such a restriction on its customers.

Consequently, the New York publisher was not responsible for the selling practices of its customers, and the customers were not bound by any contract to refrain from selling in England.

This can be used to illustrate the importance of looking ahead to see whether the contract a party makes will really cover the future situations that are likely to arise.

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14. Sandra Menefee sued Geographic Expeditions, Inc. (GeoEx), for the wrongful death of her son while on a GeoEx expedition up Mount Kilimanjaro. GeoEx moved to compel arbitration under the parties‘ limitation of liability contract. GeoEx designed its arbitration clause to limit the plaintiffs‘ recovery and required them to indemnify GeoEx for its legal costs and fees if they unsuccessfully pursued any claim covered by the release agreement.

Moreover, GeoEx required that plaintiffs pay half of any mediation fees and arbitrate in San Francisco, GeoEx‘s choice of venue, as opposed to the plaintiffs‘ home in Colorado.

Should the court require the Menefees to arbitrate? If any component of the arbitration clause is found to be unconscionable, should the court simply sever the objectionable provision and enforce the remainder of the arbitration clause? [Lhotka v. Geographic Expeditions, Inc., 104 Cal. Rptr. 3d 844 (Cal. App. 2010)] Answer: Unconscionable clauses. The court found the arbitration provision to be procedural and substantively unconscionable and refused to sever the objectionable clause, because GeoEx sought to create an inferior forum in the litigation that would give GeoEx an advantage. [Lhotka v. Geographic Expeditions, Inc., 104 Cal. Rptr. 3d 844 (Cal. App. 2010)] 15. Yarde Metals, Inc., owned six season tickets to New England Patriots football games.

Gillette Stadium, where the games are played, had insufficient men‘s restrooms in use for football games at that time, which was the subject of numerous newspaper columns. On October 13, 2002, a guest of Yarde Metals, Mikel LaCroix, along with others, used available women‘s restrooms to answer the call of nature. As LaCroix left the restroom, however, he was arrested and charged with disorderly conduct. The Patriots organization terminated all six of Yarde‘s season ticket privileges, incorrectly giving as a reason that LaCroix was ejected ―for throwing bottles in the seating section.‖ Yarde sued, contending that ―by terminating the plaintiff‘s season tickets for 2002 and for the future arbitrarily, without cause and based on false information,‖ the Patriots had violated the implicit covenant of good faith and fair dealing of the season tickets contract. The back of each Patriots ticket states: This ticket and all season tickets are revocable licenses. The Patriots reserve the right to revoke such licenses, in their sole discretion, at any time and for any reason.

How would you decide this case? [Yarde Metals, Inc. v. New England Patriots Ltd., 834 N.E.2d 1233 (Mass. App.)] Answer: Good faith and fair dealing. While every contract has an implied obligation of

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good faith and fair dealing that neither party shall do anything to destroy the rights of the other party under the contract, the season ticket holder has no contractual right to renew.

As stated on the back of the ticket and in other promotional materials, Yarde‘s rights were nothing more than a revocable license, which the Patriots reserved the right to revoke at any time for any reason. Even though the Patriot‘s action seems harsh in this case, Yarde was not able to present a contractual basis to prevail in this lawsuit. [Yarde Metals, Inc. v.

New England Patriots Ltd., 834 N.E.2d 1233 (Mass. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

West, an Indiana real estate broker, misrepresented to Zimmer that West was licensed in Kansas under the Kansas statute that regulates real estate brokers and requires all brokers to be licensed. Zimmer signed a contract agreeing to pay West a 5 percent commission for selling Zimmer‘s home in Kansas. West did not sign the contract. West sold Zimmer‘s home. If West sued Zimmer for nonpayment of commission, Zimmer would be: a.

Liable to West only for the value of services rendered.

b.

Liable to West for the full commission.

c.

Not liable to West for any amount because West did not sign the contract.

d.

Not liable to West for any amount because West violated the Kansas licensing requirements (5/92, Law, #25).

2.

Blue purchased a travel agency business from Drye. The purchase price included payment for Drye‘s goodwill. The agreement contained a covenant prohibiting Drye from competing with Blue in the travel agency business. Which of the following statements regarding the covenant is not correct? a.

The restraint must be no more extensive than is reasonably necessary to protect the goodwill purchased by Blue.

b.

The geographic area to which it applies must be reasonable.

c.

The time period for which it is to be effective must be reasonable.

d.

The value to be assigned to it is the excess of the price paid over the seller’s cost of all tangible assets (11/87, Law, #2).

[return to top]

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Solution and Answer Guide:

Answers to AICPA Questions 1.

West, an Indiana real estate broker, misrepresented to Zimmer that West was licensed in Kansas under the Kansas statute that regulates real estate brokers and requires all brokers to be licensed. Zimmer signed a contract agreeing to pay West a 5 percent commission for selling Zimmer‘s home in Kansas. West did not sign the contract. West sold Zimmer‘s home. If West sued Zimmer for nonpayment of commission, Zimmer would be: a.

Liable to West only for the value of services rendered.

b.

Liable to West for the full commission.

c.

Not liable to West for any amount because West did not sign the contract.

d.

Not liable to West for any amount because West violated the Kansas licensing requirements (5/92, Law, #25).

(d) There are two types of licensing statutes. First, there are licensing statutes intended primarily for revenue raising. Second, there are licensing statutes (regulatory) intended primarily to protect the public against dishonest or incompetent professionals. An individual without a license can collect his total compensation if the primary purpose of the statute was to raise revenue. However, if the purpose was regulatory in nature (intended to protect the public), the individual can collect nothing since the contract is voidable. Thus, an unlicensed individual who enters into a contract to provide regulated services will not be allowed to enforce the contract or recover even the value of the services rendered.

2.

Blue purchased a travel agency business from Drye. The purchase price included payment for Drye‘s goodwill. The agreement contained a covenant prohibiting Drye from competing with Blue in the travel agency business. Which of the following statements regarding the covenant is not correct? a.

The restraint must be no more extensive than is reasonably necessary to protect the goodwill purchased by Blue.

b.

The geographic area to which it applies must be reasonable.

c.

The time period for which it is to be effective must be reasonable.

d.

The value to be assigned to it is the excess of the price paid over the seller’s cost of all tangible assets (11/87, Law, #2).

(d) Answer (a), (b), and (c) are correct statements because covenants not to compete must be reasonable in time and geographic scope. The answer is (d) because it is an incorrect statement regarding the value of goodwill.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 16: Writing, Electronic Forms, and Interpretation of Contracts

[return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 16: Writing, Electronic Forms, and Interpretation of Contracts

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 130 Questions and Case Problems .......................................................................................................... 130 End of Chapter: CPA Questions and Answers ................................................................................. 137 Answers to AICPA Questions ............................................................................................................ 138

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Kelly made a written contract to sell certain land to Brown and gave Brown a deed to the land. Thereafter, Kelly sued Brown to get back a 20-foot strip of the land. Kelly claimed that before making the written contract, it was agreed that Kelly would sell all of his land to Brown to make it easier for Brown to get a building permit, but after that was done, the 20-foot strip would be reconveyed to Kelly. Was Kelly entitled to the 20-foot strip? What ethical values are involved? [Brown v. Kelly, 545 So. 2d 518 (Fla. App.)] Answer: Effect of written contract on prior oral agreement. No. The written contract made by the parties displaced any prior oral agreement that they may have made with respect to the twenty-foot strip. Consequently, even if there was an oral agreement, as claimed by Kelly, that oral agreement was displaced when it was not included in the final written agreement. Therefore, the oral agreement could not be enforced.

The case involves the ethical values of integrity, truthfulness, and promise keeping.

Whether the decision is ethical presents a difficult question. If in fact the parties made the alleged agreement with respect to the twenty-foot strip, the decision reaches a bad result: it wipes out the agreement because the promise to reconvey is not kept. If, however, there never was such an agreement, the decision protects the other party to the contract from a fraudulent claim and upholds integrity and truthfulness in their bargain. [Brown v. Kelly, 545 So. 2d 518 (Fla. App.)]

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Solution and Answer Guide:

2.

Martin made an oral contract with Cresheim Garage to work as its manager for two years.

Cresheim wrote Martin a letter stating that the oral contract had been made and setting forth all of its terms. Cresheim later refused to recognize the contract. Martin sued Cresheim for breach of the contract and offered Cresheim‘s letter in evidence as proof of the contract. Cresheim claimed that the oral contract was not binding because the contract was not in writing and the letter referring to the contract was not a contract but only a letter. Was the contract binding?

Answer: What is required by ―evidenced by a writing‖. Yes. The requirement that a contract be evidenced by a writing does not mean that the contract itself must be in writing and signed by both parties. There is evidence of proof of the contract when there is a writing signed by the defendant or the authorized agent of the defendant, and the writing sets forth all the material terms of the contract. The letter written by Cresheim was such a writing and therefore evidenced the contract existing between Martin and Cresheim and thus satisfied the statute of frauds, even though it was not a contract signed by both parties.

3.

Lawrence loaned money to Moore, who died without repaying the loan. Lawrence claimed that when he mentioned the matter to Moore‘s widow, she promised to pay the debt. She did not pay it, and Lawrence sued her on her promise. Does she have any defense? [Moore v. Lawrence, 480 S.W.2d 941 (Ark.)] Answer: Statute of frauds; promise to pay debt of another. Yes. The widow has the defense that her promise was not binding because it was not evidenced by a writing, as required by the statute of frauds. [Moore v. Lawrence, 480 S.W. 2d 941 (Ark.)]

4.

Jackson signed an agreement to sell 79 acres of land to Devenyns. Jackson owned 80 acres and was apparently intending to keep for himself the acre on which his home was located.

The written agreement also stated that ―Devenyns shall have the option to buy on property ___,‖ but nothing was stated in the blank space. Devenyns sued to enforce the agreement. Was it binding? [In re Jackson’s Estate, 892 P.2d 786 (Wyo.)] Answer: Sufficiency of writing. The court held that leaving out the description of the land reserved out of the tract to be conveyed resulted in a contract that is too indefinite to enforce. Description of land is a must for contract to sell land‘s enforceability under the statute of frauds. [In re Jackson’s Estate, 892 P. 2d 786 (Wyo.)]

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131

Solution and Answer Guide:

5.

Boeing Airplane Co. contracted with Pittsburgh– Des Moines Steel Co. for the latter to construct a supersonic wind tunnel. R.H. Freitag Manufacturing Co. sold materials to YorkGillespie Co., which subcontracted to do part of the work. To persuade Freitag to keep supplying materials on credit, Boeing and the principal contractor both assured Freitag that he would be paid. When Freitag was not paid by the subcontractor, he sued Boeing and the contractor. They defended on the ground that the assurances given Freitag were not written. Decide. What ethical values are involved? [R.H. Freitag Mfg. Co. v. Boeing Airplane Co., 347 P.2d 1074 (Wash.)]

Answer: Primary purpose exception to statute of frauds. Judgment for Freitag. The promise to pay the bills of the subcontractor was made by the defendants primarily for their benefit in order to keep the work progressing so that they in turn would not be held liable for failure to complete. Hence, the case came within the primary benefit exception to the written guaranty provision of the statute of frauds.

The ethical values of promise keeping, and integrity are involved. The statute of frauds leaves us with the question of whether it is ethical to require a person to keep a serious promise. Boeing made the promise to benefit itself rather than to benefit another.

Consequently, the statute of frauds exception applies, and Boeing is required to keep its oral promise to pay. [R.H. Freitag Mfg. Co. v. Boeing Airplane Co., 347 P. 2d 1074 (Wash.)]

6.

Louise Pulsifer owned a farm that she wanted to sell and ran an ad in the local newspaper.

After Russell Gillespie agreed to purchase the farm, Pulsifer wrote him a letter stating that she would not sell it. He sued her to enforce the contract, and she raised the defense of the statute of frauds. The letter she had signed did not contain any of the terms of the sale. Gillespie, however, claimed that the newspaper ad could be combined with her letter to satisfy the statute of frauds. Was he correct? [Gillespie v. Pulsifer, 655 S.W.2d 123 (Mo.)] Answer: Integration of separate writing to satisfy statute of frauds. No. The ad could not be combined with the signed letter because there was nothing in either of them to link it to the other. In the absence of an express internal link, separate papers cannot be combined.

[Gillespie v. Pulsifer, 655 S.W. 2d 123 (Mo.)]

7.

In February or March, Corning Glass Works orally agreed to retain Hanan as management consultant from May 1 of that year to April 30 of the next year for a present value fee of $200,000. Was this agreement binding? Is this decision ethical? [Hanan v. Corning Glass Works, 314 N.Y.S.2d 804 (A.D.)]

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Solution and Answer Guide:

Answer: Statute of frauds and contracts that cannot be performed within one year. There is a contract between the parties, but it is not enforceable in court because it is not in writing. The contract needed to be in writing because the performance was not to take place within one year from the making of the oral contract.

This decision would appear to be unethical, as ethics would require that a person keep a promise made to another person. This decision is technically correct as a matter of law because it follows the requirements of the statute of frauds. The legislature is not exclusively concerned with the right and wrong of a given situation. The legislature is concerned with the effect of a rule of law on society as a whole. When the legislature adopted the statute of frauds, it was believed that more false claims of promise than bona fide claims would be defeated by the statute. Obviously, the statute of frauds prevents judicial help to claims of certain oral contracts, even if such claims are truthful. If false claims are defeated more frequently than good claims, the statute of frauds provides greater protection from the standpoint of the general welfare of society than would be provided without the statute of frauds. Whether the statute of frauds is good or bad cannot be readily determined by any scientific study. [Hanan v. Corning Glass Works, 314 N.Y. S.2d 804 (App. Div.)] 8.

Catherine (wife) and Peter (husband) Mallen had lived together unmarried for some four years when Catherine got pregnant and a marriage was arranged. Peter asked Catherine to sign a prenuptial agreement. Although his financial statement attached to the agreement did not state his income at $560,000 per year, it showed he was wealthy, and she had lived with him for four years and knew from their standard of living that he had significant income. Catherine contends that failure to disclose Peter‘s income was a nondisclosure of a material fact when the agreement was drawn up and that accordingly the agreement is not valid. Peter contends that he fully disclosed his net worth and that Catherine was well aware of his significant income. Further, he contends that disparities in the parties‘ financial status and business experience did not make the agreement unconscionable.

Decide. [Mallen v. Mallen, 622 S.E.2d 812 (Ga. Sup. Ct.)] Answer: Prenuptial agreements [§ 0]. The record shows that the husband‘s net worth, as of 2002, appeared to be approximately $22,700,000. After eighteen years of marriage and the birth of four children, the husband filed an action for divorce in 2003 and sought to enforce the prenuptial agreement. The trial court held the prenuptial agreement enforceable ruling in accordance with the agreement that the wife was entitled to $2,900 per month in alimony for four years and the husband was entitled to all the assets which he entered the marriage and all assets accumulated during the marriage. The state

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133

Solution and Answer Guide:

Supreme Court majority upheld the decision, with three justices dissenting because of the nondisclosure of a material fact, Mr. Mallen‘s income. The prenuptial agreement provides that, in the event of a divorce, Ms. Mallen would be entitled to $1,000 per month in alimony, to be increased $100 a month for each year of the parties‘ marriage, with Ms. Mallen‘s right to alimony to terminate four years after the date of the parties‘ divorce decree. Because a party‘s income is a critical factor in determining the appropriate amount of alimony the dissent expressed the view that Mr. Mallen‘s income was material to the prenuptial agreement and should not be enforced. [Mallen v. Mallen, 622 S.E. 2d 812 (Ga. Sup. Ct.)] 9.

Panasonic Industrial Co. (PIC) created a contract making Manchester Equipment Co., Inc. (MECI), a nonexclusive wholesale distributor of its products. The contract stated that PIC reserved the unrestricted right to solicit and make direct sales of the products to anyone, anywhere. The contract also stated that it contained the entire agreement of the parties and that any prior agreement or statement was superseded by the contract. PIC subsequently began to make direct sales to two of MECI‘s established customers. MECI claimed that this was a breach of the distribution contract and sued PIC for damages.

Decide. What ethical values are involved? [Manchester Equipment Co. Inc. v. Panasonic Industrial Co., 529 N.Y.S.2d 532 (App. Div.)] Answer: Interpretation according to unambiguous terms. Judgment for PIC. The contract expressly stated that PIC had unlimited right to sell where it chose. No exception was made that PIC should not sell to established customers of MECI. Therefore, the act of selling to the established customers of MECI did not constitute a breach of the contract.

Avoidance of hardship is probably not applicable in this case because there is no indication that PIC was a much stronger party taking advantage of MECI, a much weaker party. MECI is a corporation, and the contract with PIC was undoubtedly reviewed by someone within the organization or its attorney, and whoever reviewed the document must have understood this clear and unambiguous language. MECI should have understood the risk involved in becoming a wholesale distributor of PIC products. It simply appears that MECI made a bad bargain with PIC. This case shows that the mere fact that a hardship exists does not determine the result of the case. PIC acted within the authority of the express terms of the contract. A court could not imply an antihardship provision without first eliminating or invalidating in some way the clauses within which PIC acted. The court might have declared those clauses unconscionable but chose not to do so.

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Solution and Answer Guide:

The ethical values of fairness and doing no economic harm are involved in this case. It is uncertain whether either party thought, at the time of contracting, that the ―freedom to sell‖ provision gave PIC the right to sell to customers of MECI. Certainly, if MECI thought that this was the case, it would have objected to the provision. On the other hand, MECI may have been very lax in its review of the contract prior to signing it. The social force of stability leads to the conclusion that a contract means what it says, even though at the time of contracting the parties might not have considered the situation that thereafter arose. Both parties agreed to the broad language of ―anyone,‖ and stability of contracts is furthered by giving that phrase the meaning that the word has. [Manchester Equipment Co. Inc. v. Panasonic Industrial Co., 529 N.Y. S.2d 532 (App. Div.)] 10. A University of South Carolina brochure offered Gamecock Club members the opportunity to purchase premium seating for upcoming basketball seasons for five years for the charge of $5,000 per seat for the first year, and $1,500 per seat for the following four years to be paid in addition to the value of each ticket. Thereafter, they would only be required to pay the face value of each ticket to retain their premium seats. When members were charged an additional $1,500 for their premium seats in the sixth year, the matter was litigated, with the university contending that there was no formal contract signed by the parties in compliance with the statute of frauds. The members contend that the university logo on the brochure is a valid legal signature. [Springola v. University of South Carolina, 757 S.E.2d 384 (S.C.2014)] Answer: Statute of frauds, signature of party to be charged. The presence or absence of the university‘s signature turned on whether the university logo on the brochures suffices for a legal signature. The court majority found that the logo did not constitute a legal signature.

However, Justice Pleicones admonished the court majority to be circumspect in holding that a logo can never constitute a signature for the purposes of the statute of frauds.

[Springola v. University of South Carolina,757 S.E.2d 384 (S.C. 2014)] 11. Consolidated Credit Counseling Services, Inc. (Consolidated), sued Affinity Internet, Inc., doing business as SkyNetWEB (Affinity), for breach of its contract to provide computer and Web hosting services. Affinity moved to compel arbitration, and Consolidated argued that the contract between the parties did not contain an arbitration clause. The contract between the parties stated in part: ―This contract is subject to all of SkyNetWEB‘s terms, conditions, user and acceptable use policies located at http://www.skynetweb. com/company/legal/legal.php.‖ An arbitration provision can be found by going to the Web site and clicking to paragraph 17 of the User Agreement. The contract itself makes no reference to an agreement to arbitrate, nor was paragraph 17 expressly referred to or

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Solution and Answer Guide:

described in the contract. Nor was a hard copy of the information on the Web site either signed by or furnished to Consolidated. Was Consolidated obligated to arbitrate under the clear language of paragraph 17? [Affinity Internet v. Consolidated Credit, 920 So. 2d 1286 (Fla. App.)] Answer: In corporation by reference. No. Consolidated was not obligated to arbitrate the dispute under paragraph 17. Mere reference to another document is not sufficient to incorporate that document into the contract absent specificity describing the portion of the writing to apply to the contract. [Affinity Internet v. Consolidated Credit, 920 So. 2d 1286 (Fla. App.) 12. Physicians Mutual Insurance Co. issued a policy covering Brown‘s life. The policy declared that it did not cover any deaths resulting from ―mental disorder, alcoholism, or drug addiction.‖ Brown was killed when she fell while intoxicated. The insurance company refused to pay because of the quoted provision. Her executor, Savage, sued the insurance company. Did the insurance company have a defense? [Physicians Mutual Ins. Co. v.

Savage, 296 N.E.2d 165 (Ind. App.)] Answer: Meaning of words in a contract. No. The only evidence was that the insured was intoxicated at the time of the fatal occurrence. This did not affect the liability of the insurer, as it did not prove ―alcoholism.‖ The latter, by the dictionary meaning and ordinary usage, means the continued and excessive use of alcohol. This was not shown by proof of being drunk on one occasion. Therefore, the exception was not operative, and the insurance company was required to pay. [Physicians Mutual Ins. Co. v. Savage, 296 N.E. 2d 165 (Ind. App.)] 13. The Dickinson Elks Club conducted an annual Labor Day golf tournament. Charbonneau Buick-Pontiac offered to give a new car as a prize to anyone making ―a hole in one on hole no. 8.‖ The golf course of the club was only nine holes. To play 18 holes, the players would go around the course twice, although they would play from different tees or locations for the second nine holes. On the second time around, what was originally the eighth hole became the seventeenth hole. Grove was a contestant in the tournament. He scored 3 on the no. 8 hole, but on approaching it for the second time as the seventeenth hole, he made a hole in one. He claimed the prize car from Charbonneau. The latter claimed that Grove had not won the prize because he did not make the hole in one on the eighth hole.

Decide. [Grove v. Charbonneau Buick-Pontiac, Inc., 240 N.W.2d 8533 (N.D.)] Answer: Interpretation standards. Judgment for Grove. The Court held that the offer made

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Solution and Answer Guide:

by Charbonneau was ambiguous in that it could refer either to making the hole in one as the hole on the first time around the course, or to making the hole in one in the same cup on the 8th hole on the second time around the course, when it would be the 17th hole. As Charbonneau had specified the terms, this ambiguity would be interpreted against it and in favor of Grove. The prize contract was therefore satisfied by making the hole in one on either the first or second time around the course. Since Grove had done this, he satisfied the terms of the contract and was entitled to the prize according to the court. [Grove v.

Charbonneau Buick-Pontiac, Inc., 240 N.W. 2d 8533 (N.D.)] Authors’ Comments: Students may enjoy discussing the correctness of the court‘s decision in this case. A view supporting Charbonneau Buick follows. A contract is ambiguous if the words used can support the two different meanings asserted by the disputing parties. A golf ―hole‖ consists of the designated starting position at the tee box markers and concludes when the ball enters the cup. The 17th golf hole had a different starting position than the 8th hole. There is no way that the terms "a hole in one on hole no. 8" can hold the meaning that the striking the ball from the 17th tee markers, on the participants 17th hole as designated on his score card, is a ―hole in one on hole no. 8". If the words used in the offer are not ambiguous, then the rule of construing an ambiguity against the drafting party does not apply.

14. Tambe Electric Inc. entered into a written agreement with Home Depot to provide copper wire to Tambe at a price set forth in the writing, and allowing the contractor the option of paying for the wire over a period of time. Home Depot did not fulfill this written agreement and Tambe sued for $68,598, the additional cost it had to subsequently pay to obtain copper wire for its work. Home Depot defended that it had made an oral condition precedent requiring payment in full by Tambe at the time it accepted the price quoted in the written agreement. Decide. [Tambe Electric v. Home Depot, 856 N.Y.S.2d 373] Answer: Parol evidence rule § 5. Judgment for Tambe Electric. The parol evidence of an oral condition precedent requiring payment in full at the time of the acceptance was at variance with the written agreement which expressly gave Tambe the option of purchasing the goods with payment being made over a period of time. [Tambe Electric v. Home Depot, 856 N.Y. S.2d 373)] [return to top] End of Chapter: CPA Questions and Answers

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137

Solution and Answer Guide:

Correct answers in boldface.

1.

Which of the following statements is true with regard to the statute of frauds? a.

All contracts involving consideration of more than $500 must be in writing.

b.

The written contract must be signed by all parties.

c.

The statute of frauds applies to contracts that can be fully performed within one year from the date they are made.

d.

2.

The contract terms may be stated in more than one document.

With regard to an agreement for the sale of real estate, the statute of frauds: a.

Requires that the entire agreement be in a single writing.

b.

Requires that the purchase price be fair and adequate in relation to the value of the real estate.

3.

c.

Does not require that the agreement be signed by all parties.

d.

Does not apply if the value of the real estate is less than $500.

In negotiations with Andrews for the lease of Kemp‘s warehouse, Kemp orally agreed to pay one-half of the cost of the utilities. The written lease, later prepared by Kemp‘s attorney, provided that Andrews pay all of the utilities. Andrews failed to carefully read the lease and signed it. When Kemp demanded that Andrews pay all of the utilities, Andrews refused, claiming that the lease did not accurately reflect the oral agreement. Andrews also learned that Kemp intentionally misrepresented the condition of the structure of the warehouse during the negotiations between the parties. Andrews sued to rescind the lease and intends to introduce evidence of the parties‘ oral agreement about sharing the utilities and the fraudulent statements made by Kemp. Will the parol evidence rule prevent the admission of evidence concerning each of the following?

Oral agreement

Fraudulent

regarding who

statements by

pays the utilities

Kemp

a.

Yes

Yes

b.

No

Yes

c.

Yes

No

d.

No

No

[return to top] Answers to AICPA Questions

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138

Solution and Answer Guide:

1.

Which of the following statements is true with regard to the statute of frauds? a.

All contracts involving consideration of more than $500 must be in writing.

b.

The written contract must be signed by all parties.

c.

The statute of frauds applies to contracts that can be fully performed within one year from the date they are made.

d.

The contract terms may be stated in more than one document.

(d) The contract terms need not appear in a single document so long as the several documents refer to the same transaction. Only the signature of the party against whom enforcement is sought is required. If the performance could occur within a one-year period, the contract is not within the statute and need not be written. Only contracts of $500 or more that involve the sale of goods fall under the Statute of Fraud and must be in writing.

2.

With regard to an agreement for the sale of real estate, the statute of frauds: a.

Requires that the entire agreement be in a single writing.

b.

Requires that the purchase price be fair and adequate in relation to the value of the real estate.

c.

Does not require that the agreement be signed by all parties.

d.

Does not apply if the value of the real estate is less than $500.

(c) The Statute of Frauds requires only that the written contract be signed by the party to be charged, not by all parties to the contract. Answer (a) is incorrect because it is not required that the contract be formalized in a single writing. Two or more documents can be combined to create a sufficient writing to satisfy the Statute of Frauds as long as one of the documents refers to the others. Answer (b) is incorrect because the Statute of Frauds does not require consideration to be fair and adequate. Answer (d) is incorrect because while the Statute of Frauds is applicable to the sale of goods only if the purchase price is $500 or more, it is always applicable to the sale of real estate, regardless of purchase price.

3.

In negotiations with Andrews for the lease of Kemp‘s warehouse, Kemp orally agreed to pay one-half of the cost of the utilities. The written lease, later prepared by Kemp‘s attorney, provided that Andrews pay all of the utilities. Andrews failed to carefully read the lease and signed it. When Kemp demanded that Andrews pay all of the utilities, Andrews refused, claiming that the lease did not accurately reflect the oral agreement. Andrews also learned that Kemp intentionally misrepresented the condition of the structure of the

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139

Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 17: Third Persons and Contracts

warehouse during the negotiations between the parties. Andrews sued to rescind the lease and intends to introduce evidence of the parties‘ oral agreement about sharing the utilities and the fraudulent statements made by Kemp. Will the parol evidence rule prevent the admission of evidence concerning each of the following?

Oral agreement

Fraudulent

regarding who

statements by

pays the utilities

Kemp

a.

Yes

Yes

b.

No

Yes

c.

Yes

No

d.

No

No

(c) The parol evidence rule will prevent the admission of evidence concerning the oral agreements regarding who pays the utilities, since the rule excludes evidence of prior or contemporaneous oral agreements, which would vary the written contract.

However, the parol evidence rule will not prevent the admission of the fraudulent statements by Kemp during the original negotiations. Therefore, answers (a), (b), and (d) are incorrect. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 17: Third Persons and Contracts

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 140 Questions and Case Problems .......................................................................................................... 140 End of Chapter: CPA Questions and Answers ................................................................................. 146 Answers to AICPA Questions ............................................................................................................ 147

Answers to the End-of-Chapter Questions Questions and Case Problems

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140

Solution and Answer Guide:

1.

Give an example of a third-party beneficiary contract.

Third party beneficiary contracts. A life insurance policy is an example of a third-party beneficiary contract. The insured is the obligee, who obtains the promise of the insurer, the obligor, to pay the amount of the policy to the beneficiary on the death of the insured.

Here, the intent to benefit the third person, the beneficiary of the policy, is very clear because the insurer is not obligated to render any significant service to the insured.

Answer: Authors’ Comment: It may also be noted that the death of the insured is a condition precedent to the obligation of the insurer to make payment of the policy. At the time, the only person in existence who can receive the benefit of the insurance is the beneficiary, so the intent to benefit the beneficiary is unusually strong.

Note that it is stated that during the life of the insured, the insurer is not obligated to render any ―significant service‖ to the insured. The insured typically has the right to surrender the policy for its cash surrender value or to borrow from the insurer up to that amount. Ordinarily, however, persons do not procure insurance on their lives for the purpose of obtaining such ―fringe‖ benefits; so, for practical purposes, benefiting the third party, the policy beneficiary, is the object of the contract parties.

2.

A court order required John Baldassari to make specified payments for the support of his wife and child. His wife needed more money and applied for Pennsylvania welfare payments. In accordance with the law, she assigned to Pennsylvania her right to the support payments from her husband. Pennsylvania then increased her payments.

Pennsylvania obtained a court order directing John, in accordance with the terms of the assignment from his wife, to make the support-order payments directly to the Pennsylvania Department of Public Welfare. John refused to pay on the ground that he had not been notified of the assignment or the hearing directing him to make payment to the assignee. Was he correct? [Pennsylvania v. Baldassari, 421 A.2d 306 (Pa. Super.)]

Answer: What constitutes an assignment. No. The assignment of the right to money was effective between the wife and Pennsylvania as soon as it was made, and therefore it did not matter that John was not notified of the assignment. Nor did it matter that John was not notified of the hearing directing him to pay the Department of Public Welfare, as the order merely identified who was to be paid and stated that it was John‘s obligation to pay because of the assignment. [Pennsylvania v. Baldassari, 421 A. 2d 306 (Pa. Super.)]

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Solution and Answer Guide:

3.

Lee contracts to paint Sally‘s two-story house for $2,500. Sally realizes that she will not have sufficient money, so she transfers her rights under this agreement to her neighbor Karen, who has a three-story house. Karen notifies Lee that Sally‘s contract has been assigned to her and demands that Lee paint Karen‘s house for $2,500. Is Lee required to do so?

Answer: Assignability of a right to performance. No. The right assigned called for the performance of personal services. Such a right cannot be assigned without the consent of the person who is to render the personal services. This is particularly true in this case, because this type of assignment, if allowed, would ordinarily increase the burden of performance; ordinarily, it is a greater burden to paint a three-story house than a two-story house.

4.

Assume that Lee agrees to the assignment of the house-painting contract to Karen as stated in question 3. Thereafter, Lee fails to perform the contract to paint Karen‘s house.

Karen sues Sally for damages. Is Sally liable?

Answer: Warranties of assignor. No. An assignor does not warrant that the obligor will pay or perform as required by the contract. An assignor who does not receive consideration for the assignment does not make any warranty. While an assignor receiving consideration makes certain warranties as stated in the text, these warranties do not embrace a warranty that the obligor will perform.

Authors’ Comment: In a commercial setting, this problem is commonly met by having the assignor make an express statement in the assignment that the assignment is made with recourse, or the right to go back against the assignor if the obligor defaults. As another variation, the assignment may provide that when the obligor on any assigned contract defaults in making payments, the assignor will buy back the assigned contract from the assignee. The assignor is willing to make the ―with recourse‖ or ―repurchase‖ assignment because the assignee will then pay more for the assignment because the risk is less.

5.

Jessie borrows $1,000 from Thomas and agrees to repay the money in 30 days. Thomas assigns the right to the $1,000 to Douglas Finance Co. Douglas sues Jessie. Jessie argues that she had agreed to pay the money only to Thomas and that when she and Thomas had entered into the transaction, there was no intention to benefit Douglas Finance Co. Are these objections valid?

Answer: Distinction between a third-party beneficiary contract and an assignment. No.

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While the assignment transaction involves a third party, it is not a third-party beneficiary contract. An intent to benefit the third party is required only in the case of a third-party beneficiary contract. In the case of an assignment, there is typically no intention to benefit a third party, and in most instances, the obligor will have no thought of rights being transferred to a third person. The absence of a ―benefiting‖ intent is therefore immaterial to the validity of the assignment made by Thomas.

6.

Washington purchased an automobile from Smithville Motors. The contract called for payment of the purchase price in installments and contained the defense preservation notice required by the Federal Trade Commission regulation. Smithville assigned the contract to Rustic Finance Co. The car was always in need of repairs, and by the time it was half paid for, it would no longer run. Washington canceled the contract. Meanwhile, Smithville had gone out of business. Washington sued Rustic for the amount she had paid Smithville. Rustic refused to pay on the grounds that it had not been at fault. Decide.

Answer: Consumer protection liability of assignee. Rustic was liable for the amount Washington paid Smithville. This liability is based on the consumer protection provision of the Federal Trade Commission Regulation. The fact that the assignee was not at fault was irrelevant.

7.

Helen obtained an insurance policy insuring her life and naming her niece Julie as beneficiary. Helen died, and about a year later the policy was found in her house. When Julie claimed the insurance money, the insurer refused to pay on the ground that the policy required that notice of death be given to it promptly following the death. Julie claimed that she was not bound by the time limitation because she had never agreed to it, as she was not a party to the insurance contract. Is Julie entitled to recover?

Answer: Limitations on third party beneficiary. No. Julie had only such rights as the policy created. The policy required notice promptly after death. The fact that she was not a party to the contract and had not agreed to the time limitation was irrelevant. She could enforce the contract only according to its terms. By those terms, the time limitation prevented recovery.

8.

Lone Star Life Insurance Co. agreed to make a longterm loan to Five Forty Three Land, Inc., whenever that corporation requested one. Five Forty Three wanted this loan to pay off its short-term debts. The loan was never made, as it was never requested by Five Forty Three, which owed the Exchange Bank & Trust Co. on a short-term debt. Exchange Bank then sued Lone Star for breach of its promise on the theory that the Exchange Bank was a third-

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party beneficiary of the contract to make the loan. Was the Exchange Bank correct?

[Exchange Bank & Trust Co. v. Lone Star Life Ins. Co, 546 S.W.2d 948 (Tex. App.)] Answer: Distinction between incidental and third-party beneficiaries. No. Exchange Bank was not a third-party beneficiary. When a lender agrees to lend a borrower money to pay the borrower‘s debts, there is at most an incidental benefit conferred on those debtors whose debts would thus be paid. The parties to the long-term loan did not make the contract for the purpose of benefiting the third persons. The agreement to make the loan was intended for the benefit of Five Forty Three. A creditor of Five Forty Three was at most an incidental beneficiary of the loan agreement. [Exchange Bank & Trust Co. v. Lone Star Life Ins. Co., 546 S.W. 2d 948 (Tex. App.)] 9.

The New Rochelle Humane Society made a contract with the city of New Rochelle to capture and impound all dogs running at large. Spiegler, a minor, was bitten by some dogs while in her schoolyard. She sued the school district of New Rochelle and the Humane Society. With respect to the Humane Society, she claimed that she was a thirdparty beneficiary of the contract that the Humane Society had made with the city. She claimed that she could therefore sue the Humane Society for its failure to capture the dogs that had bitten her. Was she entitled to recover? [Spiegler v. School District of the City of New Rochelle, 242 N.Y.S.2d 430] Answer: Distinction between an incidental beneficiary and a third-party beneficiary who may recover on contract. No. There was no intent on the part of the contracting parties that any person bitten by a stray dog would have the right to sue the Humane Society.

Members of the public were incidental beneficiaries of the contract. [Spiegler v. School District of the City of New Rochelle, 242 N.Y. S.2d 430]

10. Zoya operated a store in premises rented from Peerless. The lease required Zoya to maintain liability insurance to protect Zoya and Peerless. Caswell entered the store, fell through a trap door, and was injured. She then sued Zoya and Peerless on the theory that she was a third-party beneficiary of the lease requirement to maintain liability insurance.

Was she correct? [Caswell v. Zoya Intl, 654 N.E.2d 552 (Ill. App.)] Answer: Third party beneficiary (incidental). Linda Caswell could not collect as a beneficiary of the lease agreement. She was merely a visitor who fell through a trap door and was not an intended beneficiary of the lease between the store operator and store owner and had no standing to litigate the claim against the owner alleging that the owner had breached the lease provision requiring the operator to have liability insurance. The

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fact that it may have been obvious that a member of the public would be injured does not elevate those members of the public to beneficiary status. [Caswell v. Zoya Int'l, 654 N.E. 2d 552 (Ill. App.)] 11. Shannon Bakke entered into a contract with Magi- Touch Carpet One Floor & Home Inc. for the installation of floor tiles, a shower base, and home related products in a bathroom within Bakke‘s home. Magi-Touch arranged to have the shower base and tile installed by VA Solutions, LLC, an independent contractor. Bakke asserts the shower door was improperly installed, the improper installation resulted in the shower door imploding, and the implosion caused damage to property in and around the shower requiring the bathroom door and trim to be repaired. Magi-Touch refused to compensate Bakke for the repair work asserting VA Solutions was hired as an independent contractor and MagiTouch could not be held liable for the negligence of an independent contractor. Decide.

[Bakke v. Magi-Touch Carpet One Floor & Home, Inc., 920 N.W.2d 726 (N.D. 2018)] Answer: Delegation of performance. Here, Magi-Touch contracted to install floor tiles, a shower base, and related material with its performance being subject to the implied warranty of fitness for a particular purpose. A failure to satisfy the warranty of fitness for a particular purpose would be a breach of the contract between Magi-Touch and Bakke and give rise to a claim for breach of contract against Magi-Touch. While the agreement did not prevent Magi-Touch from engaging an independent contractor to do the installation, the hiring of an independent contractor does not relieve Magi-Touch from the performance of its obligations under the contract it had with Bakke, including the satisfaction of the implied warranty of fitness for a particular purpose. In summary, assuming Bakke properly asserted a claim for breach of the parties‘ contract, the delegation of Magi-Touch‘s obligation to provide labor to VA Solutions does not preclude a cause of action against Magi-Touch for a breach of the contract. [Bakke v. Magi-Touch Carpet One Floor & Home, Inc., 920 N.W.2d 726 (N.D. 2018)] 12. The Ohio Department of Public Welfare made a contract with an accountant to audit the accounts of health care providers who were receiving funds under the Medicaid program.

Windsor House, which operated six nursing homes, claimed that it was a third-party beneficiary of that contract and could sue for its breach. Was it correct? [Thornton v.

Windsor House, Inc., 566 N.E.2d 1220 (Ohio)] Answer: Third party beneficiary. The court held that a care provider subject to an audit of reimbursable costs under the Medicaid program is not an intended third-party beneficiary of the audit contract between the Ohio Department of Public Welfare and the auditor.

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[Thornton v. Windsor House, Inc., 566 N.E. 2d 1220 (Ohio)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

On August 1, Neptune Fisheries contracted in writing with West Markets to deliver to West 3,000 pounds of lobster at $4.00 a pound. Delivery of the lobsters was due October 1, with payment due November 1. On August 4, Neptune entered into a contract with Deep Sea Lobster Farms that provided as follows: ―Neptune Fisheries assigns all the rights under the contract with West Markets dated August 1 to Deep Sea Lobster Farms.‖ The best interpretation of the August 4 contract would be that it was:

2.

a.

Only an assignment of rights by Neptune.

b.

Only a delegation of duties by Neptune.

c.

An assignment of rights and a delegation of duties by Neptune.

d.

An unenforceable third-party beneficiary contract.

Graham contracted with the city of Harris to train and employ high school dropouts residing in Harris. Graham breached the contract. Long, a resident of Harris and a high school dropout, sued Graham for damages. Under the circumstances, Long will: a.

Win, because Long is a third-party beneficiary entitled to enforce the contract.

b.

Win, because the intent of the contract was to confer a benefit on all high school dropouts residing in Harris.

3.

c.

Lose, because Long is merely an incidental beneficiary of the contract.

d.

Lose, because Harris did not assign its contract rights to Long.

Union Bank lent $200,000 to Wagner. Union required Wagner to obtain a life insurance policy naming Union as beneficiary. While the loan was outstanding, Wagner stopped paying the premiums on the policy. Union paid the premiums, adding the amounts paid to Wagner‘s loan. Wagner died, and the insurance company refused to pay the policy proceeds to Union. Union may: a.

Recover the policy proceeds because it is a creditor beneficiary.

b.

Not recover the policy proceeds because it is a donee beneficiary.

c.

Not recover the policy proceeds because it is not in privity of contract with the insurance company.

d.

Not recover the policy proceeds because it is only an incidental beneficiary.

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[return to top] Answers to AICPA Questions 1.

On August 1, Neptune Fisheries contracted in writing with West Markets to deliver to West 3,000 pounds of lobster at $4.00 a pound. Delivery of the lobsters was due October 1, with payment due November 1. On August 4, Neptune entered into a contract with Deep Sea Lobster Farms that provided as follows: ―Neptune Fisheries assigns all the rights under the contract with West Markets dated August 1 to Deep Sea Lobster Farms.‖ The best interpretation of the August 4 contract would be that it was: a.

Only an assignment of rights by Neptune.

b.

Only a delegation of duties by Neptune.

c.

An assignment of rights and a delegation of duties by Neptune.

d.

An unenforceable third-party beneficiary contract.

(c) An assignment is rebuttably presumed to be an assignment of rights and a delegation of duties. Here, assignee Deep Sea Lobster Farms presumably could carry out the lobster delivery duties.

2.

Graham contracted with the city of Harris to train and employ high school dropouts residing in Harris. Graham breached the contract. Long, a resident of Harris and a high school dropout, sued Graham for damages. Under the circumstances, Long will: a.

Win, because Long is a third-party beneficiary entitled to enforce the contract.

b.

Win, because the intent of the contract was to confer a benefit on all high school dropouts residing in Harris.

c.

Lose, because Long is merely an incidental beneficiary of the contract.

d.

Lose, because Harris did not assign its contract rights to Long.

(c) Long is merely an incidental beneficiary—part of a large group that benefits from another‘s contract.

3.

Union Bank lent $200,000 to Wagner. Union required Wagner to obtain a life insurance policy naming Union as beneficiary. While the loan was outstanding, Wagner stopped paying the premiums on the policy. Union paid the premiums, adding the amounts paid to Wagner‘s loan. Wagner died, and the insurance company refused to pay the policy proceeds to Union. Union may: a.

Recover the policy proceeds because it is a creditor beneficiary.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 18: Discharge of Contracts

b.

Not recover the policy proceeds because it is a donee beneficiary.

c.

Not recover the policy proceeds because it is not in privity of contract with the insurance company.

d.

Not recover the policy proceeds because it is only an incidental beneficiary.

(a) Ordinarily the beneficiary in a life insurance policy is a donee beneficiary. However, since Union paid the premiums it is a creditor beneficiary. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 18: Discharge of Contracts

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 148 Questions and Case Problems .......................................................................................................... 148 End of Chapter: CPA Questions and Answers ................................................................................. 156 Answers to AICPA Questions ............................................................................................................ 157

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

CIT entered into a sale/leaseback contract with Condere Tire Corporation for 11 tire presses at Condere‘s tire plant in Natchez, Mississippi. Condere ceased making payments on these presses owned by CIT, and Condere filed for Chapter 11 bankruptcy. CIT thereafter contracted to sell the presses to Specialty Tires Inc. for $250,000. When the contract was made, CIT, Condere, and Specialty Tire believed that CIT was the owner of the presses and was entitled to immediate possession. When CIT attempted to gain access to the presses to have them shipped, Condere changed its position and refused to allow the equipment to be removed from the plant. When the presses were not delivered, Specialty sued CIT for damages for nondelivery of the presses, and CIT asserted the defense of impracticability. Decide. [Specialty Tires, Inc. v. CIT, 82 F. Supp. 2d 434 (W.D. Pa.)] Answer: Commercial impracticability. Judgment for CIT. The delivery of the presses to

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Specialty Tires Company was made impracticable by the actions of Condere in refusing to give up the presses. It was ―a bolt out of the blue‖ for both CIT and Specialty. It was not a risk that CIT should have expected to either bear or contract against. CIT is excused by the doctrine of impracticability from damages for nondelivery of the presses to date. The impracticability relieves the obligation for only so long as the impracticability lasts. CIT asserts it will perform when it receives possession of the presses. [Specialty Tires, Inc. v. CIT, 82 F. Supp. 2d 434 (W.D. Pa.)] 2.

Lymon Mitchell operated a Badcock Home Furnishings dealership, under which as dealer he was paid a commission on sales and Badcock retained title to merchandise on display.

Mitchell sold his dealership to another and to facilitate the sale, Badcock prepared a summary of commissions owed with certain itemized offsets it claimed that Mitchell owed Badcock. Mitchell disagreed with the calculations, but he accepted them and signed the transfer documents, closing the sale on the basis of the terms set forth in the summary, and was paid accordingly. After pondering the offsets taken by Badcock and verifying the correctness of his position, he brought suit for the additional funds owed. What defense would you expect Badcock to raise? How would you decide the case? Explain fully.

[Mitchell v. Badcock Corp., 496 S.E.2d 502 (Ga. App.)] Answer: Accord and satisfaction. Badcock raised the defense of ―accord and satisfaction.‖ Judgment for Badcock. Mitchell‘s claim asserting that Badcock‘s offsets were improper was precluded by an accord and satisfaction; when there was a dispute over the settlement amount, Mitchell accepted the disputed calculations as the amount owed him (accord) and executed the transfer documents and received payment (the satisfaction). [Mitchell v.

Badcock Corp., 496 S.E. 2d 502 (Ga. App.)]

3.

American Bank loaned Koplik $50,000 to buy equipment for a restaurant about to be opened by Casual Citchen Corp. The loan was not repaid, and Fast Foods, Inc., bought out the interest of Casual Citchen. As part of the transaction, Fast Foods agreed to pay the debt owed to American Bank, and the parties agreed to a new schedule of payments to be made by Fast Foods. Fast Foods did not make the payments, and American Bank sued Koplik. He contended that his obligation to repay $50,000 had been discharged by the execution of the agreement providing for the payment of the debt by Fast Foods. Was this defense valid? [American Bank & Trust Co. v. Koplik, 451 N.Y.S.2d 426 (A. D.)] Answer: Discharge by accord and satisfaction. No, this defense was not valid. Here, the February 1, 1979 agreement was not ―performed according to its terms‖ (General Obligations Law? 15-501[3]), inasmuch as only the initial $7,000 payment was made. Since

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the accord was never satisfied, Federal Deposit, as American Bank‘s receiver, retained its rights against defendants under their unlimited guaranties. They had the right to return to the original agreement. [American Bank & Trust Co. v. Koplik, 451 N.Y. S.2d 426 (App. Div.)] 4.

Richard Blitz owns a piece of commercial property at 4 Old Middle Street. Arthur Subklew entered into a lease with Blitz to rent the rear portion of the property. Subklew intended to operate an auto sales and repair business. Paragraph C of the lease was a zoning contingency clause that stated, ―Landlord [plaintiff] will use Landlord‘s best efforts to obtain a written verification that Tenant can operate [an] Auto Sales and Repair Business at the demised premises. If Landlord is unable to obtain such commitment from the municipality, then this agreement shall be deemed null and void and Landlord shall immediately return deposit monies to Tenant.‖ The zoning board approved the location only as a general repair business. When Subklew refused to occupy the premises, Blitz sued him for breach of contract. Decide. [Blitz v. Subklew, 810 A.2d 841 (Conn. App.)] Answer: Condition precedent. Judgment for Subklew. A condition precedent is a fact or event that the parties intend must exist before there is right to a performance. If the condition is not fulfilled, the right to enforce the contract does not come into existence.

Blitz‘s obligation to obtain written approval of a used car business from the municipality was a condition precedent to the leasing agreement. Since it was not obtained, Blitz cannot enforce the leasing agreement. [Blitz v. Subklew, 810 A.2d 841 (Conn. App.)]

5.

The Tinchers signed a contract to sell land to Creasy. The contract specified that the sales transaction was to be completed in 90 days. At the end of the 90 days, Creasy requested an extension of time. The Tinchers refused to grant an extension and stated that the contract was terminated. Creasy claimed that the 90-day clause was not binding because the contract did not state that time was of the essence. Was the contract terminated?

[Creasy v. Tincher, 173 S.E.2d 332 (W. Va.)] Answer: When time is of the essence. The contract specifically required that the transaction be completed within the 90-day period. This made such completion a condition to the existence of the contract, and in the absence of completion, the contract was discharged.

The fact that the contract did not expressly state that time was of the essence was not important because the contract stated the same idea. Instead of just saying that ―time‖ was important, the contract stated the ―90 days‖ was important. [Creasy v. Tincher, 173 S.E.2d 332 (W. Va.)]

6.

Christopher Bloom received a medical school scholarship created by the U.S. Department

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of Health and Human Services to increase the number of doctors serving rural areas. In return for this assistance, Bloom agreed to practice four years in a region identified as being underserved by medical professionals. After some problem with his postgraduation assignment, Bloom requested a repayment schedule from the agency. Although no terms were offered, Bloom tendered to the agency two checks totaling $15,500 and marked ―Final Payment.‖ Neither check was cashed, and the government sued Bloom for $480,000, the value of the assistance provided. Bloom claimed that by tendering the checks to the agency, his liability had been discharged by an accord and satisfaction. Decide. [United States v. Bloom, 112 F.3d 200 (7th Cir.)] Answer: Discharge by agreement: accord and satisfaction. Judgment for U.S. Bloom was wrong. There is no discharge by accord and satisfaction unless the creditor agreed to accept the tendered sum in discharge of a disputed claim and had accepted the sum so tendered. Here there was no agreement to accept or any acceptance by the government of the checks tendered. There was no discharge by accord and satisfaction. [United States v. Bloom, 112 F.3d 200 (7th Cir.)] 7.

Dickson contracted to build a house for Moran. When it was approximately 25 percent to 40 percent completed, Moran would not let Dickson work anymore because he was not following the building plans and specifications and there were many defects. Moran hired another contractor to correct the defects and finish the building. Dickson sued Moran for breach of contract, claiming that he had substantially performed the contract up to the point where he had been discharged. Was Dickson correct? [Dickson v. Moran, 344 So. 2d 102 (La. App.)] Answer: What constitutes substantial performance. No. There was no substantial performance because the substantial performance of a building contract requires that the building be usable for the purpose for which it was intended. Because a performance that is only 25 percent to 40 percent complete would not produce a usable building, the substantial performance doctrine could not be applied. [Dickson v. Moran, 344 So.2d 102 (La. App.)]

8.

A lessor leased a trailer park to a tenant. At the time, sewage was disposed of by a septic tank system that was not connected with the public sewage system. The tenant knew this, and the lease declared that the tenant had examined the premises and that the landlord made no representation or guarantee as to the condition of the premises. Sometime thereafter, the septic tank system stopped working properly, and the county health department notified the tenant that he was required to connect the septic tank system

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with the public sewage system or else the department would close the trailer park. The tenant did not want to pay the additional cost involved in connecting with the public system. The tenant claimed that he was released from the lease and was entitled to a refund of the deposit that he had made. Was he correct? [Glen R. Sewell Street Metal v.

Loverde, 451 P.2d 721 (Cal. App.)] Answer: Economic frustration. No. The tenant had entered into the transaction with knowledge of the sewage system that existed then. The tenant knew or had reason to know that such a system would wear out and that under the law, he might be required to connect with the public sewage system. Consequently, the event that occurred was merely the realization of a risk that was within the contemplation of the parties when the lease was made and that the tenant had assumed on entering into that lease without making any express provision as to what should happen in case it was necessary to connect with the public sewage system. [Glen R. Sewell Street Metal v. Loverde, 451 P.2d 721 (Cal. App.)] 9.

Oneal was a teacher employed by the Colton Consolidated School District. Because of a diabetic condition, his eyesight deteriorated so much that he offered to resign if he would be given pay for a specified number of ―sick leave‖ days. The school district refused to do this and discharged Oneal for nonperformance of his contract. He appealed to remove the discharge from his record. Decide. What ethical values are involved? [Oneal v. Colton Consolidated School District, 557 P.2d 11 (Wash. App.)] Answer: Discharge by disability. [Use chart of ―Guidelines to Business Ethics,‖ preliminary pages of the text]. The action of the school district was improper because the contract had already been discharged by impossibility when Oneal‘s physical condition made him unable to perform the contract.

The ethical considerations that can be discussed in this case involve values of loyalty, fairness, doing no harm, and efficiency and effectiveness. Did the school district have a duty of loyalty to Oneal? A duty of loyalty to the taxpayers? Did the discharge violate the value of fairness? This can be discussed from the standpoint of the school district, the teacher, the students, and the taxpayers. Would harm be done to any party by paying for ―sick leave‖ days? To meet the values of efficiency and effectiveness, should the school district remove a teacher who is no longer fit for the performance of his or her duties?

From the standpoint of the taxpayers, the most efficient action is to remove the teacher at the lowest possible cost. The court‘s decision had that result because it held that the contract was finished without requiring any additional payment to be made to the teacher.

The decision met the principles of efficiency and effectiveness from the standpoint of the

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school district, the taxpayers, and the students. [Oneal v. Colton Consolidated School District, 557 P.2d 11 (Wash. App.)] 10. Northwest Construction, Inc., made a contract with the state of Washington for highway construction. Part of the work was turned over under a subcontract to Yakima Asphalt Paving Co. The contract required that any claim be asserted within 180 days. Yakima brought an action for damages after the expiration of 180 days. The defense was that the claim was too late. Yakima replied that the action was brought within the time allowed by the statute of limitations and that the contractual limitation of 180 days was therefore not binding. Was Yakima correct?

Answer: Contractual limitations of time for suit. No. The parties to a contract may provide that suit must be brought within a period that is shorter than the statute of limitations.

The fact that the statute of limitations provides for a longer period does not prohibit a shorter period based on the contract of the parties. The action of Yakima was therefore barred because it was brought too late.

11. Farmer William Weber sued the North Loup Irrigation District for breach of contract because North Loup failed to deliver water to his farm during the 2010 season as a result of the destruction of a diversion dam caused by catastrophic flooding in June 2010. The contract between the parties stated that irrigation charges must be paid by December of the year preceding the irrigation season. At the time of the flood Weber had not yet paid his 2010 irrigation charges; and he paid the 2010 charge under protest on April 13, 2011.

Weber explained, ―I‘ve never wrote a check for $10,000 in my life that I didn‘t get something for.‖ Did North Loup breach its contractual duties to Weber? Was payment by December 2009 a condition precedent to North Loup‘s duty to deliver water? Decide.

[Weber v. North Loup River Power and Irrigation District, 854 N.W.2d 263 (Neb.)] Answer: Classifications of Conditions § 1(A) Condition precedents. The payment of irrigation charges by the start of the irrigation season was a condition precedent to delivery of water. Because no such payment was made North Loup‘s duty under the contract never came to fruition during the 2010 season. The contract was not breached by North Loup. [Weber v. North Loup River Power and Irrigation District, 854 N.W.2d 263 (Neb.)] 12. Suburban Power Piping Corp., under contract to construct a building for LTV Steel Corp., made a subcontract with Power & Pollution Services, Inc., to do some of the work. The subcontract provided that the subcontractor would be paid when the owner (LTV) paid the

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contractor. LTV went into bankruptcy before making the full payment to the contractor, who then refused to pay the subcontractor on the ground that the ―pay-when-paid‖ provision of the subcontract made payment by the owner a condition precedent to the obligation of the contractor to pay the subcontractor. Was the contractor correct? [Power & Pollution Services, Inc. v. Suburban Power Piping Corp, 598 N.E.2d 69 (Ohio App.)] Answer: Condition precedent; time for performance. No. The contractor is not correct. A ―pay-when-paid‖ provision in a contract between general contractor and subcontractor did not set condition precedent to general contractor‘s duty to pay but rather was absolute promise to pay, fixing payment by owner as reasonable time for payment to subcontractor, and, thus, owner‘s bankruptcy did not absolve contractor of liability for payment to subcontractor; if parties intended to shift risk of solvency of owner to subcontractor, intention should have been unambiguously expressed in contract. [Power & Pollution Services, Inc. v. Suburban Power Piping Corp., 598 N.E.2d 69 (Ohio App.)] 13. Union Pacific Railroad‘s long-term coal-hauling contract with electric utility WEPCO provided that if the railroad is prevented by ―an event of Force Majeure‖ from reloading empty coal cars (after it has delivered coal to WEPCO) with iron ore destined for Geneva, Utah, it can charge the higher rate that the contract makes applicable to shipments that do not involve backhauling. The iron ore that the railroad‘s freight trains would have picked up in Minnesota was intended for a steel mill in Utah. The steel company was bankrupt in 1999 when the parties signed the contract. In November 2001 the steel mill shut down and closed for good in February 2004. Thereafter, the railroad wrote WEPCO to declare ―an event of Force Majeure,‖ and that henceforth it would be charging WEPCO the higher rate applicable to shipments without a backhaul. WEPCO sued the railroad for breach of the force majeure provision in the contract, contending that the railroad waited over two plus years to increase rates. The railroad contends that the clause should be interpreted as written. Decide. [Wisconsin Electric Power Co. v. Union Pacific Railroad Co., 557 F.3d 504 (7th Cir.)] Answer: § 9(1) Force Majeure. Judgment for the UP railroad. The provision dealt with the foreseeable situation of the steel mill shutdown and the possibility of hauling back to the mine empty coal cars thereby generating no revenue. The contract clause was clear and unmistakable and is enforced as written. [Wisconsin Electric Power Co. v. Union Pacific Railroad Co., 557 F.3d 504 (7th Cir.)] 14. Beeson Company made a contract to construct a shopping center for Sartori. Before the work was fully completed, Sartori stopped making the payments to Beeson that the

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contract required. The contract provided for liquidated damages of $1,000 per day if Beeson failed to substantially complete the project within 300 days of the beginning of construction. The contract also provided for a bonus of $1,000 for each day Beeson completed the project ahead of schedule. Beeson stopped working and sued Sartori for the balance due under the contract, just as though it had been fully performed. Sartori defended on the ground that Beeson had not substantially completed the work. Beeson proved that Sartori had been able to rent most of the stores in the center. Was there substantial performance of the contract? If so, what would be the measure of damages?

[J.M. Beeson Co. v. Sartori, 553 So. 2d 180 (Fla. App.)] Answer: Substantial performance. The fact that the shopping center could be used for its intended purpose, that of renting stores to others, showed that there had been substantial performance of the contract. The contractor therefore could recover the contract price less any amount required to complete the construction. [J.M. Beeson Co. v. Sartori, 553 So.2d 180 (Fla. App.)] 15. New Beginnings provides rehabilitation services for alcohol and drug abuse to both adults and adolescents. New Beginnings entered into negotiation with Adbar for the lease of a building in the city of St. Louis and subsequently entered into a three-year lease. The total rent due for the three-year term was $273,000. After the lease was executed, the city denied an occupancy permit because Alderman Bosley and residents testified at a hearing in vigorous opposition to the presence of New Beginnings in the neighborhood. A court ordered the permit issued. Alderman Bosley thereafter contacted the chair of the state‘s appointment committee and asked her to pull the agency‘s funding. He received no commitment from her on this matter. After a meeting with the state director of Alcohol and Drug Abuse where it was asserted that the director said the funding would be pulled if New Beginnings moved into the Adbar location, New Beginnings‘ board decided not to occupy the building. Adbar brought suit for breach of the lease, and New Beginnings asserted that it was excused from performance because of commercial impracticability and frustration of purpose. Do you believe the doctrine of commercial impracticability should be limited in its application so as to preserve the certainty of contracts? What rule of law applies to this case? Decide. [Adbar v. New Beginnings, 103 S.W.2d 799 (Mo. App.)] Answer: Developing Doctrine of Commercial Impracticability and Frustration of Purpose.

The commercial impracticability and frustration of purpose doctrines are rejected by states that apply the common law rule. These states require the parties to anticipate risks and deal with the risks in their contract by adding conditions subsequent. These states believe these related doctrines weaken the stability of contracts. States that apply the developing

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doctrines continue to limit their application so as to preserve the certainty of contracts.

Under the above developing doctrines, if the occurrence of an event, not foreseen by the parties and not caused by or under the control of either party, destroys or nearly destroys the value or purpose of the contract, then the parties are excused from further performance. If, however, the event was reasonably foreseeable, the parties affected should have provided for its occurrence in the contract, and that party assumed the risk if it did not do so.

The possibility that opposition from neighborhood groups would occur and New Beginnings‘ funding may be threatened was foreseeable by the organization. Yet, New Beginnings did not provide for that possibility in the lease. Therefore, New Beginnings assumed the risk that their funding may be threatened and that such might frustrate the purpose of the lease. In fact, New Beginnings funding was never rescinded nor was the purpose of the lease destroyed or nearly destroyed. Judgment for Adbar. [Adbar v. New Beginnings, 103 S.W.2d 799 (Mo. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Parc hired Glaze to remodel and furnish an office suite. Glaze submitted plans that Parc approved. After completing all the necessary construction and painting, Glaze purchased minor accessories that Parc rejected because they did not conform to the plans. Parc refused to allow Glaze to complete the project and refused to pay Glaze any part of the contract price. Glaze sued for the value of the work performed. Which of the following statements is correct? a.

Glaze will lose because Glaze breached the contract by not completing performance.

b.

Glaze will win because Glaze substantially performed and Parc prevented complete performance.

c.

Glaze will lose because Glaze materially breached the contract by buying the accessories.

d.

2.

Glaze will win because Parc committed anticipatory breach.

Ordinarily, in an action for breach of a construction contract, the statute of limitations time period would be computed from the date the contract is:

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3.

a.

Negotiated

b.

Breached

c.

Begun

d.

Signed

Which of the following will release all original parties to a contract but will maintain a contractual relationship?

Novation

Substituted contract

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

[return to top] Answers to AICPA Questions 1.

Parc hired Glaze to remodel and furnish an office suite. Glaze submitted plans that Parc approved. After completing all the necessary construction and painting, Glaze purchased minor accessories that Parc rejected because they did not conform to the plans. Parc refused to allow Glaze to complete the project and refused to pay Glaze any part of the contract price. Glaze sued for the value of the work performed. Which of the following statements is correct? a.

Glaze will lose because Glaze breached the contract by not completing performance.

b.

Glaze will win because Glaze substantially performed and Parc prevented complete performance.

c.

Glaze will lose because Glaze materially breached the contract by buying the accessories.

d.

Glaze will win because Parc committed anticipatory breach.

(b) Glaze will win because he ―substantially performed‖ on the contract. Glaze should receive the contract price less the cost of damages due to minor deviations from the required performance. Glaze can also collect because Parc refused to allow Glaze the opportunity to complete the contract. Glaze can recover for substantial performance of the contract. The breach was a minor breach. Glaze breached the contract by purchasing minor accessories not allowed under the contract. In response, Parc

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 19: Breach of Contract and Remedies

refused to allow Glaze to complete the contract. This is not considered to be anticipatory breach by Parc.

2.

Ordinarily, in an action for breach of a construction contract, the statute of limitations time period would be computed from the date the contract is: a.

Negotiated

b.

Breached

c.

Begun

d.

Signed

(b) The statute of limitations in an action for breach of contract begins to toll from the time the contract is breached.

4.

Which of the following will release all original parties to a contract but will maintain a contractual relationship?

Novation

Substituted contract

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

(c) No official explanation given. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 19: Breach of Contract and Remedies

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 159 Questions and Case Problems .......................................................................................................... 159 End of Chapter: CPA Questions and Answers ................................................................................. 166 Answers to AICPA Questions ............................................................................................................ 167

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Answers to the End-of-Chapter Questions Questions and Case Problems 1.

The Forsyth School District contracted with Textor Construction, Inc., to build certain additions and alter school facilities, including the grading of a future softball field. Under the contract, the work was to be completed by August 1. Various delays occurred at the outset of the project attributable to the school district, and the architect‘s representative on the job, Mr. Hamilton, told Textor‘s vice president, William Textor, not to be concerned about a clause in the contract of $250 per day liquidated damages for failure to complete the job by August 1. Textor sued the school district for breach of contract regarding payment for the grading of the softball field, and the District counterclaimed for liquidated damages for 84 days at $250 per day for failure to complete the project by the August 1 date. What legal basis exists for Textor to defend against the counterclaim for failure to complete the job on time? Was it ethical for the school district to bring this counterclaim based on the facts before you? [Textor Construction, Inc. v. Forsyth R-III School District, 60 S.W.3d 692 (Mo. App.)] Answer: Waiver of breach; ethics of counterclaim. Textor may defend against the district's counterclaim by asserting that the school district waived its right to assess the liquidated damages clause in the contract. The statement by Mr. Hamilton not to be concerned about the liquidated damages clause of $250 per day in the context of the delays attributable to the school district was sufficient evidence to find that the district waived the right to liquidated damages for failure to complete the project on time.

Textor had a valid claim to pursue in the courts for payment for the grading work on the softball field. When the school district's attorney reviewed the case, the possibility of an apparently viable counterclaim became evident. It is likely that the validity of contractor's waiver defense was not apparent to the school district until witnesses testified at the trial.

Thus, the counterclaim was not frivolous or filed in a retaliation against the contractor for its lawsuit. The counterclaim was not unethical. [Textor Construction, Inc. v. Forsyth R-III School District, 60 S.W. 3d 692 (Mo. App.)]

2.

Self-described ―sports nut‖ Gary Baker signed up for a three-year club-seat ―package‖ that entitled him and a companion to tickets for 41 Boston Bruin hockey games and 41 Boston Celtic basketball games at the New Boston Garden Corporation‘s Fleet Center for approximately $18,000 per year. After one year, Baker stopped paying for the tickets

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thinking that he would simply lose his $5,000 security deposit. New Boston sued Baker for breach of contract, seeking the balance due on the tickets of $34,866. At trial, Baker argued to the jury that although he had breached his contract, New Boston had an obligation to mitigate damages, for example, by treating his empty seats and those of others in the same situation as ―rush seats‖ shortly before game time and selling them at a discount. New Boston argued that just as a used luxury car cannot be returned for a refund, a season ticket cannot be canceled without consequences. Decide.

Answer: Mitigation of damages. Baker admitted that he breached his contract with New Boston. New Boston, however, had an obligation to mitigate damages and it took no action to do so. The jury determined that New Boston was not entitled to the full contractual price due on the tickets of $34,866. It reduced the amount owed New Boston by $21,176 to $13,690. [Pfeiffer, ―Disenchanted Fan Scores Win in Ticket Fight,‖ Boston Globe, August 28, 1999, at B4.]

3.

Rogers made a contract with Salisbury Brick Corp. that allowed it to remove earth and sand from land he owned. The contract ran for four years with provision to renew it for additional four-year terms up to a total of 96 years. The contract provided for compensation to Rogers based on the amount of earth and sand removed. By an unintentional mistake, Salisbury underpaid Rogers the amount of $863 for the months of November and December 1986. Salisbury offered this amount to Rogers, but he refused to accept it and claimed that he had been underpaid in other months. Rogers claimed that he was entitled to rescind the contract. Was he correct? [Rogers v. Salisbury Brick Corp., 882 S.E.2d 915 (S.C.)] Answer: Basis for rescission. No. A contract will not be rescinded for a minor breach. The insignificance of the breach was indicated by the amount involved ($863) compared with the amount that could be due under the contract if it ran for its term of 96 years.

Additionally, it does not appear that the breach was intentional, as Salisbury offered to pay the underpaid amount as soon as the mistake was discovered. [Rogers v. Salisbury Brick Corp., 882 S.E. 2d 915 (S.C.)]

4.

Manny Fakhimi agreed to buy an apartment complex for $697,000 at an auction from David Mason. Fakhimi was obligated to put up 10 percent of the agreedto price at the auction as a deposit. The agreement allowed Mason to keep this deposit should Fakhimi fail to come up with the remaining 90 percent of the auction price as liquidated damages for the default. Shortly after the auction, Fakhimi heard a rumor that the military base located near the apartment complex might be closing. Fakhimi immediately stopped

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Solution and Answer Guide:

payment on the check and defaulted on the agreement. Mason sued Fakhimi for the liquidated damages specified in the sales contract. Decide. [Mason v. Fakhimi, 865 P.2d 333 (Neb.)] Answer: Liquidated damages. Because of the difficulty of forecasting the loss that might be caused by breach of a real estate purchase contract, it is held that a liquidated damage clause of 10 percent of the sale price is valid and is not a penalty. The fact that the damages sustained thereafter turned out to be less than 10 percent does not convert the 10 percent into an unreasonable forecast. The 10 percent clause remained valid as it would have remained had the damages on resale been more than 10 percent. [Mason v. Fakhimi, 865 P. 2d 333 (Neb.)] 5.

Northland Ford Dealers offered to sponsor a ―hole in one‖ contest at Moccasin Creek Country Club. A banner announced that a hole in one would win a car but gave no other details, and the local dealer parked a Ford Explorer near the banner. Northland paid a $4,602 premium to Continental Hole-In- One, Inc., to ensure the award of the contest prize. The insurance application stated in capital letters that ―ALL AMATEUR MEN AND WOMEN WILL UTILIZE THE SAME TEE.‖ And Continental established the men/women yardage for the hole to be 170 yards but did not make this known to the participants.

Jennifer Harms registered for the tournament and paid her entrance fee. At the contest hole, she teed off from the amateur women‘s red marker, which was a much shorter distance to the pin than the 170 yards from the men‘s marker—and she made a hole in one. When she inquired about the prize, she was told that because of the insurance requirements, all amateurs had to tee off from the amateur men‘s tee box, and she was disqualified. Harms, a collegiate golfer at Concordia College, returned there to complete her last year of athletic eligibility and on graduation sued Northland for breach of contract.

Northland contends that her continuation of her NCAA competition evinced intent to waive acceptance of the car. Decide. [Harms v. Northland Ford Dealers, 602 N.W.2d 58 (S.D.)] Answer: Waiver of Rights. Judgment for Harms. Northland must abide by the rules it announced, not by the ones it left unannounced that disqualified all amateur women from the contest. This was a vintage unilateral contract with performance by the offeree as acceptance. Harms earned the prize when she sank her winning shot. Waiver is a volitional relinquishment, by act or word, of a known existing right conferred in law or contract. She was told her shot from the wrong tee disqualified her. One can hardly relinquish what was never conferred. Northland‘s waiver defense is devoid of merit. [Harms v Northland Ford Dealers, 602 N.W.2d 58 (S.D.)]

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6.

The buyer of real estate made a down payment. The contract stated that the buyer would be liable for damages in an amount equal to the down payment if the buyer broke the contract. The buyer refused to go through with the contract and demanded his down payment back. The seller refused to return it and claimed that he was entitled to additional damages from the buyer because the damages that he had suffered were more than the amount of the down payment. Decide. [Waters v. Key Colony East, Inc., 345 So. 2d 367 (Fla. App.)] Answer: Effect of liquidated damages clause. The buyer could not recover the down payment and the seller could not recover greater damages because they agreed that the amount of the down payment was the amount at which damages should be set or liquidated. [Waters v. Key Colony East, Inc., 345 So. 2d 367 (Fla. App.)] Authors‘ Comment: No question was raised as to whether the liquidated damages clause was invalid. The case thus states the law when a liquidated damages clause is binding. If it were decided that the clause was not binding because it was so excessive as to constitute a penalty, the parties could then have proven the actual damages that were sustained, and the seller could have recovered greater damages if they could be proven.

7.

Kuznicki made a contract for the installation of a fire detection system by Security Safety Corp. for $498. The contract was made one night and canceled at 9:00 the next morning.

Security then claimed one-third of the purchase price from Kuznicki by virtue of a provision in the contract that ―in the event of cancellation of this agreement . . . the owner agrees to pay 33⅓ percent of the contract price, as liquidated damages.‖ Was Security Safety entitled to recover the amount claimed? [Security Safety Corp. v. Kuznicki, 213 N.E.2d 866 (Mass.)]

Answer: Liquidated damages as contrasted with a penalty. No. Under the circumstances, it was clear that the amount far exceeded the damages sustained. Therefore, the provision was void as a penalty clause, and the seller could recover only the actual amount of damages sustained. [Security Safety Corp. v. Kuznicki, 213 N.E. 2d 866 (Mass.)]

8.

FNBC is a business brokerage firm that assists in the purchase and sale of businesses.

Jennings and Hennessey were independent contractors working for FNBC. They left FNBC, and FNBC sued them for breach of their contracts with FNBC. The trial court issued a permanent injunction prohibiting the former contractors from using proprietary information and the court awarded attorneys‘ fees under a clause in the contract that

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would obligate Jennings and Hennessey to indemnify FNBC against claims ―brought by persons not a party to the provision.‖ Jennings and Hennessey appealed the decision on attorneys‘ fees. Decide. [FNBC v. Jennessey Group, LLC, 759 N.W.2d 808 (Iowa App.)] Answer: Attorney's fees. Attorney fees are generally not allowable unless authorized by statute or contractual agreement. A written contract must contain a clear and express provision regarding attorney fees in order for a court to be authorized to add attorney fees to a favorable judgment. In this case, there is no express contractual provision authorizing the award of attorney fees. The indemnification clause applied only to claims "brought by persons not a party" to the contract. The clause thus does not allow for the recovery of attorney fees. [FNBC v. Jennessey Group, LLC, 759 N.W. 2d 808 (Iowa App.)] 9.

building that was protected against fire by a sprinkler and alarm system maintained by the American District Telegraph Co. (ADT). Because of the latter‘s fault, the controls on the system were defective and allowed the discharge of water into the building, which damaged Melodee‘s property. When Melodee sued ADT, its defense was that its service contract limited its liability to 10 percent of the annual service charge made to the customer. Was this limitation valid? [Melodee Lane Lingerie Co. v. American District Telegraph Co, 218 N.E.2d 661 (N.Y.)] Answer: Validity of limitation of liability. No. The court took the position that in such a contract, there could be no limitation of liability unless the consumer was given the option of paying a higher rate in order to obtain unlimited liability. (The court noted that UCC § 7-204 applies this rule to warehousers.) [Melodee Lane Lingerie Co. v. American District Telegraph Co., 218 N.E. 2d 661 (N.Y.)]

10. JRC Trading Corp (JRC) bought computer software and hardware from Progressive Data Systems (PDS) for $167,935, which it paid in full, to track movement of its trucks with inventory and to process transactions. The purchase agreement also called for a $7,500 per year licensing fee for an 18-year period, and it stated that in the event of default PDS could ―accelerate and declare all obligations of Customer as a liquidated sum.‖ A dispute arose between the parties, and when the case was litigated the only actual contract charges owed PDS were the license fees of $7,500 for two years. The application of the liquidated damages clause would yield an additional $120,000 cash for PDS for the future fees for 16 years without any reduction for expenses or the present cash value for the notyet-earned fees. JRC contends that actual damages were clearly ascertainable and that the liquidated damages clause was a penalty provision that should not be enforced.

Progressive argued that the court must interpret the contract as written, stating that the

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court has no power to rewrite the contract. Decide. [Jefferson Randolf Corp. v. PDS, 553 S.E.2d 304 (Ga. App.)] Answer: Liquidated damages. Actual damages were clearly ascertainable and not difficult to determine. The amount sought was excessive. The court deemed the liquidated damages clause an unenforceable penalty and PDS was relegated to recovering its actual contractual damages. [Jefferson Randolf Corp. v. PDS, 553 S.E. 2d 304 (Ga. App.)] 11. Ken Sulejmanagic, aged 19, signed up for a course in scuba diving taught by Madison at the YMCA. Before the instruction began, Ken was required to sign a form releasing Madison and the YMCA from liability for any harm that might occur. At the end of the course, Madison, Ken, and another student went into deep water. After Ken made the final dive required by the course program, Madison left him alone in the water while he took the other student for a dive. When Madison returned, Ken could not be found, and it was later determined that he had drowned. Ken‘s parents sued Madison and the YMCA for negligence in the performance of the teaching contract. The defendants raised the defense that the release Ken signed shielded them from liability. The plaintiffs claimed that the release was invalid. Who was correct? [Madison v. Superior Court, 250 Cal. Rptr. 299 (Cal. App.)] Answer: Validity of limitation of liability. The release provision of the contract under which the scuba diving course was offered by Madison and YMCA provided ―a complete defense‖ to the plaintiff‘s lawsuit. Under the course contract ―release‖ language Ken clearly accepted responsibility for any act of negligence by Madison and the YMCA. The release form is binding. [Madison v. Superior Court, 250 Cal. Rptr. 299 (Cal. App.)] 12. Wassenaar worked for Panos under a three-year contract stating that if the contract were terminated wrongfully by Panos before the end of the three years, he would pay as damages the salary for the remaining time that the contract had to run. After three months, Panos terminated the contract, and Wassenaar sued him for pay for the balance of the contract term. Panos claimed that this amount could not be recovered because the contract provision for the payment was a void penalty. Was this provision valid?

[Wassenaar v. Panos, 331 N.W.2d 357 (Wis.)] Answer: Limitation of damages. Yes. The limitation satisfied the two requirements of (a) circumstances in which it would be very difficult to determine the actual damages suffered and (b) the specification of an amount that was a reasonable attempt to estimate or approximate those damages. The fact that the amount declined when the breach occurred

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at a later date confirmed the conclusion that the limitation was a reasonable effort to meet a difficult situation. [Wassenaar v. Panos, 331 N.W. 2d 357 (Wis.)] 13. Soden, a contractor, made a contract to build a house for Clevert. The sales contract stated that ―if either party defaults in the performance of this contract,‖ that party would be liable to the other for attorneys‘ fees incurred in suing the defaulter. Soden was 61 days late in completing the contract, and some of the work was defective. In a suit by the buyer against the contractor, the contractor claimed that he was not liable for the buyer‘s attorneys‘ fees because he had made only a defective performance and because ―default‖ in the phrase quoted meant ―nonperformance of the contract.‖ Was the contractor liable for the attorneys‘ fees? [Clevert v. Soden, 400 S.E.2d 181 (Va.)] Answer: What is breach of contract? Interpretation of contract. Yes. The word ―default‖ is to be given its ordinary, usual meaning in the absence of any evidence that the parties used the word in a peculiar or different sense. Because the contractor did not offer any evidence of such a special use, the usual meaning is controlling. By the usual meaning, a default is the failure to do that which is required. The obligation of the contractor was to complete the performance in the time specified and to do proper work with proper materials. That is, default embraces both nonperformance and improper performance. Both constitute a breach of the contract. Accordingly, the contractor was liable. [Clevert v. Soden, 400 S.E. 2d 181 (Va.)] 14. Protection Alarm Co. made a contract to provide burglar alarm security for Fretwell‘s home. The contract stated that the maximum liability of the alarm company was the actual loss sustained or $50, whichever was the lesser, and that this provision was agreed to ―as liquidated damages and not as a penalty.‖ When Fretwell‘s home was burglarized, he sued for the loss of approximately $12,000, claiming that the alarm company had been negligent. The alarm company asserted that its maximum liability was $50. Fretwell claimed that this was invalid because it bore no relationship to the loss that could have been foreseen when the contract was made or that in fact ―had been sustained.‖ Decide.

Answer: Validity of limitation of liability. Judgment for the alarm company. The provision in the contract was clearly a limitation of liability because the amount specified was not intended by the parties to bear any reasonable relationship to the possible loss that could be sustained. The validity of the limitation of liability clause therefore did not depend on satisfying the criteria applicable to a liquidated damages clause. In view of the fact that an alarm system can be disabled by an intruder, it was neither unconscionable nor contrary to public policy to allow an alarm company to limit its liability. The $50 limitation was

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therefore binding and limited Fretwell‘s recovery to $50.

15. Variel Warner developed an 85-unit apartment complex with Verdugo serving as general contractor in 2005. In 2007 Sobrato Interests III acquired the property from Variel Warner, with the Purchase Agreement containing the following language in part: Sobrato ―shall rely solely upon [its] own knowledge of the Property based on its investigation of the Property and its own inspection of the Property in determining the Property’s physical condition, except with respect to… [the] representations, warranties and covenants [made by Variel Warner in the Purchase Agreement]… .‖ Sobrato released, inter alia, Variel Warner, Variel Builders, Troxler, Troxler Venture and Verdugo… from all claims arising out of any condition of the Property including construction errors, omissions or defects.

In 2008 Sobrato assigned all its interests in the property to SI XX, LLC. Subsequently, SI XX, LLC observed water leaking from the podium and pool deck in the parking garage, and it discovered major construction defects, which should have been discovered by Warner and the contractor but for their negligence in supervising the construction, inspection and development of the property. Accordingly, it sued Variel Warner. Decide. [SI 59 LLC v.

Variel Warner Ventures, LLC, 29 Cal. App. 5th 146 (2018)] Answer: Limitation of liability clause. A general release clause in the Purchase Agreement barred a negligence claim against the general contractor. The release was also enforceable as to the seller‘s negligence in failing to inspect, manage and develop the property. [SI 59 LLC v. Variel Warner Ventures, LLC, 29 Cal. App. 5th 146 (2018)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Master Mfg., Inc., contracted with Accur Computer Repair Corp. to maintain Master‘s computer system. Master‘s manufacturing process depends on its computer system operating properly at all times. A liquidated damages clause in the contract provided that Accur pay $1,000 to Master for each day that Accur was late responding to a service request. On January 12, Accur was notified that Master‘s computer system had failed.

Accur did not respond to Master‘s service request until January 15. If Master sues Accur

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under the liquidated damages provision of the contract, Master will: a.

Win, unless the liquidated damage provision is determined to be a penalty.

b.

Win, because under all circumstances liquidated damages provisions are enforceable.

2.

c.

Lose, because Accur‘s breach was not material.

d.

Lose, because liquidated damage provisions violate public policy (5/93, Law, #25).

Jones, CPA, entered into a signed contract with Foster Corp. to perform accounting and review services. If Jones repudiates the contract prior to the date performance is due to begin, which of the following is not correct? a.

Foster could successfully maintain an action for breach of contract after the date performance was due to begin.

b.

Foster can obtain a judgment ordering Jones to perform.

c.

Foster could successfully maintain an action for breach of contract prior to the date performance is due to begin.

d.

Foster can obtain a judgment for the monetary damages it incurred as a result of the repudiation (5/89, Law, #35).

3.

Which of the following concepts affect(s) the amount of monetary damages recoverable by the nonbreaching party when a contract is breached?

Foreseeability of

Mitigation of

damages

damages

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

[return to top] Answers to AICPA Questions 1.

Master Mfg., Inc., contracted with Accur Computer Repair Corp. to maintain Master‘s computer system. Master‘s manufacturing process depends on its computer system operating properly at all times. A liquidated damages clause in the contract provided that Accur pay $1,000 to Master for each day that Accur was late responding to a service request. On January 12, Accur was notified that Master‘s computer system had failed.

Accur did not respond to Master‘s service request until January 15. If Master sues Accur

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under the liquidated damages provision of the contract, Master will: a. Win, unless the liquidated damage provision is determined to be a penalty. b. Win, because under all circumstances liquidated damages provisions are enforceable. c. Lose, because Accur‘s breach was not material. d. Lose, because liquidated damage provisions violate public policy (5/93, Law, #25). (a) Answer (a) is correct because liquidated damage clauses are valid if they are not a penalty on top of other damages and are agreed to as a reasonable projection of damages.

2.

Jones, CPA, entered into a signed contract with Foster Corp. to perform accounting and review services. If Jones repudiates the contract prior to the date performance is due to begin, which of the following is not correct? a.

Foster could successfully maintain an action for breach of contract after the date performance was due to begin.

b.

Foster can obtain a judgment ordering Jones to perform.

c.

Foster could successfully maintain an action for breach of contract prior to the date performance is due to begin.

d.

Foster can obtain a judgment for the monetary damages it incurred as a result of the repudiation (5/89, Law, #35).

(c) Answer (a) is incorrect because when there is a reputation, the non-breaching party can await performance, can wait to file suit, or can file suit immediately. Answer (b) is incorrect because specific performance is not an available remedy in personal services contracts. Answer (c) is correct because Foster can bring an action before performance is slated to begin—it is Foster‘s choice. Answer (d) is incorrect because we don‘t know about an actual judgment—there has to be a suit filed and a determination of damages.

3.

Which of the following concepts affect(s) the amount of monetary damages recoverable by the nonbreaching party when a contract is breached?

Foreseeability of

Mitigation of

damages

damages

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

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d.

No

No

(a) Answers (a), (c), and (d) are incorrect because there is not yet anything to recover if there has been no breach. If a contract runs five years and there is a breach in the last year and the typical statute of limitations of four years, there would be no remedy for the non-breaching party. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 20: Personal Property and Bailments

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 169 Questions and Case Problems .......................................................................................................... 169

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

On March 6, Colt Manufacturing Co., a handgun manufacturer, sponsored a farewell dinner for one of its officers, Marc Fontane. At the dinner, two Colt officials presented Fontane with a .45-caliber Colt revolver. After the presentation an agent of Colt‘s took possession of the revolver for the purpose of improving it by installing ivory grips and adding engraving. Fontane inquired over a period of months as to when he would receive the revolver and was ultimately told that ―the gun has been sold and there will be no replacement.‖ Fontane sued Colt for the conversion of the gift with the promised improvements with a value of $8,155. The employer asserts that there was no completed gift because there was no delivery. Decide. [Fontane v. Colt Manufacturing Co., 814 A.2d 433 (Conn. App.)] Answer: Elements of a gift: intent and delivery. Giving the handgun at the retirement dinner in front of all associates present evidences an intent to make a gift. The public presentation of the revolver constituted a constructive form of delivery. Fontane is entitled to the value of the revolver with promised improvements, $8155. [Fontane v. Colt Manufacturing Co., 814 A. 2d 433 (Conn. App.)]

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2.

Joe obtained a box of antique Lenox china dishes that had been left at the Mashpee town dump. He supplemented the sizable but incomplete set of dishes with other Lenox pieces found at antique dealers. At dinner parties, he proudly told of the origin of his china.

When Marlene discovered that Joe had taken her dishes from the dump, she hired an attorney to obtain their return. What result?

Answer: Abandoned property. Marlene has no rights for Joe merely took property that had been abandoned. Marlene‘s rights ended.

3.

Joyce Clifford gave a check for $5,000 to her nephew Carl to help with living expenses for his last year of college. The face of the check stated, ―As a loan.‖ Years later, Carl wrote to his aunt asking what he should do about the loan. She responded on her Christmas card simply, ―On money—keep it—no return.‖ After Joyce‘s death, her administrator sued Carl after discovering the ―As a loan‖ canceled check. Decide.

Answer: Transfer by gift. The issues were whether the $5,000 was a gift or a contract that required Carl to repay what was due. The elements for a gift include intent and delivery.

The money was delivered initially as a loan without the intent. But Joyce‘s later Christmas card note qualifies as sufficient evidence of intention. Therefore, before Joyce‘s death, there was an inter vivos gift with all the required elements.

4.

Rachel Auffert purchased a $10,000 certificate of deposit on January 7, 1981, creating a joint tenancy in this bank deposit payable to herself or either of her two children, Leo or Mary Ellen, ―either or the survivor.‖ When Rachel died, a note dated January 7, 1981, written in Rachel‘s handwriting and signed by her, was found with the certificate of deposit. The note stated the mother‘s wishes: Leo: If I die this goes to Sr. Mary Ellen, Wanted another name on it.

S/Rachel Auffert Jan 7 1981 Mary Ellen cashed the certificate of deposit and retained the proceeds. Leo sued to recover one-half the value of the certificate. Decide. [Auffert v. Auffert, 829 S.W.2d 95 (Mo. App.)] Answer: Joint tenancy. Judgment for Leo. There was statutory compliance when the

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certificate of deposit was purchased, and thus a statutory joint tenancy was created. The only means available to Rachel to alter the joint tenants‘ proportionate interests was to change the names on the account during her lifetime. Because Rachel failed to do so, the law presumes that Leo and Mary Ellen equally owned the certificate of deposit.

5.

Arthur Grace, a world-renowned photo-journalist, had an agreement with Sygma-Paris and Sygma-New York whereby Grace turned well over 40,000 of his photographic images to Sygma, and Sygma agreed to act as Grace‘s agent to license the images and administer the fee-setting process and delivery and return of the images. Grace terminated his agreement with Sygma, and Sygma was unable to return all of the photographs to Grace as obligated under the agreement. From Sygma‘s perspective it was a nightmare to keep track of all of the images. Identify the legal classification of this transaction and the status of the principals. Did Grace have a legal basis to sue Sygma for the value of the images it failed to return? [Grace v. Corbis Sygma, 403 F. Supp. 2d (S.D.N.Y.)] Answer: Duties and liabilities of bailees. The delivery of the photographs by the bailor, Grace, to the bailee, Sygma, and the acceptance by Sygma, constituted a transaction called a bailment, under which the bailee was obligated to return the photographs at the termination of the bailment. Failure to do so was in violation of the bailment contract and Sygma was liable for $472,000 in damages for failure to return 40,000 images. [Grace v.

Corbis Sygma, 403 F. Supp. 2d (S.D.N.Y.)]

6.

In 1971, Harry Gordon turned over $40,000 to his son, Murray Gordon. Murray opened two $20,000 custodial bank accounts under the Uniform Gifts to Minors Act for his minor children, Eden and Alexander. Murray was listed as the custodian of both accounts. On January 9, 1976, both accounts were closed, and a single bank check representing the principal of the accounts was drawn to the order of Harry Gordon. In April 1976, Murray and his wife, Joan, entered into a separation agreement and were later divorced.

Thereafter, Joan, on behalf of her children, Eden and Alexander, brought suit against Murray to recover the funds withdrawn in January 1976, contending that the deposits in both accounts were irrevocable gifts. Murray contended that the money was his father‘s and that it was never intended as a gift but was merely a means of avoiding taxes. Decide.

[Gordon v. Gordon, 419 N.Y.S.2d 684 (App. Div.)] Answer: Uniform Gifts to Minors Act. Judgment was for Joan on behalf of Eden and Alexander. In order to find that an inter vivos gift has been made, there must be donative intent and delivery. The UGMA expressly deals with delivery and provides that this element of a gift is satisfied by documentary compliance with the procedures of the statute. The

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issue of donative intent is not conclusively resolved by determining that there was documentary compliance with the statute. However, documentary compliance with the procedures set forth by the UGMA is highly probative on the issue of intent and is prima facie evidence that a gift was not only made but intended. Murray‘s allegations do not controvert the impressive documentary evidence of donative intent. [Gordon v. Gordon, 419 N.Y. S.2d 684 (App. Div.)] 7.

New York‘s banking law provides that a presumption arises that a joint tenancy has been created when a bank account is opened in the names of two persons ―payable to either or the survivor.‖ While he was still single, Richard Coddington opened a savings account with his mother, Amelia. The signature card they signed stated that the account was owned by them as joint tenants with the right of survivorship. No statement as to survivorship was made on the passbook. Richard later married Margaret. On Richard‘s death, Margaret claimed a share of the account on the ground that it was not held in joint tenancy because the passbook did not contain words of survivorship and because the statutory presumption of a joint tenancy was overcome by the fact that Richard had withdrawn substantial sums from the account during his life. Decide. [Coddington v. Coddington, 391 N.Y.S.2d 760 (Sup. Ct. App. Div.)] Answer: Multiple ownership—joint tenancy. The signature card providing ―Joint Account— Payable to Either or Survivor‖ created prima facie presumption that a joint tenancy was created even though the words ―Payable to Either or the Survivor‖ did not appear on the passbook or some ledger card. The withdrawals of most of the money by one depositor does not overcome the presumption. [Coddington v. Coddington, 391 N.Y. S.2d 760 (Sup. Ct. App. Div.)]

8.

Martin Acampora purchased a shotgun at a garage sale years ago, never used the weapon, and did not know of any defects in it. His 31-year-old son Marty borrowed the shotgun to go duck hunting. As Marty attempted to engage the safety mechanism, the shotgun fired.

The force of the shotgun‘s firing caused it to fall to the ground and to discharge another shot, which struck Marty in the hand. Classify the bailment in this case. What duty of care was owed by the bailor in this case? Is Martin liable to his son for the injury?

Answer: Classification of bailment; duties of bailor. The case described is a gratuitous bailment. The father loaned the weapon to his son without charge. The duty of care owed by the father to the son in this case, which is a bailment for the sole benefit of the bailee, is to inform the bailee of known defects. Because Martin knew of no defects, he violated no duty owed to his son, and he is not liable for the injury.

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9.

Baena Brothers agreed to reupholster and reduce the size of the arms of Welge‘s sofa and chair. The work was not done according to the contract, and the furniture when finished had no value to Welge and was not accepted by him. Baena sued him for the contract price. Welge counterclaimed for the value of the furniture. Decide. [Baena Brothers v.

Welge, 207 A.2d 749 (Conn. Cir. Ct.)] Answer: Duties of bailee. Judgment was for Welge on the counterclaim. When Baena Brothers made a contract with respect to the furniture, it was required to perform that contract according to the ordinary principles of contract law. The concept of due care, which would protect Baena Brothers if the goods were damaged by a third person, an act of God, or an accident, does not apply when the question is whether the bailee has performed the contract. Because a failure to perform the contract occurred, Baena Brothers was liable for damages for such breach. [Baena Brothers v. Welge, 207 A.2d 749 (Conn. Cir. Ct.)]

10. Schroeder parked his car in a parking lot operated by Allright, Inc. On the parking stub given him was printed in large, heavy type that the lot closed at 6:00 p.m. Under this information, printed in smaller, lighter type, was a provision limiting the liability of Allright for theft or loss. A large sign at the lot stated that after 6:00 p.m. patrons could obtain their car keys at another location. Schroeder‘s car was stolen from the lot sometime after the 6:00 p.m. closing, and he sued Allright for damages. Allright defended on the basis of the limitation-of-liability provision contained in the parking stub and the notice given Schroeder that the lot closed at 6:00 p.m. Decide. [Allright, Inc. v. Schroeder, 551 S.W.2d 745 (Tex. Civ. App.)] Answer: Duties of bailee, contract modification of liability. Judgment for Schroeder. When a bailee attempts to limit liability by printing such a limitation on a claim check, the limitation must be called to the attention of the bailor before it may become part of the bailment contract. The limitation on the claim check was not called to the attention of the bailor, Schroeder, when he left his automobile. Notice that a lot ―closes at 6:00 p.m.‖ does not tell customers that cars remaining after such time are left at the owners‘ risk. [Allright, Inc. v. Schroeder, 551 S.W. 2d 745 (Tex. Civ. App.)] 11. John Hayes and Lynn Magosian, auditors for a public accounting firm, went to lunch at the Bay View Restaurant in San Francisco. John left his raincoat with a coatroom attendant, but Lynn took her new raincoat with her to the dining room, where she hung it on a coat hook near her booth. When leaving the restaurant, Lynn discovered that someone had taken her

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raincoat. When John sought to claim his raincoat at the coatroom, it could not be found.

The attendant advised that it might have been taken while he was on his break. John and Lynn sued the restaurant, claiming that the restaurant was a bailee of the raincoats and had a duty to return them. Are both John and Lynn correct?

Answer: Necessity of delivery of property to give rise to bailment; return of bailed property.

John gave possession of his raincoat to the restaurant at the restaurant‘s coatroom, and the restaurant, through its attendant, accepted possession of the coat. In accepting responsibility, the restaurant did not seek to limit the responsibility it assumed when it accepted the coat by communicating to John any limitation on its liability. All of the elements of a bailment were present. There was delivery of possession of the bailed item, the raincoat, and the acceptance of the item by the bailee. The intentions of the parties were clear from their conduct. The bailment was for the mutual benefit of the parties, with John to receive care for his coat and the restaurant to receive John‘s luncheon patronage.

As such, the restaurant had a duty to provide ―ordinary‖ care of the raincoat or ―reasonable care under the circumstances‖. The facts indicated that the coatroom was left unattended while the attendant was on his break. This demonstrates that the bailee, the restaurant, did not exercise ordinary or reasonable care under the circumstances.

Therefore, the restaurant was liable to John for the bailed property.

Because the restaurant did not take possession of Lynn‘s raincoat, no bailment was ever created, and Lynn would not be successful in her suit against the restaurant.

Answer: Authors‘ Comment: The question may be asked whether the restaurant could disclaim responsibility for loss of articles of clothing by posting a large sign at the door of the coatroom stating that the restaurant is not responsible for lost or stolen articles of clothing. What if the disclaimer appeared only on the back of a claim check? (See the general discussion on modification of liability). It is suggested that the large sign is reasonably calculated to notify the bailor of the limitation of liability prior to leaving the article of clothing and should be binding on the bailor. To the contrary, a claim check is designed primarily to identify the owner of the bailed property for the purpose of claiming the property, and a disclaimer on the back of the claim check would not reasonably notify the bailor of the bailee‘s attempt to disclaim liability.

12. Rhodes parked his car in the self-service park-andlock lot of Pioneer Parking Lot, Inc. The ticket that he received from the ticket meter stated the following: ―NOTICE. THIS CONTRACT LIMITS OUR LIABILITY. READ IT. WE RENT SPACE ONLY. NO BAILMENT IS CREATED.‖ Rhodes parked the car himself and kept the keys. There was no attendant at

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the lot. The car was stolen from the lot. Rhodes sued the parking lot on the theory that it had breached its duty as a bailee. Was there a bailment? [Rhodes v. Pioneer Parking Lot, Inc., 501 S.W.2d 569 (Tenn.)]

Answer: Elements of a bailment; renting of space. No. By parking the car himself, locking it, and keeping the keys, Rhodes retained control of the car. And with no attendant on duty and no ticket verification system in effect, the parking lot did not exercise realistic control over the car. Therefore, the car was not in the possession of the parking lot, as the ability to control property is an essential element of possessing it. No bailor-bailee relationship existed. Rhodes had a mere license to park, or a lease of parking space. [Rhodes v. Pioneer Parking Lot, Inc., 501 S.W. 2d 569 (Tenn.)]

13. Newman underwent physical therapy at Physical Therapy Associates of Rome, Inc. (PTAR), in Rome, Georgia, for injuries sustained in an auto accident. At a therapy session on February 6, it was necessary for Newman to take off two necklaces. She placed one of the necklaces on a peg on the wall in the therapy room, and the therapist placed the other necklace on another peg. After the session, Newman forgot to retrieve her jewelry from the wall pegs. When she called the next day for the forgotten jewelry, it could not be found. She sued PTAR for the value of the jewelry on a bailment theory. PTAR raised the defense that there was no bailment because Newman retained the right to remove the jewelry from the wall pegs. Decide. [Newman v. Physical Therapy Associates of Rome, Inc., 375 S.E.2d 253 (Ga. App.)] Answer: Elements of a bailment. Judgment for PTAR Inc. There was no delivery of the jewelry to the exclusive possession or control of PTAR Inc. and no acceptance of the jewelry by PTAR Inc. The jewelry was placed on a wall peg within the control of Newman.

[Newman v. Physical Therapy Associates of Rome, Inc., 375 S.E. 2d 253 (Ga. App.)] 14. Charles and Nicolette went to Italy in November 2008, where Charles proposed marriage and presented Nicolette with a diamond ring. She accepted the proposal and the ring. On the same day, Nicolette asked Charles where he had purchased the ring. She became disappointed when he told her where he bought it, and she gave him back the ring, suggesting a different style she would like. He returned the ring to the jeweler and received a refund of $5,000. He then purchased a new ring for $12,000. Charles testified that near the end of November he ―reproposed‖ and presented the second ring to Nicolette. The relationship soon soured and in late February 2009 Charles asked for the return of the ring. Contrary to Charles‘ testimony that he gave the second ring as an engagement ring in late November, Nicolette testified that he gave the second ring to her

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a few days before Christmas as a holiday gift. Was it an engagement ring or a holiday gift?

What legal significance is there to how the gift is classified? Decide. [Miller v. Chiaia, 2011 WL 1367050 (Conn. Superior)] Answer: Conditional Gifts. If the ring was a holiday gift, it was completed upon delivery. If it was an engagement ring it is considered a conditional gift. The court found that the more credible evidence supports Charles‘ claim that the ring was an engagement ring.

Such a ring is ―inherently conditional‖. A ―no fault‖ approach to the ring‘s ownership resolves the matter in favor of the donor, Charles. [Miller v. Chiaia, 2011 WL 1367050 (Conn. Superior)] 15. Charter Apparel, Inc., supplied fabric to Marco Apparel, Inc., in December to manufacture finished articles of clothing at its Walnut Grove, Mississippi, facilities. The fabric arrived just before the Christmas holiday shutdown and was stacked on cutting tables in the old building, which was known to have a roof that leaked. The evidence showed that no precautions were taken to cover the fabric and no guard was posted at the plant during the shutdown. Severe weather and freezing rain occurred during the shutdown, and it was discovered that the rain had leaked through the roof and destroyed more than $400,000 worth of the fabric. Marco denied that it was negligent and argued that it exercised ordinary care. It offered no evidence to rebut Charter‘s prima facie case or to rebut Charter‘s evidence of negligence. It asserted, however, that as a bailee it was not an insurer of goods against severe weather conditions. Decide. [California Union Ins. v. City of Walnut Grove, 857 F. Supp. 515 (S.D. Miss.)]

Answer: Bailee‘s duties; duty of care. The Mississippi court held the clothing manufacturer liable as a matter of law for damage to its customer‘s fabric caused by a leak at the manufacturer‘s facility and the lease held the manufacturer responsible for maintenance.

The manufacturer did not establish ordinary care with respect to the fabric. [California Union Ins. v. City of Walnut Grove, 857 F. Supp. 515 (S.D. Miss.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Legal Aspects of Supply Chain Management

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Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 177 Questions and Case Problems .......................................................................................................... 177

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

What social forces are involved in the rule of law governing the liability of a common carrier for loss of freight?

Answer: Social forces and the law. The common carrier is absolutely liable for the loss of freight unless it can prove that the loss was caused solely by an excepted cause. This rule of law places on the carrier the burden of proving that the cause of the loss is something for which the carrier is not liable.

The social force advanced by this rule of law is the protection of property in that the rule gives to the shipper‘s property a greater protection than would exist if the shipper had the burden of proving the cause of harm or if liability were limited to instances of fault of the carrier. The rule furthers the prevention of oppression because shippers would be repeatedly oppressed by finding themselves unable to prove what had happened to the goods and therefore would be barred from recovering from the carrier if shippers were required to prove the cause of loss. The rule furthers trade in that the owner of property would be willing to use a carrier because the danger of loss has been reduced by this rule.

The rule oppresses the carriers because they are often liable when no one knows what happened or when the cause of the loss was a third person‘s fault.

2.

American Cyanamid shipped 7,000 vials of DPT—a vaccine for immunization of infants and children against diphtheria, pertussis, and tetanus—from its Pearl River, New York, facility to the U.S. Defense Department depot in Mechanicsburg, Pennsylvania, by New Penn Motor Express, a common carrier. Cyanamid‘s bill of lading included a ―release value,‖ which stated that the value of the property was declared as not exceeding $1.65 per pound. Cyanamid‘s shipment weighed 1,260 pounds. The bill of lading accepted by New Penn on picking up the DPT vaccine on February 6 also clearly stated that the shipment contained drugs and clearly warned to ―protect from freezing.‖ The bill further recited ―rush . . . must be delivered by February 8, 1989.‖ New Penn permitted the vaccine to sit in

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an unheated uninsulated trailer while it gathered enough other merchandise to justify sending a truck to Mechanicsburg. The DPT vaccine was delivered on February 10 in worthless condition, having been destroyed by the cold. New Penn admitted that it owed $2,079 in damages pursuant to the bill of lading ($1.65 × 1,260 lb.). Cyanamid claimed that the actual loss was much greater, $53,936.75. It stated that because New Penn breached its contract with Cyanamid, it could not invoke the benefits of that same contract, namely, the release value clause. Was it ethical for New Penn to hold the vaccine while waiting for enough merchandise to justify the trip? How would you decide the case? [American Cyanamid Co. v. New Penn Motor Express, Inc., 979 F.2d 301 (3d Cir.)] Answer: Ethics [Chapter 3]; liability of common carrier; bill of lading. It would appear to be a violation of the ethical principle of promise keeping for the carrier to consciously let vaccine sit for days in an unheated trailer while it promised delivery within two days. Also, it accepted the obligation of preventing the DPT from freezing. Its failure to keep this promise was contrary to the ethical principle of doing no harm. It is poor business judgment for carriers to violate ethical principles, and a pattern to such conduct will lead to an overall loss of business. The reality may well have been that unintentional human error was involved in this case. It would be in the shipper‘s and carrier‘s best interest to conspicuously mark bills of lading and boxes containing perishable goods so that employees readily know they are dealing with such goods.

A bill of lading is both a receipt for the goods and a memorandum of a contract stating the terms of carriage. The court decided that Cyanamid was bound by the release value clause in the bill of lading, which was Cyanamid‘s own form and which directly governed liability by the carrier when it breached the contract by not delivering the goods as agreed.

Cyanamid is thus entitled to only $2,079. [American Cyanamid Co. v. New Penn Motor Express, Inc., 979 F. 2d 301 (3d. Cir.)] 3.

Compare the liens of carriers, warehouses, and hotels in terms of being specific.

Answer: Nature of the liens of warehousers, hotels, carriers. The liens of all three are specific in that they do not extend to other property of the debtor. There is a slight difference between the liens: the liens of the warehouser and the carrier are for service rendered directly to the goods; whereas the lien of the hotel on goods of a guest is not for a benefit conferred directly to the goods, but rather is to enforce and collect the bill owed by the patron of the hotel. The warehousers‘ lien has a carryover to other goods by noting on the receipt of one lot of goods that a lien is also claimed thereon for charges as to other goods.

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4.

Compare the limitations of the liability of a warehouse and of a hotelkeeper.

Answer: Limitation of liability of warehousers; liability of hotels. Both warehousers and hotels may limit liability with respect to goods. In the case of the warehouser, the limitation results from the customer and the warehouser‘s agreement that liability should be limited. In the case of a hotel, a statute will typically declare that the hotel may limit its liability by providing a safe storage place and notifying its patrons of the availability of such place. The two differ also in that the warehouser must give the customer the option of storing without any limitation of liability on paying a higher storage fee. In the case of hotels, there is no ability to obtain unlimited liability by paying a higher room rate.

5.

Compare warehouse receipts and bills of lading as to negotiability.

Answer: Negotiability of warehouse receipts; negotiability of bills of lading. Both warehouse receipts and bills of lading may be in negotiable form, and when either is duly negotiated the purchaser ordinarily acquires rights superior to those of the person who delivered the goods to the warehouse or the common carrier. The two are not negotiable to the extent of giving the purchaser of the paper ownership of the goods if the customer of the warehouser or the shipper did not have ownership. Consequently, the purchaser of a warehouse receipt or a bill of lading does not acquire title when the customer or shipper was a thief who stole the goods.

Certain exceptions are also imposed by which title under a warehouse receipt or a bill of lading is defeated (UCC §§ 7-205, 7-503).

6.

Doyle Harms applied to his state‘s Public Utilities Commission for a Class B permit authorizing performance as a common carrier. Doyle testified that it was not his intention to haul in a different direction than he was already going, stating in part: No way, that’s not what I’m asking for. I’ve got enough business of my own, it’s just the times when you get done with a sale at the end of the day and you’ve got a half load and somebody else has a half load, then you’d be able to help each other out. It’s kind of the name of the game in my mind.

He also testified that the application was so he could haul cattle for his own customers.

State law defines a common carrier as ―a motor carrier which holds itself out to the general public as engaged in the business of transporting persons or property in intrastate

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commerce which it is accustomed to and is capable of transporting from place to place in this state, for hire.‖ Its property is ―devoted to the public service.‖ Should Doyle Harms be issued a common carrier permit? [In re Harms, 491 N.W.2d 760 (S.D.)] Answer: Common carrier definition. The court held that Harms was not a ―common carrier‖ entitled to a common carrier permit where he dedicated his equipment first to serve his own needs which is in contravention of common carrier‘s duty to devote itself to public service without discrimination. [In re Harms, 491 N.W. 2d 760 (S.D.)] 7.

Motorola manufactured cell phones for Nextel of Mexico at its facility in Plantation, Florida. Nextel used Westwind International to arrange transportation of the cell phones.

Westwind utilized Transpro Logistics to administer the transportation process and Transpro entered a Broker Transportation Agreement (BTA) with Werner Enterprises, a common carrier, to transport the phones from Florida to Texas on a regular basis. The BTA incorporated Werner‘s tariff, giving shippers the option of selecting Carmack Liability fullvalue coverage or the carrier‘s limitation of liability of a maximum of $200,000 per truckload shipment. In its contract with Nextel, Westwind notified Nextel that third-party carriers might limit their liability for loss and stated that it would request excess valuation coverage only upon specific written instructions from Nextel. Nextel simply relied on Westwind to handle shipping issues. On October 8, 2004, a shipment of 7,958 cell phones valued at $1,251,673 was stolen from one of Werner‘s trucks. Werner contended that it owed a maximum liability of $200,000 under its tariff. Nextel‘s insurer, Ace Seguros SA, sued Werner for the full value of the shipment, contending that contracts downstream by Westwind and Transpro cannot be imputed back to Nextel—and that the cargo owner Nextel had not been given the opportunity to choose between two or more levels of liability as required by the Carmack Amendment. Can intermediaries like Westwind and/or Transpro negotiate an enforceable agreement with a carrier it engages? Was Nextel given a reasonable opportunity to choose between two or more levels of liability? Decide.

[Werner Enterprises, Inc. v. Ace Seguros SA, 554 F.3d 1319 (11th Cir.)] Answer: Complexities in international and domestic shipping; reasonable opportunity for excess liability coverage. Under the Norfolk Southern Ry. v. Kirby decision of the U.S. Supreme Court, ―when it comes to liability limitations for negligence resulting in damage, an intermediary can negotiate reliable and enforceable agreements with the carrier it engages‖. Transpro had limited agency authority to contract with the common carrier, Werner; and the contract provided the shipper with a reasonable opportunity to choose between two or more levels of liability. That is all that is required under the Carmack Amendment. Since the shipper, or the shipper‘s agent, did not elect the higher coverage,

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the shipper and its insurer were only entitled to the capped coverage of $200,000 per truckload. [Werner Enterprises, Inc. v. Ace Seguros S.A., 554 F. 3d 1319 (11th Cir.)] 8.

Richard Schewe and others placed personal property in a building occupied by Winnebago County Fair Association, Inc. Prior to placing their property in the building, they signed a ―Storage Rental Agreement‖ prepared by the County Fair Association, which stated: ―No liability exists for damage or loss to the stored equipment from the perils of fire . . . .‖ The property was destroyed by fire. Suit was brought against the County Fair Association to recover damages for the losses on the theory of negligence of a warehouse.

The County Fair Association claimed that the language in the storage agreement relieved it of all liability. Decide. [Allstate Ins. Co. v. Winnebago County Fair Ass’n, Inc., 475 N.E.2d 230 (Ill. App.)] Answer: Limitation of liability of warehouser. Judgment for the plaintiffs. Exemption from all liability for fire damage, including loss attributable to negligence, is not expressly stated in the disclaimer. UCC § 1-102(3) states that the obligations of good faith, diligence, and reasonableness in care cannot be disclaimed by agreement. UCC § 7-204 allows a limitation on the monetary amount of damage, as opposed to a total exemption from all liabilities. Because the agreement did not specify claim exemption from negligence or an agreed-on limitation of damages, the standard of reasonable care prevailed and the fire loss due to Winnebago‘s negligence could allow a finding of total liability. The rental storage agreement was not a complete bar to all claims. [Allstate Ins. Co. v. Winnebago County Fair Ass'n, Inc., 475 N.E. 2d 230 (Ill. App.)]

9.

Buffett sent a violin to Strotokowsky by International Parcel Service (IPS), a common carrier. Buffett declared the value of the parcel at $500 on the pick-up receipt given him by the IPS driver. The receipt also stated: ―Unless a greater value is declared in writing on this receipt, the shipper hereby declares and agrees that the released value of each package covered by this receipt is $100.00, which is a reasonable value under the circumstance surrounding the transportation.‖ When Strotokowsky did not receive the parcel, Buffett sued IPS for the full retail value of the violin—$2,000. IPS‘s defense was that it was liable for just $100. Decide.

Answer: Limitation of common carrier‘s liability. Judgment for Strotokowsky for $500. As a common carrier, IPS is liable for the nondelivery of the violin. Because plaintiff assigned the shipment a value of $500, this contractually agreed-to valuation must therefore stand, regardless of the actual value of the violin or the $100 limitation stated in the receipt.

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10. Glen Smith contracted with Dave Watson, a common carrier, to transport 720 hives of live bees along with associated equipment from Idabel, Oklahoma, to Mandan, North Dakota.

At 9:00 a.m. on May 24, 1984, while en route, Watson‘s truck skidded off the road and tipped over, severely damaging the cargo. Watson notified Smith about what had happened, and Smith immediately set out for the scene of the accident. He arrived at 6:00 p.m. with two bee experts and a Bobcat loader. They were hindered by the turned-over truck on top of the cargo, and they determined that they could not safely salvage the cargo that evening. The next day, an insurance adjuster determined that the cargo was a total loss. The adjuster directed a bee expert, Dr. Moffat, to conduct the cleanup; Moffat was allowed to keep the salvageable cargo, valued at $12,326, as compensation. Smith sued Watson for damages. Watson denied liability and further contended that Smith failed to mitigate damages. Decide. [Smith v. Watson, 406 N.W.2d 685 (N.D.)] Answer: Liability of common carriers. Judgment for Smith. Watson, a common carrier, was liable for damages to the consigned property for any cause whatsoever (unless the damages were caused by one of the excepted causes not relevant in this case), from the time Watson accepted the property until proper delivery. Watson, not Smith, had the duties to mitigate damages and to pay the cost of the cleanup. [Smith v. Watson, 406 N.W. 2d 685 (N.D.)] 11. Garrett and his wife checked into the St. Louis Airport North Holiday Inn on March 29, taking advantage of the hotel‘s ―Park and Fly‖ package, which provided one night of lodging to individuals, provided a shuttle service to Lambert International Airport, and allowed individuals to keep a vehicle on the hotel‘s parking lot for up to two weeks. When the Garretts returned from their vacation on April 17, they discovered that their vehicle was stolen. They sued the hotel, contending that a special relationship of an innkeeper and guest was created by the ―Park and Fly‖ marketing package, and that the hotel‘s knowledge of criminal activity on its parking lot created a duty to warn the Garretts, which it failed to do. What status did the Garretts have with the hotel regarding the protection of their vehicle after boarding the plane on their vacation trip? Was there a bailment of the vehicle under the ―Park and Fly‖ marketing package? [Garrett v. IMPAC Hotels Inc., 87 S.W.3d 870 (Mo. App.)] Answer: Duration of guest relationship, liability for guest’s property. After Garrett checked out of the hotel and went on his trip, he was no longer a guest. The hotel‘s innkeeperguest relationship and duty to protect was terminated at that time. There was no bailment of his vehicle because upon appellant‘s return, he was at liberty to drive home without any hindrance from or interaction with the hotel. The hotel would have had to assume a

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greater duty than that of the innkeeper-guest relationship in order to be liable for appellant‘s vehicle which remained on hotel property after appellant was no longer its guest. Moreover, Garrett did not return to the hotel until April 17, eighteen days after his departure, well beyond the ―park and fly‖ package of 14 days. [Garrett v. IMPAC Hotels, Inc., 87 S.W. 3d 870 (Mo. App.)] 12. On March 30, Emery Air Freight Corp. picked up a shipment of furs from Hopper Furs, Inc. Hopper‘s chief of security filled in certain items in the airbill. In the box entitled ZIP Code, he mistakenly placed the figure ―61,045,‖ which was the value of the furs. The ZIP Code box was immediately above the Declared Value box. The airbill contained a clause limiting liability to $10 per pound of cargo lost or damaged unless the shipper makes a declaration of value in excess of the amount and pays a higher fee. A higher fee was not charged in this case, and Gerald Doane signed the airbill for the carrier and took possession of the furs. The furs were lost in transit by Emery, and Hopper sued for the value of the furs, $61,045. Emery‘s offer to pay $2,150, the $10-per-pound rate set forth in the airbill, was rejected. Hopper claimed that the amount of $61,045, which was mistakenly placed in the ZIP Code box, was in fact part of the contract set forth in the airbill and that Emery, on reviewing the contract, must have realized a mistake was made. Decide. [Hopper Furs, Inc. v. Emery Air Freight Corp., 749 F.2d 1261 (8th Cir.)] Answer: Limitation of liability of common carrier. Judgment for Emery. A shipper that brings a negligence action against a common carrier may not recover in excess of the amount specified in the bill of lading or airbill. When no value was declared, the $10-per-pound rate was applicable. A unilateral mistake was made by Hopper, and such may not be the basis for reformation of the contract. No evidence suggested that Emery recognized the mistake on valuation. To the contrary, Emery did not charge a higher fee, as it does when a higher value is declared. [Hopper Furs, Inc. v. Emery Air Freight Corp., 749 F. 2d 1261 (8th Cir.)] 13. When de Lema, a Brazilian resident, arrived in New York City, his luggage consisted of three suitcases, an attaché case, and a cylindrical bag. The attaché case and the cylindrical bag contained jewels valued at $300,000. De Lema went from JFK Airport to the Waldorf Astoria Hotel, where he gave the three suitcases to hotel staff in the garage, and then he went to the lobby to register. The assistant manager, Baez, summoned room clerk Tamburino to assist him. De Lema stated, ―The room clerk asked me if I had a reservation. I said, ‗Yes. The name is José Berga de Lema.‘ And I said, ‗I want a safety deposit box.‘ He said, ‗Please fill out your registration.‘‖ While de Lema was filling out the registration form, paying $300 in cash as an advance, and Tamburino was filling out a receipt for that

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amount, de Lema had placed the attaché case and the cylindrical bag on the floor. A woman jostled de Lema, apparently creating a diversion, and when he next looked down, he discovered that the attaché case was gone. De Lema brought suit against the hotel for the value of the jewels stolen in the hotel‘s lobby. The hotel maintained a safe for valuables and posted notices in the lobby, garage, and rooms as required by the New York law that modifies a hotelkeeper‘s common law liability. The notices stated in part that the hotel was not liable for the loss of valuables that a guest had neglected to deliver to the hotel for safekeeping. The hotel‘s defense was that de Lema had neglected to inform it of the presence of the jewels and to deliver the jewels to the hotel. Is the hotel liable for the value of the stolen jewels? [De Lema v. Waldorf Astoria Hotel, Inc., 588 F. Supp. 19 (S.D.N.Y.)] Answer: Hotelkeepers‘ liability. Judgment was for the hotel. De Lema was a guest when the jewels were stolen, because he made reservations, gave his suitcases to an employee in the garage, and was in the process of registering. However, because he failed to disclose to the assistant manager or the room clerk the nature and value of his property, the hotel was not liable. Under the New York statute enacted for the benefit of hotels, the fact that de Lema asked for a safety deposit box does not satisfy the New York requirement of disclosure and delivery. [De Lema v. Waldorf Astoria Hotel, Inc., 588 F.Supp.

19 (S.D. N.Y.)] 14. Frosty Land Foods shipped a load of beef from its plant in Montgomery, Alabama, to Scott Meat Co. in Los Angeles via Refrigerated Transport Co. (RTC), a common carrier. Early Wednesday morning, December 7, at 12:55 a.m., two of RTC‘s drivers left the Frosty Land plant with the load of beef. The bill of lading called for delivery at Scott Meat on Friday, December 9, at 6:00 a.m. The RTC drivers arrived in Los Angeles at approximately 3:30 p.m. on Friday, December 9. Scott notified the drivers that it could not process the meat at that time. The drivers checked into a motel for the weekend, and the load was delivered to Scott on Monday, December 12. After inspecting 65 of the 308 carcasses, Scott determined that the meat was in off condition and refused the shipment. On Tuesday, December 13, Frosty Land sold the meat, after extensive trimming, at a loss of $13,529.

Frosty Land brought suit against RTC for its loss. Decide. [Frosty Land Foods v. Refrigerated Transport Co., 613 F.2d 1344 (5th Cir.)] Answer: Liability of common carriers. Judgment for Frosty Land Foods. The beef was in good condition when given to Refrigerated Transport. It was damaged when delivered by Refrigerated Transport. Refrigerated Transport was a common carrier, and on proof of the in-transit loss, it became liable for that loss unless it could show that the loss had been

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 22: Nature and Form of Sales

due solely to one or more of the excepted causes. The carrier did not establish that the loss was due to such a cause. Therefore, the carrier was liable for the loss. [Frosty Land Foods v. Refrigerated Transport Co., 613 F. 2d 1344 (5th Cir.)] 15. Tate hired Action-Mayflower Moving & Storage to ship his belongings. Action prepared a detailed inventory of Tate‘s belongings, loaded them on its truck, and received the belongings at its warehouse, where they would be stored until Tate asked that they be moved. Months later, a dispute arose, and Tate asked Action to release his property to a different mover. Tate had prepaid more than enough to cover all charges to this point.

Action refused to release the goods and held them in storage. After allowing storage charges to build up for 15 months, Action sold Tate‘s property under the warehouser‘s public sale law. Tate sued Action for damages. Decide. [Tate v. Action-Mayflower Moving & Storage, Inc., 383 S.E.2d 229 (N.C. App.)] Answer: Warehouser’s lien. Judgment for Tate. At the time Tate demanded the release of his property, he did not owe Action anything for storage. Action therefore had no right to retain possession (a lien) and had no right to sell the property. Action‘s conduct constituted conversion, for which Action was liable to Tate. [Tate v. Action-Mayflower Moving & Storage, Inc., 383 S.E. 2d 229 (N.C. App.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 22: Nature and Form of Sales

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 185 Questions and Case Problems .......................................................................................................... 185 End of Chapter: CPA Questions and Answers ................................................................................. 194 Answers to AICPA Questions ............................................................................................................ 195

Answers to the End-of-Chapter Questions Questions and Case Problems

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1.

Triple H Construction Co. contracted with Hunter‘s Run Stables, Inc., to erect a horse barn and riding arena on Hunter‘s Run‘s property in Big Flats, New York. Hunter‘s Run got a guarantee in its contract with Triple H that ―such design with the span so shown will support its weight and will withstand natural forces including but not limited to snow load and wind.‖ Hunter‘s Run also got the following guarantee from Rigidply, the manufacturer of the rafters: ―Rigidply . . . hereby guarantees that the design to be used for the construction of a horse barn by Triple H . . . will support the weight of such barn and to snow load and wind as per drawings.‖ The barn was completed in 1983 and collapsed under the weight of snow in 1994. Hunter‘s Run has sued Triple H for UCC Article 2 remedies. Does Article 2 apply? [Hunter’s Run Stables, Inc. v. Triple H, Inc., 938 F. Supp. 166 (W.D.N.Y.)] Answer: Application of UCC. The court held that the UCC does not apply and there was no warranty protection. The main objective of the contract was construction, not sales of the products. It was a service, not a sales contract. [Hunter’s Run Stables, Inc. v. Triple H, Inc., 938 F. Supp. 166 (W.D. N.Y.)]

2.

R-P Packaging manufactured cellophane wrapping material that was used by Kern‘s Bakery in packaging its product. Kern‘s decided to change its system for packaging cookies from a tied bread bag to a tray covered with printed cellophane wrapping. R-P took measurements to determine the appropriate size for the cellophane wrapping and designed the artwork to be printed on the wrapping. After agreeing that the artwork was satisfactory, Kern placed a verbal order for the cellophane at a total cost of $13,000. When the printed wrapping material was received, Kern complained that it was too short for the trays and that the artwork was not centered. The material, however, conformed exactly to the order placed by Kern. Kern returned the material to R-P by overnight express. R-P sued Kern. Kern claimed that because there was no written contract, the suit was barred by the statute of frauds. What result? [Flowers Baking Co. v. R-P Packaging, Inc., 329 S.E.2d 462 (Va.)] Answer: Nonresellable goods. If goods are custom-manufactured for the buyer, not suitable for sale to others in the course of the seller‘s business, and the seller has made substantial progress in manufacturing them, then oral contracts for the sale of goods are enforceable even when not evidenced by a writing. Kern will be required to pay R-P under the specially manufactured goods exception. [Flowers Baking Co. v. R-P Packaging, Inc., 329 S.E. 2d 462 (Va.)]

3.

Power & Telephone Supply Company (PTSC) put together a PowerPoint presentation for

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Dumont Telephone Company that showed the ―head-end‖ system—a new phone system that would provide Dumont‘s customers with new video features that Dumont was not currently providing, including a TV-based Web browser with access to Internet radio, Web content, and social media. The quote purported to be a ―cost estimate for Dumont Telephone.‖ It contained the words: ―For Budgetary Purposes only.‖ It also listed a number of items of equipment. Some items were quoted at a specific quantity; others simply had ―1‖ listed as the quantity. Some items were quoted at a specific price; others had no price listed. Is there enough between the quote and the presentation to constitute an offer?

What would happen if the two companies just proceeded as if there were a contract?

[Dumont Telephone Co. v. Power & Telephone Supply Co, 962 F. Supp. 2d 1064 (N.D. Iowa)] Answer: Formation; offer and acceptance. The students should discuss the issue of intent— does the clarifying language that the proposal is for budget purposes only affect intent to contract? There are missing price terms, but the UCC can provide those. The parties going ahead with performance does tend to show intent to contract. In this case, the court held that there was enough there between the proposal and the performance to find a contract existed. In fact, the court ordered the parties to follow the proposal terms that required arbitration and sent them to arbitration. [Dumont Telephone Co. v. Power & Telephone Supply Co., 962 F. Supp. 2d 1064 (N.D. Iowa)] 4.

Mrs. Downing was fitted for dentures by a dentist, Dr. Cook. After she received her dentures, Mrs. Downing began experiencing mouth pain that she attributed to Dr. Cook‘s manufacture of dentures that did not fit her properly. Mrs. Downing filed suit against Dr. Cook for breach of warranty under Article 2 of the UCC. Dr. Cook defended on the grounds that his denture work was a service and therefore not covered under Article 2 warranties. The trial court found for Mrs. Downing, and Dr. Cook appealed. Is Dr. Cook correct? Are the dentures a contract for services or goods? [Cook v. Downing, 891 P.2d 611 (Oka. App.)] Would silicone breast implants be covered by the UCC Article 2 warranties?

Does implantation of silicone gel implants constitute a sale of goods by the surgeon? [In re Breast Implant Product Liability Litigation, 503 S.E.2d 445 (S.C.)] Answer: Sale of goods vs. service. The court held that Dr. Cook is not a merchant and is not in the business of selling dentures. Rather, Dr. Cook is a professional who renders medical services that are governed by common law contracts provisions as well as the provisions in state law for professional malpractice. Mrs. Downing might have had a suit, but it was one based on negligence and not on the sale of goods because the agreement to produce dentures was a medical service and not a sale of goods.

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Silicone would, likewise, not be a sale by a merchant. For the most part, this court and others have ruled that the implantation of the devices is not the sale of goods and that any defects in the implants provide remedies in malpractice against the physician or product liability against the manufacturers, but such is not the sale of goods under Article II. Article II of the UCC applies only to transactions in goods. Section 36-2-103 (1976) defines ―seller" as "a person who sells or contracts to sell goods." "The Code warranty provisions do not govern contracts which are purely for services." James J. White & Robert S. Summers, Uniform Commercial Code 479 (4th ed. 1995). The South Carolina Court of Appeals has recognized that in this state, a sale must occur before an implied warranty can arise. Priest v. Brown, 302 S.C. 405, 396 S.E. 2d 638 (Ct. App.). Further, it has been observed that the UCC's implied warranty appears inapplicable to services. F. Patrick Hubbard & Robert L. Felix, South Carolina Law of Torts 262 (2d 1997).

Our conclusion above—that health care providers offer services, not products— determines our holding as to the issues of warranty under Article II of the UCC. Cases from other jurisdictions have similarly disallowed such claims. See In Re: TMJ Implants Products Liability Litigation, 872 F. Supp. 1019 (D. Minn.) (physician who installed temporomandibular joint implant could not, under North Carolina law, be liable under UCC breach of warranty theories); Cook v. Downing, 891 P. 2d 61 1 (Okla. Ct. App.) (dentist was not a "merchant," and "dentures" were not "goods" under the UCC); Pitler v. Michael Reese Hosp., 92 III. App. 3d 719, 47 III. Dec. 942, 415 N.E. 2d 1255 (UCC did not apply to radiation treatments). [In re Breast Implant Product Liability Litigation, 503 S.E. 2d 445 (S.C.)] 5.

Meyers was under contract with Henderson to install overhead doors in a factory that Henderson was building. Meyers obtained the disassembled doors from the manufacturer.

His contract with Henderson required Meyers to furnish all labor, materials, tools, and equipment to satisfactorily complete the installation of all overhead doors. Henderson felt that the doors were not installed properly and paid less than one-half of the contract price after subtracting his costs for correcting the installation. Because of a business sale and other complications, Meyers did not sue Henderson for the difference in payment until five years later. Henderson raised the defense that because the contract was for the sale of goods, it was barred by the Code‘s four-year statute of limitations. Meyers claimed that it was a contract for services and that suit could be brought within six years. Who is correct?

Why? [Meyers v. Henderson Construction Co., 370 A.2d 547 (N.J. Super.)]

Answer: Sales of goods vs. service. The subject matter at the time of the contracting was goods. The contract is one for sale of goods and the four-year statute of limitation applies.

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Meyers is incorrect. [Meyers v. Henderson Construction Co., 370 A. 2d 547 (N.J. Super.)]

6.

Valley Trout Farms ordered fish food from Rangen. Both parties were merchants. The invoice that was sent with the order stated that a specified charge—a percentage common in the industry—would be added to any unpaid bills. Valley Trout Farms did not pay for the food and did not make any objection to the late charge stated in the invoice. When sued by Rangen, Valley Trout Farms claimed that it had never agreed to the late charge and therefore was not required to pay it. Is Valley Trout Farms correct? [Rangen, Inc. v.

Valley Trout Farms, Inc., 658 P.2d 955 (Idaho)] Answer: Acceptance; change and additional terms. No. The late charge became part of the contract because it did not constitute a material alteration, and no objection was made to it, as provided in UCC § 2-207. Both parties were merchants, and a late charge was customary in this industry. [Rangen, Inc. v. Valley Trout Farms, Inc., 658 P. 2d 955 (Idaho)]

7.

LTV Aerospace Corp. manufactured all-terrain vehicles for use in Southeast Asia. LTV made an oral contract with Bateman under which Bateman would supply the packing cases needed for the vehicles‘ overseas shipment. Bateman made substantial beginnings in the production of packing cases following LTV‘s specifications. LTV thereafter stopped production of its vehicles and refused to take delivery of any cases. When Bateman sued for breach of contract, LTV argued that the contract could not be enforced because there was no writing that satisfied the statute of frauds. Was this a valid defense? [LTV Aerospace Corp. v. Bateman, 492 S.W.2d 703 (Tex. App.)] Answer: The nonresellable goods exception to the statute of frauds. No. The packing cases could not be resold by Bateman in the ordinary course of business. The contract therefore came within the exception made by UCC § 2 -201(3)(a). Bateman made a substantial beginning in the production of the cases and could therefore enforce the oral contract.

[LTV Aerospace Corp. v. Bateman, 492 S.W. 2d 703 (Tex. App.)]

8.

Syrovy and Alpine Resources, Inc., entered into a ―Timber Purchase Agreement.‖ Syrovy agreed to sell and Alpine agreed to buy all of the timber produced during a two-year period. The timber to be sold, purchased, and delivered was to be produced by Alpine from timber on Syrovy‘s land. Alpine continued harvesting for one year and then stopped after making an initial payment. Syrovy sued Alpine. Alpine alleged that there was no contract because the writing to satisfy the statute of frauds must contain a quantity term.

Decide. [Syrovy v. Alpine Resources, Inc., 841 P.2d 1279 (Wash. App.)]

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Answer: Nature of the writing required regarding quantity. Judgment for Syrovy. The terms of the agreement stated, ―all of the timber produced in two years.‖ This was a sufficient quantity term. [Syrovy v. Alpine Resources, Inc., 841 P. 2d 1279 (Wash. App.)] 9.

A subcontractor agreed to remove and dispose of cabinets from a public housing project.

When a dispute arose, one party argued that the UCC applied, and the other argued that it was the common law contract. Explain who is correct and why. [J.O. Hooker’s Sons v.

Roberts Cabinet, 683 So. 2d 396] Answer: Sales of goods v. service. The court held that the contract was a service contract not governed by the UCC. [J.O. Hooker's Sons v. Roberts Cabinet, 683 So. 2d 396)]

10. Fastener Corp. sent a letter to Renzo Box Co. that was signed by Ronald Lee, Fastener‘s sales manager, and read as follows: ―We hereby offer you 200 type #14 Fastener bolts at $5 per bolt. This offer will be irrevocable for ten days.‖ On the fifth day, Fastener informed Renzo it was revoking the offer, alleging that there was no consideration for the offer.

Could Fastener revoke? Explain.

Answer: Firm offer. No. The offer was a firm offer, as it (1) expressed the intention that it not be revoked, (2) was in writing, and (3) was signed by the merchant who made the offer. Therefore, the offer is irrevocable, even though no consideration was given for the ten-day period.

11. Accessory Overhaul Group, Inc. (AOG), provides commercial aircraft component testing, overhauling, and certification services. AOG had submitted a bid to Mesa Air Group, Inc. (―Mesa‖), and its subsidiary, Mesa Airlines, Inc., for work on its planes, which Mesa accepted in the fall of 2007.

AOG began performing work for Mesa in October 2007, and the next month the parties executed a memorandum of understanding (MOU). The MOU provides that it ―shall remain in effect until the execution of the Contract by the Parties or its termination as described herein.‖ From 2007 to 2012, AOG serviced and maintained Mesa‘s wheels, tires, and brakes.

Mesa entered Chapter 7 bankruptcy and the parties continued working together without a written contract in place. Mesa then changed companies for its tire contract and refused to pay AOG for its work to date. AOG filed suit and Mesa filed a motion for summary judgment on AOG‘s claims. In making its decision on the parties‘ rights under the law,

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which law should the court apply (common law or UCC)? Explain your reasoning.

[Accessory Overhaul Group, Inc. v. Mesa Airlines, Inc., 994 F. Supp. 2d 1296 (N.D. Ga. 2014)] Answer: Contract for sale of goods or sale of services. Whether the UCC or common law applies depends on whether the parties‘ relationship predominantly involved goods or services. AOG performed repair services, and while those services may have involved goods, the primary purpose of AOG‘s work was to service the wheels, tires, and brakes of their aircraft.

In repair-contract cases, which typically involve goods and services, courts look to the ―fundamental nature of the transaction.‖ ―The primary purpose of a repair transaction is not to sell or purchase parts, but to change or improve the item and return it to the owner.

In such cases, the provision of goods is incidental, and the UCC does not apply.‖ Here, the parties‘ own words show that the primary purpose of their relationship was for AOG to provide wheel, tire, and brake services to Mesa. Beginning with the MOU, the parties characterized their relationship as a service-based one. The MOU provides that AOG would be the wheels/tire/brakes maintenance and repair and management services provider for Mesa. Thus, the MOU set forth the ―terms and conditions under which AOG will provide such services to Mesa.‖ Similarly, the CTA continued the parties‘ service relationship. [Accessory Overhaul Group, Inc. v. Mesa Airlines, Inc., 994 F. Supp. 2d 1296 (N.D. Ga. 2014)] 12. REMC furnished electricity to Helvey‘s home. The voltage furnished was in excess of 135 volts and caused extensive damage to his 110-volt household appliances. Helvey sued REMC for breach of warranty. Helvey argued that providing electrical energy is not a transaction in goods but a furnishing of services, so that he had six years to sue REMC rather than the UCC‘s four-year statute of limitations, which had expired. Was it a sale of goods or a sale of services? Identify the ethical principles involved in this case. [Helvey v.

Wabash County REMC, 278 N.E.2d 608 (Ind. App.)] Answer: The court held that this transaction was a sale of goods. Helvey tried to extend or delay the time period within which he could have brought a cause of action when he should have commenced an action within a shorter period of time and therefore did not act fairly. [Helvey v. Wabash County REMC, 278 N.E. 2d 608 (Ind. App.)] 13. U.S. Surgical manufactures medical surgical instruments and markets the instruments to hospitals. The packaging for U.S. Surgical‘s disposable medical instruments is labeled ―for

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single use only.‖ As an example, one label contains the following language: ―Unless opened or damaged, contents of package are sterile. DO NOT RESTERILIZE. For multiple use during a SINGLE surgical procedure. DISCARD AFTER USE.‖ Orris provides a service to the hospitals that purchase U.S. Surgical‘s disposable instruments. After the hospitals use or open the instruments, Orris cleans, resterilizes, and/or resharpens the instruments for future use and returns them to the hospitals from which they came.

U.S. Surgical filed suit asserting that reprocessing, repackaging, and reuse of its disposable instruments constituted a violation of its patent and trademark rights. Orris says that U.S. Surgical did not prohibit hospitals from reusing the instruments and that it was not doing anything that violated the contracts U.S. Surgical had with the hospitals. U.S. Surgical says the language on the packaging was an additional term that the hospitals accepted by opening the packages and using the instruments. Who is correct? [U.S. Surgical Corp. v.

Orris, Inc., 5 F. Supp. 2d 1201 (D. Kan.); aff‘d, 185 F.3d 885 (10th Cir.) and 230 F.3d 1382 (Fed. Cir.)] Answer: Additional terms in acceptance. The sale of medical instruments is governed by Article 2 of the UCC. Even if the product label is considered a written confirmation of the order under UCC § 2-207, the "single use only" term is not binding on the customer if the additional term materially alters the agreement and the customer does not confirm the seller's expressly conditional acceptance requiring the additional term or otherwise expressly assent to the additional term. The single-use terms on the package were a material change that the hospitals were free to reject and that they did not accept by use.

The warning on the package did not make the use of the instruments the acceptance of the package terms. The use of the surgical tools was neither a modification nor an additional term binding under § 2-207 for it was material and even if it was not, the use of the tools with the label was too far removed from the contract. [U.S. Surgical Corp. v. Orris, Inc., 5 F. Supp. 2d 1201 (D. Kan.); affirmed 185 F. 3d 885 (10th Cir.) and 230 F. 3d 1382 (Fed. Cir.)] 14. Flora Hall went to Rent-A-Center in Milwaukee and signed an agreement to make monthly payments of $77.96 for 19 months in exchange for Rent-A-Center‘s allowing her to have a Rent-A-Center washer and dryer in her home. In addition, the agreement required Hall to pay tax and a liability waiver fee on the washer and dryer. The total amount she would pay under the agreement was $1,643.15. The agreement provided that Hall would return the washer and dryer at the end of the 19 months, or she could, at that time, pay $161.91 and

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own the washer and dryer as her own. Is this a sales contract? Is this a consumer lease? At the time Hall leased her washer and dryer, she could have purchased a set for about $600.

What do you think about the cost of her agreement with Rent-A-Center? Is it unconscionable? Refer to Chapter 30, and determine whether any other consumer laws apply. Must this contract be in writing? [Rent-A-Center, Inc. v. Hall, 510 N.W.2d 789 (Wis.)] Answer: Sales vs. leases; UCC applicability. In the case, the court held the agreement was not a lease, but a consumer credit sale. Because it was an extension of credit and a sale, the Rent-A-Center was subject to Article 2's unconscionability constraints and credit disclosure statutes. The result was that the amount of fees charged, and the lack of full disclosure constituted unconscionability. [Rent-A-Center, Inc. v. Hall, 510 N.W. 2d 789 (Wis.)] 15. Click2Boost, Inc. (C2B), entered into an Internet marketing agreement with the New York Times (NYT) on May 10, 2002, for C2B to solicit subscribers for home delivery of the New York Times newspaper through ―pop up ads‖ at Web sites with which C2B maintained ―[m]arketing [a]lliances.‖ The agreement required NYT to pay C2B a fee or commission for each home delivery subscription C2B submitted to NYT. NYT paid C2B more than $1.5 million in subscription submission fees from May 2002 to September 2003, but most of the subscriptions were ended, so NYT terminated the C2B agreement on September 16, 2003.

In October 2003, Wall Street Network (WSN) took over C2B and filed suit for breach of contract against NYT. WSN said that NYT had breached the agreement by terminating it before September 30, 2003, because the contract was one for goods and C2B had furnished those goods. WSN wanted damages under the UCC for breach of a contract because the pop-up ads were sold independently as goods. NYT argued that the contract was one for services for furnishing subscribers, something C2B did not do successfully.

WSN countered that the customers generated from the pop-up ads were what was being sold, just like selling a list of names, something that would be considered a good. The trial court granted the NYT summary judgment and WSN appealed. Should WSN win the case?

Why or why not? [Wall Street Network, Ltd. v. New York Times Company, 164 Cal. App. 4th 1171, 80 Cal. Rptr. 3d 6, 66 U.C.C. Rep. Serv. 2d 261] Answer: Goods vs. services; UCC application. The court held that a contract for subscriber names generated from pop-up ads was the result of a service provided by C2B. The bulk of C2B‘s work was in providing the service of the pop-ups and collecting the information from them. Such a contract for services falls outside the scope of the UCC. [Wall Street

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Network, Ltd. v. New York Times Company,164 Cal. App. 4th 1171, 80 Cal. Rptr. 3d 6, 66 UCC Rep. Serv. 2d 261] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Webstar Corp. orally agreed to sell Northco, Inc., a computer for $20,000. Northco sent a signed purchase order to Webstar confirming the agreement. Webstar received the purchase order and did not respond. Webstar refused to deliver the computer to Northco, claiming that the purchase order did not satisfy the UCC statute of frauds because it was not signed by Webstar. Northco sells computers to the general public, and Webstar is a computer wholesaler. Under the UCC Sales Article, Webstar‘s position is: a.

Incorrect, because it failed to object to Northco’s purchase order.

b.

Incorrect, because only the buyer in a sale-of-goods transaction must sign the contract.

c.

Correct, because it was the party against whom enforcement of the contract is being sought.

d.

2.

Correct, because the purchase price of the computer exceeded $500.

On May 2, Lace Corp., an appliance wholesaler, offered to sell appliances worth $3,000 to Parco, Inc., a household appliances retailer. The offer was signed by Lace‘s president and provided that it would not be withdrawn before June 1. It also included the shipping terms: ―F.O.B.—Parco‘s warehouse.‖ On May 29, Parco mailed an acceptance of Lace‘s offer. Lace received the acceptance June 2. Which of the following is correct if Lace sent Parco a telegram revoking its offer and Parco received the telegram on May 25? a.

A contract was formed on May 2.

b.

Lace‘s revocation effectively terminated its offer on May 25.

c.

Lace’s revocation was ineffective because the offer could not be revoked before June 1.

d.

3.

No contract was formed because Lace received Parco‘s acceptance after June 1.

Bond and Spear orally agreed that Bond would buy a car from Spear for $475. Bond paid Spear a $100 deposit. The next day, Spear received an offer of $575, the car‘s fair market value. Spear immediately notified Bond that Spear would not sell the car to Bond and returned Bond‘s $100. If Bond sues Spear and Spear defends on the basis of the statute of

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frauds, Bond will probably:

4.

a.

Lose, because the agreement was for less than the fair market value of the car.

b.

Win, because the agreement was for less than $500.

c.

Lose, because the agreement was not in writing and signed by Spear.

d.

Win, because Bond paid a deposit.

Cookie Co. offered to sell Distrib Markets 20,000 pounds of cookies at $1.00 per pound, subject to certain specified terms for delivery. Distrib replied in writing as follows: ―We accept your offer for 20,000 pounds of cookies at $1.00 per pound, weighing scale to have valid city certificate.‖ Under the UCC: a.

A contract was formed between the parties.

b.

A contract will be formed only if Cookie agrees to the weighing scale requirement.

c.

No contract was formed because Distrib included the weighing scale requirement in its reply.

d.

5.

No contract was formed because Distrib‘s reply was a counteroffer.

Under the Sales Article of the UCC, which of the following requirements must be met for a writing to be an enforceable contract for the sale of goods?

6.

a.

The writing must contain a term specifying the price of the goods.

b.

The writing must contain a term specifying the quantity of the goods.

c.

The writing must contain the signatures of all parties to the writing.

d.

The writing must contain the signature of the party seeking to enforce the writing.

Card communicated an offer to sell Card‘s stereo to Bend for $250. Which of the following statements is correct regarding the effect of the communication of the offer? a.

Bend should immediately accept or reject the offer to avoid liability to Card.

b.

Card is not obligated to sell the stereo to Bend until Bend accepts the offer.

c.

Card is required to mitigate any loss Card would sustain in the event Bend rejects the offer.

d.

Bend may not reject the offer for a reasonable period of time.

[return to top] Answers to AICPA Questions 1.

Webstar Corp. orally agreed to sell Northco, Inc., a computer for $20,000. Northco sent a signed purchase order to Webstar confirming the agreement. Webstar received the purchase order and did not respond. Webstar refused to deliver the computer to Northco,

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claiming that the purchase order did not satisfy the UCC statute of frauds because it was not signed by Webstar. Northco sells computers to the general public, and Webstar is a computer wholesaler. Under the UCC Sales Article, Webstar‘s position is: a.

Incorrect, because it failed to object to Northco’s purchase order.

b.

Incorrect, because only the buyer in a sale-of-goods transaction must sign the contract.

c.

Correct, because it was the party against whom enforcement of the contract is being sought.

d.

Correct, because the purchase price of the computer exceeded $500.

(a) The Statute of Frauds requires that a contract for goods of $500 or more be in writing. UCC 2-207, however, provides that in a contract between merchants, the Statute of Frauds is satisfied if a written confirmation is sent within a reasonable time. The confirmation must be received by the other party who knows or should know the confirmation‘s contents. If the recipient merchant fails to object to the confirmation‘s contents within a reasonable time they will be bound to the contract.

2.

On May 2, Lace Corp., an appliance wholesaler, offered to sell appliances worth $3,000 to Parco, Inc., a household appliances retailer. The offer was signed by Lace‘s president and provided that it would not be withdrawn before June 1. It also included the shipping terms: ―F.O.B.—Parco‘s warehouse.‖ On May 29, Parco mailed an acceptance of Lace‘s offer. Lace received the acceptance June 2. Which of the following is correct if Lace sent Parco a telegram revoking its offer and Parco received the telegram on May 25? a.

A contract was formed on May 2.

b.

Lace‘s revocation effectively terminated its offer on May 25.

c.

Lace’s revocation was ineffective because the offer could not be revoked before June 1.

d.

No contract was formed because Lace received Parco‘s acceptance after June 1.

(c) Merchant‘s firm offers cannot be revoked.

3.

Bond and Spear orally agreed that Bond would buy a car from Spear for $475. Bond paid Spear a $100 deposit. The next day, Spear received an offer of $575, the car‘s fair market value. Spear immediately notified Bond that Spear would not sell the car to Bond and returned Bond‘s $100. If Bond sues Spear and Spear defends on the basis of the statute of frauds, Bond will probably: a.

Lose, because the agreement was for less than the fair market value of the car.

b.

Win, because the agreement was for less than $500.

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Solution and Answer Guide:

c.

Lose, because the agreement was not in writing and signed by Spear.

d.

Win, because Bond paid a deposit.

(b) An agreement for the sale of goods under $500 need not be in writing to be enforceable. Thus, Bond and Spear had a valid oral contract, and Spear has breached the contract by agreeing to sell the car to a third party. The adequacy of consideration is not a contract issue. The agreement does not need to be in writing because it was under $500. Paying a deposit is not the deciding factor in this case.

The key point is that the agreement was for the sale of goods under $500.

4.

Cookie Co. offered to sell Distrib Markets 20,000 pounds of cookies at $1.00 per pound, subject to certain specified terms for delivery. Distrib replied in writing as follows: ―We accept your offer for 20,000 pounds of cookies at $1.00 per pound, weighing scale to have valid city certificate.‖ Under the UCC: a.

A contract was formed between the parties.

b.

A contract will be formed only if Cookie agrees to the weighing scale requirement.

c.

No contract was formed because Distrib included the weighing scale requirement in its reply.

d.

No contract was formed because Distrib‘s reply was a counteroffer.

(a) Under common law, an acceptance must be unequivocal and unqualified in agreeing to the precise terms specified by the offer. However, the Uniform Commercial Code alters this general rule as far as the sale of goods is concerned. Under the UCC, an acceptance containing additional term sis a valid acceptance unless the acceptance is expressly conditional upon the offeror‘s agreement to the additional terms. In this situation, a valid contract has been formed between Cookie Co. and Distrib Markets.

Answer (b) is incorrect because Distrib Markets‘ acceptance was not conditional upon Cookie‘s agreement to the additional term and, thus, a contract is formed regardless of Cookie‘s agreement or objection to the additional term. Answers (c) and (d) are incorrect because this contract was for the sale of goods and is governed by the UCC rather than by common law. Under common law, Distrib Markets‘ reply would have been a rejection and counteroffer, but under the UCC, a contract was formed.

5.

Under the Sales Article of the UCC, which of the following requirements must be met for a writing to be an enforceable contract for the sale of goods? a.

The writing must contain a term specifying the price of the goods.

b.

The writing must contain a term specifying the quantity of the goods.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 23: Title and Risk of Loss

c.

The writing must contain the signatures of all parties to the writing.

d.

The writing must contain the signature of the party seeking to enforce the writing.

(b) A contract cannot provide for ―some goods‖ or ―an amount to be determined.‖ There must be a quantity except in outputs and requirements contract. Answer (a) is incorrect because the UCC has sections to provide a price if the parties fail to specify it in the contract. Answer (c) is incorrect because the contract need only be signed by the party against whom enforcement is sought. Answer (d) is incorrect for the same reason—the party who seeks to enforce need not have signed.

6.

Card communicated an offer to sell Card‘s stereo to Bend for $250. Which of the following statements is correct regarding the effect of the communication of the offer? a.

Bend should immediately accept or reject the offer to avoid liability to Card.

b.

Card is not obligated to sell the stereo to Bend until Bend accepts the offer.

c.

Card is required to mitigate any loss Card would sustain in the event Bend rejects the offer.

d.

Bend may not reject the offer for a reasonable period of time.

(b) An offer needs an acceptance or there is not contract. No performance is required until there is acceptance. Answer (a) is incorrect because no one is required to accept an offer. Answer (c) is incorrect because offerors do not have contract rights until someone accepts and there can be no damages for those who have simply made a proposal. Answer (d) is incorrect because offers can be rejected immediately, not at all, or delayed. The only issue is whether the offer is still open should they delay acceptance. But no offeree has to contemplate an offer for any period of time. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 23: Title and Risk of Loss

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 199 Questions and Case Problems .......................................................................................................... 199 End of Chapter: CPA Questions and Answers ................................................................................. 209

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Solution and Answer Guide:

Answers to AICPA Questions ............................................................................................................ 211

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Schock, the buyer, negotiated to purchase a mobile home that was owned by and located on the sellers‘ property. On April 15, 1985, Schock appeared at the Ronderos‘ (the sellers‘) home and paid them the agreed-on purchase price of $3,900. Shock received a bill of sale and an assurance from the Ronderos that the title certificate to the mobile home would be delivered soon. Also on April 15 and with the permission of the sellers, Schock prepared the mobile home for removal. His preparations included the removal of skirting around the mobile home‘s foundation, the tie-downs, and the foundation blocks, leaving the mobile home to rest on the wheels of its chassis.

Schock intended to remove the mobile home from the Ronderos‘ property a week later, and the Ronderos had no objection to having the mobile home remain on their premises until that time. Two days later, the mobile home was destroyed by high winds as it sat on the Ronderos‘ property. Schock received a clear certificate of title to the mobile home in the mail. Thereafter, Schock sued the Ronderos for return of his money on the ground that when the mobile home was destroyed, the risk of loss remained with the Ronderos. Who should win the lawsuit? [Schock v. Ronderos, 394 N.W.2d 697 (N.D.)] Answer: Title; risk of loss. If the seller is a nonmerchant, the risk of loss passes to the buyer on tender of delivery. Tender of delivery requires that the seller ―put and hold conforming goods at the buyers‘ disposition . . . .‖ At the time of destruction, all that remained to be done was to have the buyer remove the mobile home from the property. Tender of delivery by the sellers had taken place, and risk of loss had passed to the buyer. Judgment was affirmed.

The UCC deviated significantly from the earlier common law discounting the role of title in determining risk of loss. See UCC § 2-401. While many traditionalists bemoaned the loss, the realities of commerce affected the course of the law, because the best party to bear the risk of loss at a particular juncture in a business transaction often has nothing to do with who had title at the time. The UCC sought to eliminate this arbitrariness and further economic efficiency in transactions for goods, so to that end, it is the party that is in the best position to prevent a loss that bears the risk of loss, thus UCC § 2-509. Tender of delivery is the logical and objective demarcation for where this risk passes, as embodied in

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Solution and Answer Guide:

UCC § 2-503.

Where a party has breached, UCC § 2-209 does not apply, its sibling § 2-210 applies instead. Under § 2-210, whichever party is in breach bears the risk of loss. [Schock v.

Ronderos, 394 N.W. 2d 697 (N.D.)] 2.

John C. Clark, using the alias Thomas Pecora, rented a 1994 Lexus from Alamo Rent-A-Car on December 21, 1994. Clark did not return the car and, using falsified signatures, obtained a California so-called quick title.

Clark advertised the car for sale in the Las Vegas Review Journal. Terry and Vyonne Mendenhall called the phone number in the ad and reached Clark. He told them that he lived at a country club and could not have people coming to his house to look at the car.

He instead drove the car to their house for their inspection the next morning. The car title was in the name of J. C. Clark Enterprises. The Mendenhalls bought the car for $34,000 in cash. They made some improvements on the car and registered it in Utah. On February 24, 1995, Alamo reported the car stolen. On March 21, 1995, the Nevada Department of Motor Vehicles seized the car from the Mendenhalls. The car was returned to Alamo and the Mendenhalls filed suit. The lower court found for the Mendenhalls, and Alamo appealed. Who gets the car and why? [Alamo Rent-A-Car v. Mendenhall, 937 P.2d 69 (Nev.)] Answer: Void; voidable title. Although the Mendenhalls might have been bona fide purchasers, Clark did not have voidable title. He was a thief, and a thief can never pass good title to stolen property. Even in the case of good-faith purchasers for value, void title can never be turned into good title. The car belongs to Alamo and the Mendenhalls’ only remedy is against Clark. [Alamo Rent-A-Car v. Mendenhall, 937 P. 2d 69 (Nev.)]

3.

Dan Cake, a company in Portugal, for Dan Cake to ship tins of cookies for sale at CVS pharmacies. The cookies were originally supposed to be delivered on or before September 7, 2007. There were several delays and the cookies did not arrive at CVS warehouses until between December 5 and December 15, 2007. Because of the delay, CVS proposed a new arrangement whereby it would ―pay on scan,‖ meaning that it would pay Dan Cake for all cookies sold up through December 25, 2007, but would not pay for any other cookies shipped. CVS only sold $19,000 of the cookies and the original contract had been for $197,351.08. CVS paid Dan Cake the $19,000 and sent back the remaining cookies. Dan Cake filed suit saying that CVS had taken delivery and owed Dan Cake for the cookies.

What should the court do with the issues in the case? [Dan Cake (Portugal) S.A. v. CVS

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Pharmacy, Inc., 862 F. Supp. 2d 120 (D.R.I.)] Answer: Sale on approval; sale or return. The court held that ―pay on scan‖ meant that CVS would pay only if the cookies sold. The arrangement was, therefore, a type of sale or return that meant that CVS could send the cookies back. Although the original contract was one for the out-and-out sale of goods, the delayed delivery found the parties modifying their contract and resorting to a sale or return arrangement because of the high risk of not selling the cookies so close to Christmas. [Dan Cake (Portugal) S.A. v. CVS Pharmacy, Inc., 862 F. Supp. 2d 120 (D. R.I.)] 4.

Helen Thomas contracted to purchase a pool heater from Sunkissed Pools. As part of the $4,000 contract, Sunkissed agreed to install the pool heater, which was delivered to Thomas‘s home and left in the driveway. The heater was too heavy for Thomas to lift, and she was forced to leave it in the driveway because no one from Sunkissed responded to her calls about its installation. Subsequently, the heater disappeared from the driveway.

Sunkissed maintained that the risk of loss had passed to Thomas. Thomas maintained that the failure to install the heater as promised is a breach of contract. Who should bear the risk for the stolen pool heater? [In re Thomas, 182 B.R. 774 (Bankr. S.D. Fla.)] Answer: Risk of loss. The court held that delivery had not yet occurred because delivery included installment. Sunkissed still had the risk of loss, not Mrs. Thomas. [In re Thomas, 182 B.R. 774 (Bankr. S.D. Fla.)]

5.

Around June 2005, PPI purchased three pallets of computer wafers from Omneon Video Graphics. PPI requested that Omneon ship the wafers directly to the City University of New York, the end purchaser of the goods. Omneon and PPI agreed that Omneon would ship the wafers FOB Omneon‘s dock. Somewhere between the loading dock and City University, one pallet of the wafers disappeared. Who bears the loss for the lost pallet and why? [OneBeacon Ins. Co. v. Hass Industries, Inc., 634 F.3d 1092 (9th Cir.)] Answer: Rick of loss. Ownership of the wafers had passed from Omneon to PPI when the shipment left Omneon's dock. The direct shipment to City University does not interfere with the passage of risk of loss to the buyer, which was PPI. So, PPI‘s insurer would need to cover the loss. [OneBeacon Ins. Co. v. Hass Industries, Inc., 634 F. 3d 1092 (9th Cir.)]

6.

Using a bad check, B purchased a used automobile from a dealer. B then took the automobile to an auction at which the automobile was sold to a party who had no knowledge of its history. When B‘s check was dishonored, the dealer brought suit against

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Solution and Answer Guide:

the party who purchased the automobile at the auction. Was the dealer entitled to reclaim the automobile? [Greater Louisville Auto Auction, Inc. v. Ogle Buick, Inc., 387 S.W.2d 17 (Ky.)] Answer: Ability of vendor with voidable title to transfer valid title. While B had only a voidable title because of the fraud in using a bad check, B had the power under the UCC to pass a good title to a good faith buyer for value. Such a buyer may buy either directly from the holder of the voidable title or at an auction at which the holder of the voidable title has put up the goods for sale. The use of the public auction does not affect the application of the rule. As a practical matter, the use of the public auction makes it easier for the ultimate purchaser to prove that a purchase was made in good faith, as in such a case the buyer never had any direct dealings with the holder of the voidable title and therefore would ordinarily have less reason to suspect that anything was wrong and likewise would be less able to ask questions of anyone. [Greater Louisville Auto Auction, Inc. v. Ogle Buick, Inc., 387 S.W. 2d 17 (Ky.)] 7.

Coppola, who collected coins, joined a coin club, First Coinvestors, Inc. The club would send coins to its members, who were to pay for them or return them within 10 days. What was the nature of the transaction? [First Coinvestors, Inc. v. Coppola, 388 N.Y.S.2d 833] Answer: Distinction between sale on approval and sale or return. The transaction was a sale on approval. Because the goods could be returned by the buyer, the transaction was either a sale on approval or a sale or return. Because the agreement did not specify which type of sale was involved, the type is determined by the purpose of the purchase. Coppola bought for personal use, not for resale. Consequently, by the express provision of UCC § 2 -236(1)(a), the transaction was a sale on approval. [First Coinvestors, Inc. v. Coppola, 388 N.Y. S. 2d 833]

8.

Does a pawnbroker who purchases property in good faith acquire good title to that property? Can the pawnbroker pass good title? [Fly v. Cannon, 813 S.W.2d 458 (Tenn.

App.)] Answer: Passage of title; theft. The pawnbroker passes only the title that he has. If there is a theft involved, title cannot pass regardless of good faith. If there is no theft, a pawnbroker can pass good title. [Fly v. Cannon, 813 S.W. 2d 458 (Tenn. App.)]

9.

Larsen Jewelers sold a necklace to Conway on a layaway plan. Conway paid a portion of the price and made additional payments from time to time. The necklace was to remain in

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the possession of Larsen until payment was fully made. The Larsen jewelry store was burglarized, and Conway‘s necklace and other items were taken. Larsen argued that Conway must bear the risk of loss. Conway sought recovery of the full value of the necklace. Decide. [Conway v. Larsen Jewelry, 429 N.Y.S.2d 378] Answer: Risk of loss. In this case, risk of loss remains with the merchant seller until the buyer obtains the goods. Conway does not bear the loss. [Conway v. Larsen Jewelry, 429 N.Y. S. 2d 378] 10. Future Tech International, Inc., is a buyer and distributor of Samsung monitors and other computer products. In 1993, Future Tech determined that brand loyalty was important to customers, and it sought to market its own brand of computer products. Future Tech, a Florida firm, developed its own brand name of MarkVision and entered into a contract in 1994 with Tae II Media, a Korean firm to produce the computer products for Future Tech.

The contract for production did not go well, but did go slowly.

Future Tech, through threats and demands, was able to have the first line of MarkVision products completed. Tae II Media delivered the computers to a boat but, while in transit, ordered the shipping line (Maersk Lines) to return the computers. The terms of their contract provided for delivery ―FOB Pusan Korea.‖ Future Tech filed suit, claiming that Tae II Media could not take the computer products because title had already passed to Future Tech. Is this interpretation of who has title correct? [Future Tech Int’l, Inc. v. Tae II Media, Ltd., 944 F. Supp. 1538 (S.D. Fla.)] Answer: Risk of loss. Future Tech, not Tae II Media, has title to the computer equipment in the containers. The goods in question were sold on the terms F.O.B. Pusan, Korea and ―net 90 days.‖ In other words, ―delivery‖ to Future Tech occurred not in Miami, but in Pusan, where title and the risk of loss passed to Future Tech. Thus, although the goods were— and continue to be—in the possession of Future Tech‘s shipper, Future Tech has had lawful title to the equipment since delivery at Pusan. It is noteworthy that Park‘s affidavit never suggests that Future Tech, the consignee on the bills of lading and the insurer of the goods, does not have title to the equipment. Moreover, the fact that actual delivery of the equipment to Future Tech has not yet been affected by Maersk Lines is of no moment to our analysis. Judgment for Future Tech. [Future Tech Int’l, Inc. v. Tae II Media, Ltd., 944 F. Supp. 1538 (S.D. Fla.)] 11. Without permission, Grissom entered onto land owned by another and then proceeded to cut and sell the timber from the land. On learning that the timber had been sold, the

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owner of the land brought an action to recover the timber from the purchaser. The purchaser argued that he was a good-faith purchaser who had paid value and therefore was entitled to keep the timber. Decide. [Baysprings Forest Products, Inc. v. Wade, 435 So. 2d 690 (Miss.)]

Answer: Effect of sale on title. The buyer had no title to the timber. A purchaser receives only the title that the seller had. Because the seller had no title to the timber, the buyer was liable to the true owner for the timber or its value. [Baysprings Forest Products, Inc. v.

Wade, 435 So. 2d 690 (Miss.)]

12. Brown Sales ordered goods from Eberhard Manufacturing Co. The contract contained no agreement about who would bear the risk of loss. There were no shipping terms. The seller placed the goods on board a common carrier with instructions to deliver the goods to Brown. While in transit, the goods were lost. Which party will bear the loss? Explain.

[Eberhard Manufacturing Co. v. Brown, 232 N.W.2d 378 (Mich. App.)] Answer: Transfer of risk loss in a shipment contract. The buyer will bear the loss. Because the contract required shipment to the buyer, and no agreement was made as to who would bear the loss, the loss is the buyer‘s when the goods are delivered to the carrier.

[Eberhard Manufacturing Co. v. Brown, 232 N.W. 2d 378 (Mich. App.)] 13. Andrew Pruitt was the chief supervisor at the Fort Lewis army base commissary meat department. In 1978, Pruitt, Patrick Weber, and Reagan Joe Baker formed a corporation to operate two restaurants in Washington known as Steak N‘ Lobster, Incorporated.

Pruitt and Frank Long, another supervisor at Fort Lewis, diverted meat that had been ordered for Fort Lewis to various locations including Pruitt‘s restaurant, Steak N‘ Lobster.

The meat was diverted after commissary personnel examined the meat. Pruitt or Long would direct portions of the meat back to the truck, and the driver for Randy‘s Meat was instructed to deliver the meat to various locations, including the Steak N‘ Lobster restaurant. Or the meat would be labeled ―will call‖ with Fort Lewis marked on the boxes, and Weber would then pick up the meat at a later time.

The FBI began an investigation and arrested all the men. Three months before the trial, Pruitt was killed in a hunting accident, but he had written a statement before that exculpating Weber and Baker. Long and Baker were found guilty of theft, conspiracy, and perjury.

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On appeal, the men argued that proof that the meat belonged to the United States was necessary for the case to proceed in federal court. The meat contracts provided: Unless this contract specifically provides for earlier passage, title to supplies . . . shall pass to the government upon formal acceptance, regardless of when or where the government takes physical possession.

The question then boiled down to whether the meat had been identified and whether the United States had accepted the meat and had some interest in the meat. Provide your analysis of whether the men could be charged with theft. [U.S. v. Long, 706 F.2d 1044 (9th Cir.)] Answer: Identification passage of title. Here is the court‘s analysis: The first principle which bears on this case is that title to goods cannot pass under a contract of sale until specific goods have been identified as the objects to be sold pursuant to the terms of the agreement. See UCC § 2–401(1). Such identification occurs when certain goods are ―marked or otherwise designated by the seller as goods to which the contract refers.‖ UCC § 2–501(1)(b).

The past course of conduct followed by Randy's and Pruitt in the purchase and sale of meat was clearly sufficient to establish that the meat was identified as having been ordered pursuant to the contract with the United States under UCC § 2–501(1).

The Uniform Commercial Code is also instructive as to when title passes to identified goods. UCC § 2–401(2) provides that title passes at the time and place at which the seller completes his performance with reference to physical delivery of the goods.

The meat taken from the will-call trailer had been marked, identified and stored in a special place at Randy's to be picked up by Pruitt's agent. Randy's performance was complete prior to the time the meat was picked up by the thief. Thus, title passed to the government prior to the theft.

We are satisfied from our analysis of the law which applies to commercial transactions, and the conduct of the parties as reflected in this record, that the United States had a property interest in the meat sufficient to comply with the jurisdictional requirements of 18 U.S.C. § 641.

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Long also argues that the district court was required to determine whether title to the meat passed to the government before submitting this issue to the jury. The Supreme Court, however, has recognized that ―[e]very court in rendering a judgment, tacitly, if not expressly, determines its jurisdiction over the parties and the subject matter.‖ [U.S. v. Long, 706 F.2d 1044 (9th Cir.)] 14. A husband and wife (only named as ―Anonymous‖ in their suit) had a prenuptial agreement that provided that any paintings that they owned at the time of marriage would continue to be their sole property. For paintings acquired after their marriage, title belonged to the spouse whose name appeared on the invoice from the art gallery or auction house. Anonymous and Anonymous did not fare so well in their marriage. In dissolving the marriage, who had title to which payment became a stumbling block to finalizing their property rights.

On some of the invoices there was only the name of one spouse, but the account at the gallery or auction house had them listed as joint account holders. With the invoices and accounts being unclear, where should the court turn to determine who holds title to the paintings? [Anonymous v. Anonymous. 51 N.Y.S.3d 66 (Sup. Ct. 2017)] Answer: Passage of title. The court held that an invoice cannot be used as the sole mechanism for determining title. The court remanded the case for the lower court to look at terms of delivery, who accepted delivery, and all things UCC in order to determine title.

If the paintings were delivered—what were the delivery terms and who took delivery. If the paints were not delivered, who picked up the paintings? [Anonymous v. Anonymous, 51 N.Y.S.3d 66 (Sup. Ct. 2017)] 15. Brent J. Brevelle‘s vehicle struck a vehicle driven by Melissa Dauzat as she was leaving the Winn-Dixie grocery store parking lot in Marksville, Louisiana. Teasha, who was thirteen years old at the time, was a guest passenger in the Dauzat vehicle, a 1997 Isuzu pickup truck. Debra Hewitt had allowed Ms. Hewitt initially named Mr. Brevelle and his liability insurer, Safeway Insurance Company of Louisiana, as defendants. She later amended the suit to name State Farm as an additional defendant, asserting that State Farm provided liability insurance coverage for the 1997 Isuzu pickup truck.

State Farm did not dispute that it issued a liability insurance policy to Catherine M. Bordelon listing the 1997 Isuzu pickup truck as the covered automobile. At the time of the accident, Ms. Bordelon still held record title to the truck. However, prior to the accident, Ms. Bordelon entered into the following handwritten agreement with Ms. Hewitt:

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Lease Purchase I Catherine M. Bordelone [sic] do hereby Lease purchase one 1997 Green Isuzu Hombre pickup-VIN # 1GGCS1448V8659834, odo. 00009 to Debra S. Hewitt for the amount of 272–80/xx per month plus 80.00 insurance payment for a period of 60 months For a total of 352.80 per mo.

All insurance proceeds will go to Catherine M. Bordelon + Debra S. Hewitt to repair or replace said vehicle.

In the event this agreement falls 45 days delequient [sic] Purchaser Debra S. Hewitt will return said vehicle to Seller Catherine M. Bordelone [sic] and forfiet [sic] all previous payments.

Payment [sic] are to begin July 1, 1997. Ending July 1, 2002 This agreement entered into jointly by: /s/ Debra S. Hewitt + /s/ Catherine M. Bordelon State Farm asked to not be held liable for the accident because the car no longer belonged to its insured, The trial court awarded Teasha general and special damages, found Ms. Dauzat totally at fault in causing the accident, and held that State Farm provided liability insurance coverage for the accident. State Farm appealed on the grounds that its liability policy did not provide coverage for the Isuzu truck because the policy holder no longer held title to the truck.

What should the court decide about the case and why? List the cautions you have learned for application after reading about this case. [Hewitt v. Safeway Insurance Co. of Louisiana, 787 So. 2d 1182 (3rd Cir.)] Answer: Passage of title; risk of loss. The court noted that there is the title registration system created by state law but there is also the UCC with its rules for passage of title. The ultimate passage of a title document is not the moment of title transfer—the sales transaction with its deliver is. And the fact that it was a lease/purchase did not change the

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title implications. The court reversed the verdict against State Farm.

From the court‘s opinion: The transfer of ownership of property in Louisiana takes place ―as soon as there is agreement on the thing and the price is fixed, even though the thing sold is not yet delivered nor the price paid.‖ Louisiana has declined to recognize the common law concept of conditional sale of movables where the vendor attempts to retain ownership until the purchase price is paid in full. Security Ctr. Protection Servs., Inc. v.

All–Pro Sec., Inc., 97–1070 (La.App. 4 Cir. 11/26/97); 703 So.2d 806. We addressed the treatment of such contracts in Haymon v. Holliday, 405 So.2d 1304, 1307 (La.App. 3 Cir.1981) as follows: Accordingly, if the parties have agreed on the thing and the price, the sale is complete. The parties cannot validly agree that the seller will retain title to the object until payment of the purchase price, as Louisiana does not recognize the common law conditional sales contract for movable property. Roy O. Martin Lumber Co. v.

Sinclair, 220 La. 226, 56 So.2d 240 (1951). The effect of this law is that the seller is divested of ownership as soon as the buyer is unconditionally bound to pay the purchase price, and such contractual attempts to retain title until payment are of no effect.

In other words, an attempted conditional sale agreement is simply ―treated as a credit sale in which ownership of the object of the sale passes at the time the contract is entered into.‖ Succession of Dunham, 408 So.2d 888, 896 (La.1981).

Additionally, Louisiana has recognized the difference between a lease with an option to purchase and a conditional sale disguised as a lease.

The distinction between a valid ―lease with option to purchase‖ and a disguised ―conditional sale‖ is that in the former, there is an option to give additional consideration in order to purchase the leased item at the end of the contract term, while in the latter, there is an obligation to pay the full price regardless of whether the option is exercised or not. Pastorek v. Lanier Systems Co., 249 So.2d 224 (La.App. 4th Cir. 1971).

A contract by which a party binds himself to pay in installments a certain sum for the use of a thing, with the privilege of becoming owner thereof upon paying a further

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sum, for which he has not bound himself absolutely, is simply a lease with an option to purchase, and is not a sale. An alleged lease, in which at the end of the term the lessee is to become owner of the thing leased, in consideration of the rent to be paid, is in fact a sale translative of the property from its very inception. Byrd v. Cooper, 166 La. 402, 117 So. 441 (1928).

A lease contract is ―a synallagmatic contract, to which consent alone is sufficient, and by which one party gives to the other the enjoyment of a thing, or his labor, at a fixed price.‖ However, it is clear that the June 1997 agreement contemplated that Ms. Bordelon would eventually transfer title to the 1997 Isuzu to Ms. Hewitt upon compliance of the payment schedule contained in the agreement without any further consideration.

Despite its use of ―lease purchase‖ language, we find that the June 1997 agreement did immediately transfer ownership of the 1997 Isuzu to Ms. Hewitt. Although the price was not paid in full at that time, the agreement established a fixed price [$352.80 per month for sixty months] for the thing purchased [the 1997 Isuzu pickup truck] as required by La.Civ.Code art. 2456. Once ownership of the vehicle was transferred to Ms. Hewitt, State Farm's obligations to its insured, Ms. Bordelon, ceased to exist. Therefore, we conclude that the trial court erred in finding that the State Farm policy provided liability coverage for the accident sued upon.

The lessons learned are: Private transactions such as this could use a lawyer to be sure all legal issues are covered. Notify your insurance company of sales and purchases of cars immediately. Transferring the title at the time of the sale is perhaps the best thing for a clean title and insurance transaction. The odds are astronomical that an accident would occur in this type of a timing sequence but assume the Black Swan factor and arrange your legal affairs accordingly. [Hewitt v. Safeway Insurance Co. of Louisiana, 787 So. 2d 1182 (3rd Cir.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Bond purchased a painting from Wool, who is not in the business of selling art. Wool tendered delivery of the painting after receiving payment in full from Bond. Bond

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informed Wool that Bond would be unable to take possession of the painting until later that day. Thieves stole the painting before Bond returned. The risk of loss:

2.

a.

Passed to Bond at Wool‘s tender of delivery.

b.

Passed to Bond at the time the contract was formed and payment was made.

c.

Remained with Wool, because the parties agreed on a later time of delivery.

d.

Remained with Wool, because Bond had not yet received the painting.

Which of the following statements applies to a sale on approval under the UCC Sales Article? a.

Both the buyer and seller must be merchants.

b.

The buyer must be purchasing the goods for resale.

c.

Risk of loss for the goods passes to the buyer when the goods are accepted after the trial period.

d.

3.

Title to the goods passes to the buyer on delivery of the goods to the buyer.

If goods have been delivered to a buyer pursuant to a sale or return contract, the: a.

Buyer may use the goods but not resell them.

b.

Seller is liable for the expenses incurred by the buyer in returning the goods to the seller.

4.

c.

Title to the goods remains with the seller.

d.

Risk of loss for the goods passes to the buyer.

Cey Corp. entered into a contract to sell parts to Deck, Ltd. The contract provided that the goods would be shipped ―FOB Cey‘s warehouse.‖ Cey shipped parts different from those specified in the contract. Deck rejected the parts. A few hours after Deck informed Cey that the parts were rejected, they were destroyed by fire in Deck‘s warehouse. Cey believed that the parts were conforming to the contract. Which of the following statements is correct? a.

Regardless of whether the parts were conforming, Deck will bear the loss because the contract was a shipment contract.

b.

If the parts were nonconforming, Deck had the right to reject them, but the risk of loss remains with Deck until Cey takes possession of the parts.

c.

If the parts were conforming, risk of loss does not pass to Deck until a reasonable period of time after they are delivered to Deck.

d.

If the parts were nonconforming, Cey will bear the risk of loss, even though the contract was a shipment contract.

5.

Under the Sales Articles of the UCC, when a contract for the sale of goods stipulates that

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the seller ship the goods by common carrier ―FOB purchaser‘s loading dock,‖ which of the parties bears the risk of loss during shipment? a.

The purchaser, because risk of loss passes when the goods are delivered to the carrier.

b.

The purchaser, because title to the goods passes at the time of shipment.

c.

The seller, because risk of loss passes only when the goods reach the purchaser’s loading dock.

d.

The seller, because risk of loss remains with the seller until the goods are accepted by the purchaser.

6.

When do title and risk of loss for conforming goods pass to the buyer under a shipment contract covered by the Sales Article of the UCC? a.

When the goods are identified and designated for shipment.

b.

When the goods are given to a common carrier.

c.

When the goods arrive at their destination.

d.

When the goods are tendered to the buyer at their destination.

[return to top] Answers to AICPA Questions 1.

Bond purchased a painting from Wool, who is not in the business of selling art. Wool tendered delivery of the painting after receiving payment in full from Bond. Bond informed Wool that Bond would be unable to take possession of the painting until later that day. Thieves stole the painting before Bond returned. The risk of loss: a.

Passed to Bond at Wool‘s tender of delivery.

b.

Passed to Bond at the time the contract was formed and payment was made.

c.

Remained with Wool, because the parties agreed on a later time of delivery.

d.

Remained with Wool, because Bond had not yet received the painting.

(b) Risk of loss passes at the time the contract is formed and payment is made when the seller is not a merchant. If the seller was a merchant, risk of loss would pass upon the buyer‘s receipt of the goods. In this problem, the facts clearly specify that Wool is not a merchant in the goods being sold, so we can determine that risk of loss passed to Bond upon payment.

2.

Which of the following statements applies to a sale on approval under the UCC Sales Article?

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a.

Both the buyer and seller must be merchants.

b.

The buyer must be purchasing the goods for resale.

c.

Risk of loss for the goods passes to the buyer when the goods are accepted after the trial period.

d.

Title to the goods passes to the buyer on delivery of the goods to the buyer.

(c) The purchase of goods on a sale on approval allows the buyer to return the goods even if they conform to the contract. Therefore, the seller retains the title and the risk of loss until the buyer accepts the goods. Thus, answer (d) is incorrect. Answers (a) and (b) are incorrect because these are not requirements for a sale on approval to be valid.

3.

If goods have been delivered to a buyer pursuant to a sale or return contract, the: a.

Buyer may use the goods but not resell them.

b.

Seller is liable for the expenses incurred by the buyer in returning the goods to the seller.

c.

Title to the goods remains with the seller.

d.

Risk of loss for the goods passes to the buyer.

(d) Under a sale or return contract, the sale is considered as completed although it is voidable at the buyer‘s election. As such, risk of loss passes to the buyer, who also has title to the goods until they are returned; therefore, answer (c) is incorrect.

Furthermore, the return of the goods is at the buyer‘s risk and expense; thus, answer (b) is incorrect. Answer (a) is incorrect because, under the definition of a sale or return contract, the buyer is acquiring the goods for resale.

4.

Cey Corp. entered into a contract to sell parts to Deck, Ltd. The contract provided that the goods would be shipped ―FOB Cey‘s warehouse.‖ Cey shipped parts different from those specified in the contract. Deck rejected the parts. A few hours after Deck informed Cey that the parts were rejected, they were destroyed by fire in Deck‘s warehouse. Cey believed that the parts were conforming to the contract. Which of the following statements is correct? a.

Regardless of whether the parts were conforming, Deck will bear the loss because the contract was a shipment contract.

b.

If the parts were nonconforming, Deck had the right to reject them, but the risk of loss remains with Deck until Cey takes possession of the parts.

c.

If the parts were conforming, risk of loss does not pass to Deck until a reasonable period of time after they are delivered to Deck.

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d.

If the parts were nonconforming, Cey will bear the risk of loss, even though the contract was a shipment contract.

(d) The UCC places risk of loss on the breaching party. Since Cey shipped nonconforming goods, it breached the contract and would have risk of loss until the nonconforming goods were accepted by the buyer or until the goods were cured by Cey. Since Deck rejected the goods and Cey did not cure the goods, risk of loss remained with Cey. Shipping terms have no bearing on risk of loss in this situation because the goods did not conform to the contract. Answer (a) is incorrect because Deck would only bear risk of loss if the goods conformed to the contract. Answer (b) is incorrect because the risk of loss was never transferred to Deck since the goods were nonconforming. Answer (c) is incorrect because if the goods were conforming, risk of loss would pass to Deck at Cey‘s warehouse based on the shipping terms AFOB Cey‘s warehouse.

5.

Cey Corp. entered into a contract to sell parts to Deck, Ltd. The contract provided that the goods would be shipped ―FOB Cey‘s warehouse.‖ Cey shipped parts different from those specified in the contract. Deck rejected the parts. A few hours after Deck informed Cey that the parts were rejected, they were destroyed by fire in Deck‘s warehouse. Cey believed that the parts were conforming to the contract. Which of the following statements is correct? a.

Regardless of whether the parts were conforming, Deck will bear the loss because the contract was a shipment contract.

b.

If the parts were nonconforming, Deck had the right to reject them, but the risk of loss remains with Deck until Cey takes possession of the parts.

c.

If the parts were conforming, risk of loss does not pass to Deck until a reasonable period of time after they are delivered to Deck.

d.

If the parts were nonconforming, Cey will bear the risk of loss, even though the contract was a shipment contract.

(c) Under an FOB place of shipment contract, the risk of loss passes when the goods arrive at their destination and are available to the buyer (tender). In this case, arrival at the loading dock is tender.

6.

When do title and risk of loss for conforming goods pass to the buyer under a shipment contract covered by the Sales Article of the UCC? a.

When the goods are identified and designated for shipment.

b.

When the goods are given to a common carrier.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 24: Product Liability: Warranties and Torts

c.

When the goods arrive at their destination.

d.

When the goods are tendered to the buyer at their destination.

(b) Title and risk of loss in a shipment contract, which the exam defines as ―FOB place of shipment,‖ meaning that all the seller has to do is get the goods to the carrier for title and risk of loss to pass. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 24: Product Liability: Warranties and Torts

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 214 Questions and Case Problems .......................................................................................................... 214

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

in Queens, New York. The hot water supplied to their apartment was heated by a Morflo water heater, which had a temperature control device on its exterior manufactured by Robertshaw and sold to Morflo. Maria Garcia, the owner of the Gonzalezes‘ apartment, had purchased and installed the water heater. The Morflo heater was located in the basement of the apartment house, which was locked and inaccessible to tenants.

Extensive warnings were on the water heater itself and in the manual given to Garcia at the time of her purchase. The warning on the Robertshaw temperature device read: ―CAUTION: Hotter water increases the risk of scald injury.‖ The heater itself contained a picture of hot water coming from a faucet with the word ―DANGER‖ printed above it. In addition, the water heater had a statement on it: ―Water temperature over 120 degrees Fahrenheit can cause severe burns instantly or death from scalds. Children, disabled, and elderly are at highest risk of being scalded. Feel water before bathing or showering.

Temperature limiting valves are available, see manual.‖

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In the Morflo manual, the following warning appeared: DANGER! The thermostat is adjusted to its lowest temperature position when shipped from the factory. Adjusting the thermostat past the 120 degree Fahrenheit bar on the temperature dial will increase the risk of scald injury. The normal position is approximately 120 degrees Fahrenheit.

DANGER: WARNING: Hot water can produce first degree burns in 3 seconds at 140 degrees Fahrenheit (60 degrees Celsius), in 20 seconds at 130 degrees Fahrenheit (54 degrees Celsius), in 8 minutes at 120 degrees Fahrenheit (49 degrees Celsius).

On October 1, 1992, 15-month-old Angel Gonzalez was being bathed by his 15-year-old brother, Daniel. When the telephone rang, Daniel left Angel alone in the bathtub. No one else was at home with the boys, and Daniel left the water running. Angel was scalded by the water that came from the tap. Angel and his mother brought suit against Morflo and Robertshaw, alleging defects in the design of the water heater and the failure to warn.

Should they recover? [Gonzalez v. Morflo Industries, Inc., 931 F. Supp. 159 (E.D.N.Y.)] Answer: Product liability; defect. There was no design defect. There was sufficient warning on the product. That the landlord did not extend the warning to the tenants is not the responsibility of the product manufacturer. Hot water is hot—this simple fact does not allow recovery in this case. [Gonzalez v. Morflo Industries, Inc., 931 F. Supp. 159 (E.D. N.Y.)] 2.

Paul Parrino purchased from Dave‘s Professional Wheelchair Service a wheelchair manufactured by 21st Century Scientific, Inc. The sales brochure from 21st Century Scientific stated that the wheelchair would ―serve [the buyer] well for many years to come.‖ Parrino had problems with the wheelchair within a few years and filed suit against Dave‘s and 21st Century for breach of express warranty. Both defended on the grounds that the statement on years of service was puffery, not an express warranty. Are they right? [Parrino v. Sperling, 648 N.Y.S.2d 702] Answer: Express warranty. The statement about the wheelchair's service for years to come did not rise to the level of a promise of future performance for purposes of an express warranty. Under section 2-725 of the UCC, the promise was not specific enough to commit the seller to certain number of years of performance. [Parrino v. Sperling, 648 N.Y. S. 2d 702]

3.

Jane Jackson purchased a sealed can of Katydids, chocolate-covered pecan caramel

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Solution and Answer Guide:

candies manufactured by NestlT. Shortly after, Jackson bit into one of the candies and allegedly broke a tooth on a pecan shell embedded in the candy. She filed a complaint, asserting breach of implied warranty. How would you argue on behalf of the company?

How would you argue on behalf of Jackson? In your answer, discuss both the reasonable expectation test and the foreign substance/natural substance test. [Jackson v. NestlT-Beich, Inc., 589 N.E.2d 547 (Ill. App.)] Answer: Warranties for sale of food or drink. The NestlT Company would argue that under the foreign-natural doctrine, the fact that there was a harmful ingredient natural to the product (pecan shell in pecan meat) should not allow recovery by Mrs. Jackson. Mrs. Jackson would argue that under the reasonable expectations test, she expected the food to be free of things that would cause harm, whether natural or foreign. Discuss with your class how this case would be handled under your state‘s approach to this type of food problem. Solutions vary widely from state to state. [Jackson v. NestlT-Beich, Inc., 589 N.E. 2d 547 (Ill. App.)] 4.

TTI designs, markets, and manufactures a variety of vacuums and carpet cleaners including the Hoover SteamVac SpinScrub®. TTI and Wal-Mart market the Hoover carpet cleaners as ―Steam Vacs and Steam Cleaners.‖ Both TTI and Wal-Mart know the SteamVac® does not produce steam—it uses hot tap water without heating the water itself in its cleaning process. Melissa Boyd purchased the SteamVac® at a Wal-Mart. Boyd received a product worth substantially less than the product . . . would have been worth‖ if it used steam to clean. Wal-Mart still markets, advertises, and sells TTI‘s Hoover SteamVac®. Boyd filed suit against both TTI and Wal-Mart for breach of express warranty. Is there a breach of an express warranty? [Boyd v. Floorcare North America, 230 F. Supp. 3d 1266 (N.D. Ala. 2011)] Answer: Express warranty. The court held that the use of the word steam was not an express warranty. There were no allegations that the machines did not clean. Also, nothing in the labeling of the product indicates that steam is part of the cleaning element. There is no breach of express warranty.

FROM THE COURT‘S OPINION: Notably, Plaintiffs do not allege that the respective products fail to clean effectively or do not clean as well as they would if they produced steam. Instead, Plaintiffs vaguely allege an injury because the products purchased would be worth more if they produced steam.

Likewise, nowhere in their complaints do Plaintiffs assert that they purchased the products because they believed they produced steam. Nonetheless, as a matter of contract law,

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Plaintiffs assert that Bissell and TTI expressly warranted that the SteamVac® and PowerSteamer® produced steam—as opposed to merely using hot water—at some point in the cleaning process. Likewise, Plaintiffs assert that because Wal–Mart sold the products, it apparently ratified the express warranty that they used steam.

Unfortunately for Plaintiffs, the absence of caselaw supporting their claim undermines their contentions. Indeed, other courts considering similar questions have noted that absence as well when rejecting such claims. See, e.g., Szajna, 104 Ill. Dec. 898, 503 N.E.2d at 771(―[N]one of those cases stand for the proposition that a trade name is a description creating an express warranty that the product is of a particular quality or that its component parts are of a particular quality.‖); Hertzog, 2002 WL 1609032, at *5, 2002 Wash. App. LEXIS 1724, at *16 (―[Plaintiff] offers no authority for his contention that this name constitutes an express warranty . . . .‖); 1278 Miller v. Showcase Homes, Inc., No. 98C-2009, 1999 WL 199605, at *4 (N.D. Ill. Mar. 31, 1999) (―Finally, there is no support for plaintiffs' contention that the use of a trademark or trade name gives rise to an assurance of quality‖ or that the ―use of the Showcase trade name is itself an express warranty of quality.‖) (emphasis in original).

Conversely, the cases cited by Defendants more clearly address the relationship of a product's name to an available breach of warranty claim. Indeed, courts reject reliance upon a tradename to show the existence of an express warranty or deception as to a product's functionality, quality, duration, or effectiveness based solely on the product's name. See, e.g., Szajna, 104 Ill. Dec. 898, 503 N.E.2d at 771(rejecting the name of the car as an express warranty as to the components the car would use); McKinnis, 2007 WL 4766060, at *15–16 (rejecting contentions that the name ―FrootLoops‖ is an express warranty that the cereal contained fruit); Sugawara, 2009 WL 1439115 at *4–5, 2009 LEXIS 43127 at *12 (rejecting that the product's tradename, ―Cap'n Crunch with Crunchberries‖ creates an express warranty that it contains berries); see also Schreib v. Walt Disney Co., No. 1-050094, 2006 WL 573008, at *2 (Ill. App. 1 Dist. Feb. 1, 2006) (―In this case, defendant, by naming the products ‗Gold Collection‘ or ‗Masterpiece Collection‘ did not make an affirmation of fact or a promise that the videotapes would last for generations or that they would have an extraordinary life span.‖); Showcase Homes, 1999 WL 199605, at *4 (―Finally, there is no support for Plaintiffs' contention that the use of a trademark or trade name gives rise to an assurance of quality‖ or that the ―use of the Showcase trade name is itself an express warranty of quality.‖) (emphasis in original).

Here, the products in question include the word ―steam‖ in their names, which Plaintiffs assert expressly warrants that the vacuums will use steam or produce steam when

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cleaning. Importantly, Plaintiffs do not allege and apparently concede that the advertising and packaging associated with Defendants' products make no mention of steam nor any claims to use or produce steam. (Defendants' briefs note the absence in the respective complaints of allegations that the word ―steam‖ appears on the products' packaging or in advertisements, which Plaintiffs do not rebut). The court is persuaded, then, that the trademarked name alone, as in Szajna or Sugawara, makes no warranty as to what a product does or contains. Plaintiffs contend, however, that unlike those cases, here, a steam cleaning vacuum is a specific thing and the name of the products misleads consumers into believing the SteamVac® and PowerSteamer® are, in fact, steam cleaning vacuums. However logical Plaintiffs' contention, a product's trademarked name is more akin to sales talk and puffery, which are not actionable bases for an express warranty claim, than to a description of a product, a promise, or an affirmation of fact. Again, the court notes that Plaintiffs allege only a breach of warranty claim, not a claim for fraud or a claim under Alabama's deceptive trade statute.

Ultimately, the court is persuaded that the trade names SteamVac® and PowerSteamer® do not expressly warrant what those products will or can do. Indeed, this is the crucial point. Plaintiffs' citations to case law reiterate the limit of what a product's trademarked name can expressly warrant—authenticity. The names in question here do not provide an affirmation of fact as to what the product does. They provide, instead, an affirmation of what the product is—in other words, they provide a promise that the product sold is an authentic SteamVac® or PowerSteamer®. They do not create an affirmation of fact nor do they describe the cleaning process the product uses. [Boyd v. Floorcare North America, 230 F. Supp. 3d 1266 (N.D. Ala. 2011)] 5.

Andy‘s Sales (owned by Andy Adams) sold a wellbuilt trampoline to Carl and Shirley Wickers. The Wickerses later sold the trampoline to Herbert Bryant. While using the trampoline, Herbert‘s 14-year-old nephew, Rex, sustained injuries that left him a quadriplegic. Rex‘s guardian filed suit for breach of express warranty and merchantability.

The sales brochure for the round trampoline described it as ―safe‖ because it had a ―uniform bounce‖ and ―natural tendency to work the jumper toward the center.‖ The Wickerses had purchased an oval-shaped trampoline. Discuss Rex‘s ability to recover. Is privity an issue? [Bryant v. Adams, 448 S.E.2d 832 (N.C. App.)] Answer: Express warranty; privity. Privity is not an issue if the product has a defective design because the theories of strict tort liability could be used. Whether an express warranty applies is a different question because the sales brochure was for a different trampoline. Was it (the statement) a basis of the bargain? Since it was a secondary sale,

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the express warranty may not have been made.

Another theory of recovery might be inadequate warnings about the use of the product (strict tort liability) and the importance of staying in the center of the trampoline. [Bryant v.

Adams, 448 S.E. 2d 832 (N.C. App.)] 6.

Advent purchased ink from Borden. On the labels of the ink drums delivered to Advent, Borden had imprinted in one-sixteenth-inch type in all caps: SELLER MAKES NO WARRANTY, EXPRESS OR IMPLIED, CONCERNING THE PRODUCT OR THE MERCHANTABILITY OR FITNESS THEREOF FOR ANY PURPOSE CONCERNING THE ACCURACY OF ANY INFORMATION PROVIDED BY BORDEN. This language was printed beneath the following: BORDEN PRINTING INKS—―ZERO DEFECTS: THAT’S OUR GOAL‖ All of the printing was in boldface type. The disclaimer was also printed on the sales invoice and on the reverse side of the Borden form, but there was nothing on the front to call attention to the critical nature of the terms on the back because there were simply capital letters reading ―SEE REVERSE SIDE.‖ All of the terms on the back were in boldface and although the disclaimer was the first of 19 paragraphs, nothing distinguished it from the other 18 paragraphs of detailed contract terms.

Advent said that Borden failed to age the black ink that it purchased, resulting in the ink separating in Advent‘s printing machines. Advent refused to pay for the ink and wrote to Borden explaining that it would not tender payment because the ink was defective and demanding that Borden reimburse it for its lost profits from the downtime of printing machines. The trial court held that Borden had disclaimed any and all warranties on the ink and Advent appealed. What would you decide about the disclaimer and why? [Borden, Inc. v. Advent Ink Co., 701 A.2d 255 (Pa. Sup.)] Answer: Unconscionability; disclaimers. Even though the warranty disclaimer was in bold print on the barrels of ink, so was all the other language imprinted there. Nothing there would call the attention of the buyer to the disclaimer. Such a disclaimer must be ―attention-getting,‖ which means that the disclaimer must be printed in type that can reasonably be expected to draw attention to it. Because the type was small, was the same size as all other type on the ink barrel, and did nothing to draw attention to it, the

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warranty was not conspicuous and the disclaimer was invalid. [Borden, Inc. v. Advent Ink Co., 701 A. 2d 255 (Pa. Sup.)] 7.

John Clark purchased a paintball gun at a pawn shop and then participated in a community sport of shooting paintball guns at cars. While John and his friend were riding around their small town with their paintball guns, they spotted Chris and shot his car. Chris Rico then aimed his Brass Eagle paintball gun at the car John was riding in, but instead hit John in the eye. John required surgery on his eye that evening and filed suit against Brass Eagle under a theory of strict tort liability. Brass Eagle responded by stating that its gun was not defective and that the young men had ignored warnings about the need to wear eye protection when using the guns. John said he purchased his gun used and was not given all the packaging and instructions. Brass Eagle says that its gun was not defective and that it functioned as it was supposed to. John says the guns are inherently dangerous.

Who should be responsible for the injury? Are paintball guns defective if they can harm individuals? How should the courts allocate the risk and loss on products such as these?

[Clark v. Brass Eagle, Inc., 866 So. 2d 456 (Miss.)]

Answer: Defective products. Discuss with the students the fact that there are some products that are inherently dangerous and there is some assumption of risk. Discuss the importance of warnings and then discuss the risks in buying second-hand products—the warnings are not made available and there is not privity, which is not required for recovery, but not when the warnings would have protected John‘s eyes—i.e., he should have been wearing eye protection.

Discuss also the public policy issues of a company that manufacturers these products, but is not held responsible for resulting injuries as well as the other side of the coin that there are products that are dangerous, but we allow them to be manufactured and hold users accountable. [Clark v. Brass Eagle, Inc., 866 So. 2d 456 (Miss.)]

8.

James Jelinek purchased Hytest BMR Sorghum Sudan grass seed, which was produced and marketed by Land O‘Lakes. Land O‘Lakes warranted the seed to be free from defects and expressly warranted that by using normal farming practices and proper maintenance, Mr. Jelinek would obtain yields of 4 1/2 tons per acre. The seed resulted in reduced yields and an inferior quality crop. As a result, Mr. Jelinek was not able to sell his crop and had significant economic losses. Mr. Jelinek filed suit for breach of express warranty. Is the promise of a crop yield an express warranty? Explain your answer. [Jelinek v. Land O’Lakes, Inc., 797 N.W.2d 289 (Neb. App.)]

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Answer: Express warranty. Whether statements in grain seed producer's brochure were assertions of fact of which buyers were ignorant, as required for statements to create an express warranty as to seed yield, was issue for jury, in action against producer by farmers who had bought the seed; although brochure did not use words ―warranty‖ and ―guarantee,‖ brochure contained comparison chart supporting a conclusion that the seed produced high yields, stated that seed was a ―forage breakthrough,‖ provided ―exceptional yield potential and high quality forage‖ with an ―extended window of harvest,‖ provided ―more PROFIT $ per acre return,‖ had ―high quality over the entire growing season,‖ was ―highly palatable,‖ and had ―low water requirement, good drought stress tolerance‖.

The complaint withstood summary judgment and a promise of performance (crop yield) is a basis for an express warranty, even though the words ―warrant‖ or ―promise‖ are not used. [Jelinek v. Land O'Lakes, Inc., 797 N.W. 2d 289 (Neb. App.)] 9.

Brianna Kriefall, a child, died after she ate meat at a Sizzler restaurant that was later found to contain E. coli. Her family brought suit against Sizzler USA to recover for the loss of their daughter. Is Sizzler liable for the death? Explain your answer. What would be the liability of Sizzler‘s meat supplier in the case? [Estate of Kriefall v. Sizzler USA Franchise, Inc., 801 N.W.2d 781 (Wis. App.)] Answer: Implied warranty of merchantability. (1) Franchisor was a ―buyer‖ of meat for purposes of determining application of implied warranty under Uniform Commercial Code; (2) meat processor's contractual agreement to indemnify restaurant was valid; (3) restaurant was not entitled to recover money paid by franchisor's insurer to restaurant's insurer to help pay claims; (4) evidence supported jury's finding that restaurant was 20% at fault; and (5) franchisor paid $1.5 million to family of deceased child. [Estate of Kriefall v.

Sizzler USA Franchise, Inc., 801 N.W. 2d 781 (Wis. App.)]

10. Zogarts manufactured and sold a practice device for beginning golfers. According to statements on the package, the device was completely safe, and a player could never be struck by the device‘s golf ball. Hauter was hit by the ball while using the device. He sued Zogarts, which denied liability on the ground that the statements were merely matters of opinion, so liability could not be based on them. Was this a valid defense? [Hauter v.

Zogarts, 534 P.2d 377 (Cal.)] Answer: Express warranty; puffing. No. The statements were not merely matters of the seller‘s opinion, but were made as statements of fact: the characteristics of the product.

Therefore, liability could not be avoided on the ground that such statements were merely

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opinion or sales talk. [Hauter v. Zogarts, 534 P. 2d 377 (Cal.)] 11. GE Oil & Gas, Inc., is a company that manufactures gas compressors. Berge Helene owns a large barge that it leases to oil companies for purposes of storing and producing petroleum offshore. GE Oil & Gas sold Berge Helene gas compressors that were to be used on the barge. Berge Helene representatives asked GE representatives, as they were negotiating the contract for the compressors, whether the compressors could withstand the movement and vibration that would occur on the front of the barge once it was out in the ocean. GE‘s representatives assured those from Berge Helene that the compressors were self-stabilizing. Once out in the ocean, the gas compressors on the hull exploded once the vibrations began. Berge Helene brought suit against GE for the resulting crew injuries and damage to the barge. Could Berge Helene recover and, if so, what theory of product liability would apply? [Berge Helene Ltd. v. GE Oil & Gas, Inc., 830 F. Supp. 2d 235 (S.D. Tex.)] Answer: Implied warranty of fitness for a particular purpose. The case withstood summary judgment because the court held that there were representations made that the compressors were stable enough to be safe on the front of the barge. The seller knew of their planned use and made representations about their stability. Recovery was, therefore, possible for breach of warranty for a particular purpose. [Berge Helene Ltd. v. GE Oil & Gas, Inc., 830 F. Supp. 2d 235 (S.D. Tex.)] 12. After watching a male horse owned by Terry and Manita Darby perform at a horse show, Ashley Sheffield contacted the Darbys about buying him. The Darbys assured her that the horse had no problems and would make a good show horse for use in competition. In the presence of and in consultation with her father (who raised horses for a business), Sheffield rode the horse and decided to purchase him for $8,500.

Within three weeks, Sheffield and her trainer discerned that the horse was lame. Sheffield sued the Darbys for fraud and for breach of express and implied warranties, and the court entered summary judgment in favor of the Darbys on all claims. Sheffield appealed. Was the court correct in granting summary judgment? Was there a breach of an express warranty? [Sheffield v. Darby, 535 S.E.2d 776 (Ga. App.)] Answer: Puffing; express warranty. A party may not justifiably rely on and assume to be true representations consisting of mere expressions of opinion, hope, expectation, puffing, and the like; rather, the party must inquire into and examine such representations to ascertain the truth. Statements that a horse has no problems and would make a good

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show horse are mere opinions, commendations, or puffing. Sheffield‘s failure to have a comprehensive veterinarian exam of the horse, which exam her father conceded was ―something a prudent person would do‖ and was something he typically did when purchasing a horse, precludes her from claiming justifiable reliance on the Darbys‘ opinion that the horse had no problems and would make a good show horse. Since the Darbys‘ statements were mere opinions, commendations, or puffing, Sheffield‘s express warranty claim cannot stand. No breach of implied warranty can be shown. [Sheffield v. Darby, 535 S.E. 2d 776 (Ga. App.)] 13. On July 27, 2000, Sheldorado Aluminum Products, Inc., installed an aluminum awning on the back of Marie Villette‘s home for use as a carport. On January 11, 2001, the awning collapsed on top of Ms. Villette‘s new Mercedes automobile. Ms. Villette brought suit against Sheldorado, seeking recovery of the $3,000 she had paid to them for the awning.

There was no formal written contract between the parties; the only writing was a one-page order/ bill designated a ―contract,‖ dated July 11, 2000, and signed by Ms. Villette and apparently by Jack Finklestein, Sheldorado‘s salesman. No advertising or promotional material was presented by either party. Ms. Villette testified to no express warranty or representation on the transaction, and none appears in the writing. Sheldorado acknowledges that no instructions or warnings were given to Ms. Villette as to care, maintenance, or use of the awning.

When the awning collapsed, Sheldorado took the position that the cause was an accumulation of snow and high winds and that it bore no responsibility for the loss. Its only response to the incident was to refer Ms. Villette to the insurer on their homeowner‘s policy.

Does Ms. Villette have any rights that would allow her to collect damages? Apply the UCC to answer this question. [Villette v. Sheldorado Aluminum Products, Inc., 2001 WL 881055 (N.Y. Supp.), 45 U.C.C. Rep Serv. 2d 470 (N.Y. Civ. Ct.)] Answer: Warranty of merchantability. The ordinary purposes of an awning are to provide shade and other protection from the elements; an awning that leaks and then collapses is clearly not fit for those purposes.

Sheldorado had knowledge of how the carport had been installed, and what precautions should have been taken to prevent the defect that resulted. The foreseeability of the risk of the weight of snow operating upon a defective installation is something the seller

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understands. The purchaser was not given any warnings about the awning, the weather, and maintenance. Without such, the weather was foreseeable and the awning was not fit for use in a climate in which snow could accumulate and weigh down the awning. Villette recovered her $3,000. [Villette v. Sheldorado Aluminum Products, Inc., 2001 WL 881055 (N.Y. Supp.), 45 UCC Rep. Serv. 2d 470 (N.Y. Civ. Ct.)] 14. Drehman Paving & Flooring Co. installed a brick floor at Cumberland Farms that its salesman promised would be ―just like‖ another floor Cumberland had installed several years earlier. The bricks in the new floor came loose because Drehman had failed to install expansion joints. Expansion joints were not included in the second floor contract but were part of the first. Can Cumberland recover? Under what theory? [Cumberland Farms, Inc. v.

Drehman Paving & Flooring Co., 520 N.E.2d 1321 (Mass. Ct. App.)] Answer: Express warranty; warranty of fitness for a particular purpose. Yes, recovery could be on the basis of the salesman‘s express warranty or his warranty of fitness for a particular purpose. Cumberland was relying on Drehman and its expertise in making the floors match. [Cumberland Farms, Inc. v. Drehman Paving & Flooring Co., 520 N.E. 2d 1321 (Mass. Ct. App.)] 15. Tracy Simpson and others purchased dog food brands produced by Champion Petfoods, USA, Inc. The Champion dog food bags (for the Orijen and Acana brands) included the following: ORIJEN IS THE FULLEST EXPRESSION OF OUR BIOLOGICALLY APPROPRIATE™ AND FRESH REGIONAL INGREDIENTS COMMITMENT. ORIJEN ORIGINAL features unmatched inclusions of free-run poultry, wild-caught fish and whole nest-laid eggs—sustainably farmed or fished in our region and delivered daily, FRESH or RAW and preservative-free, so they‘re bursting with goodness and taste. ―NO RENDERED POULTRY, FISH OR MEAT MEALS,‖ and instead, ―features richly nourishing ratios of poultry, organs and cartilage‖ and ―FRESH, RAW or DEHYDRATED ingredients, from minimally processed poultry fish and eggs that are deemed fit for human consumption prior to inclusion in our foods.‖ Simpson and the other plaintiffs had tests run, and the results indicated that Champion‘s products contain ―high levels of heavy metals.‖ Champion acknowledged in a white paper that there are levels of arsenic, lead, cadmium,

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 25: Obligations and Performance

and mercury in their finished products.

They filed suit for breach of express warranty under the UCC and violations of the Kentucky (KCPA) and Virginia Consumer Protection Acts. The court held that privity under the statutes required direct contact between buyer and seller. The court then went on to hold that because the privity requirement was not met under those statutes, it was not met under the UCC standards for express warranty. What arguments could you make against the court‘s holding? What do you need to know to decide if the court is correct in its decision on express warranties? [Simpson v. Champion Petfoods USA, Inc., 397 F. Supp.

3d 952 (E.D. Ken. 2019)] Answer: Express warranty. The Kentucky statute reads: A seller's warranty whether express or implied extends to any natural person who is in the family or household of his buyer or who is a guest in his home if it is reasonable to expect that such person may use, consume or be affected by the goods and who is injured in person by breach of the warranty. A seller may not exclude or limit the operation of this section. KRS § 355.2-318 The point to understand is that the statutory provisions on warranties and representations may be different from the UCC—the two statutes must be compared to see if the differing standards of privity make a difference in meeting privity requirements.

It looks like Kentucky has adopted Alternative A and that will restrict a class action because not everyone purchased the same kind of dog food from the same place. The question becomes one of determining whether a dog injured as a result of dog food commercials (running to the TV screen ready to fight) or whether someone in the household was injured as a result. The court just lopped the two standards together—that the KCPA standard was the same as the UCC standard, and that may not be true, for now. [Simpson v. Champion Petfoods USA, Inc., 397 F. Supp. 3d 952 (E.D. Ken. 2019)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 25: Obligations and Performance

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Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 226 Questions and Case Problems .......................................................................................................... 226

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

In 1992, Donna Smith telephoned Clark, the manager of Penbridge Farms, in response to an advertisement Clark had placed in the July issue of the Emu Finder about the availability for sale of proven breeder pairs. Clark told Smith that he had a breeder pair available.

Clark sold the pair to Smith for $16,500. Some months later, after Smith had had a chance to inspect the pair, she discovered that Clark had sold her two males. Smith immediately notified Clark and revoked her acceptance of the animals. Clark said the revocation was too late. Was it? [Smith v. Penbridge Associates, Inc., 655 A.2d 1015 (Pa. Super.)]

Answer: Revocation. No. The gender of an emu is not discernible by mere external observation. The only certain way to tell, apart from internal examination, is to observe them in mating. Smith, upon observing both Rachel and Andrew, her two male breeders, grunting, concluded that she had two male emus and not a male and a female breeder because grunting is a male trait. Rachel may have looked like a female emu and walked like a female emu, but it did not sound like a female emu. When Smith heard the noise, she immediately notified Clark. Her notification was timely, and the problem with the bird was a material and substantial impairment because Smith had paid a high price specifically for breeders, not two male emus for pets. [Smith v. Penbridge Associates, Inc., 655 A. 2d 1015 (Pa. Super.)]

2.

On January 3, 1991, Central District Alarm (CDA) and Hal-Tuc entered into a written sales agreement providing that CDA would sell and install new security equipment described on an equipment list attached to the contract. This list included a Javelin VCR. When the system was installed, CDA installed a used JVC VCR instead of a new Javelin VCR. Hal-Tuc called CDA the day after the installation and complained that the equipment was not the Javelin brand, and that the VCR was a used JVC VCR. CDA told Hal-Tuc that the equipment was not used and that a JVC VCR was better than a Javelin. Hal-Tuc telephoned CDA personnel over a two-week period during which they denied that the equipment was used.

After two weeks of calls, CDA‘s installation manager went to the store to see the

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equipment and admitted that it was used. No one from CDA advised Hal-Tuc in advance that it was installing used equipment temporarily until the right equipment arrived. CDA offered to replace it with a new Javelin VCR as soon as one arrived, which would take one or two months. Hal-Tuc asked CDA to return its deposit and take the equipment back, but CDA refused. Hal-Tuc put all the equipment in boxes and stored it. CDA filed a petition against Hal-Tuc for damages for breach of contract. Hal-Tuc filed a counterclaim, alleging fraud. CDA asserted it had the right to cure by tendering conforming goods after Hal-Tuc rejected the nonconforming goods. Was CDA correct? [Central District Alarm, Inc. v. HalTuc, Inc., 866 S.W.2d 210 (Mo. App.)] Answer: Right to care. Under Missouri‘s enactment of UCC § 2-508, Hal-Tuc was not given seasonable notification by CDA of its intention to cure the nonconforming tender. Also, there were no reasonable grounds for CDA to believe that a used VCR or its use on a temporary basis would be acceptable since there was no prior course of dealing, course of performance or usage of the trade upon which to base such a belief. Judgment in favor of Hal-Tuc on breach of contract is affirmed. There must be sufficient evidence to support the lack of intent. Absent evidence that CDA intended not to supply a new VCR when the agreement was made or evidence from which such an intent can be inferred, the requisite elements of fraud, clearly and convincingly, are not present. Judgment in favor of Hal-Tuc on fraud counterclaim is reversed.

This dispute also can be seen to be a question of a lack of good faith dealing by CDA. The obligation of good faith imposed by UCC § 1-106 is the basic principle running through the entire UCC, but it is most easily evident in sections like § 2-508. However, even if one does not use § 2-508, the same result can be reached through the obligation of good faith. CDA, acting in good faith, would have brought to Hal-Tuc‘s attention that the desired new VCR was not currently available and then good faith would drive Hal-Tuc‘s decision whether to accept the temporary substitute. Good faith would have resulted in immediate investigation by CDA of Hal-Tuc‘s claim that the installed VCR was used, upon which an offer to seasonable cure would be made. Even though it seems very likely that CDA did act with some degree of bad faith, it did not rise to the level of fraud as the HalTuc had claimed.

Note that CDA‘s repeated denials that used equipment was installed worked against CDA‘s contention that it made a seasonable notification of its intention to cure. Whether or not CDA was simply stalling in hopes that Hal-Tuc would relent becomes irrelevant as it constructively forfeited any right to cure the nonconforming tender by ignoring the repeated phone calls from Hal-Tuc. [Central District Alarm, Inc. v. Hal-Tuc, Inc., 866 S.W. 2d

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210 (Mo. App.)] 3.

Bobby Murray Chevrolet, Inc., submitted a bid to the Alamance County Board of Education to supply 1,200 school bus chassis to the district. Bobby Murray was awarded the contract and contracted with General Motors (GM) to purchase the chassis for the school board.

Between the time of Bobby Murray‘s contract with GM and the delivery date, the Environmental Protection Agency (EPA) enacted new emission standards for diesel vehicles, such as school buses. Under the new law, the buses Bobby Murray ordered from GM would be out of compliance, as would the buses Bobby Murray specified in its bid to the school board.

GM asked for several extensions to manufacture the buses within the new EPA guidelines.

The school board was patient and gave several extensions, but then, because of its need for buses, purchased them from another supplier after notifying Bobby Murray of its intent to do so. The school board had to pay an additional $150,152.94 for the buses from its alternative source and sued Bobby Murray for that amount. Bobby Murray claimed that it was excused from performance on the grounds of commercial impracticability. Is Bobby Murray correct? Does the defense of commercial impracticability apply in this situation? Be sure to compare this case with other cases and examples in the chapter. [Alamance County Board of Education v. Bobby Murray Chevrolet, Inc., 465 S.E.2d 306 (N.C. App.); rev. denied, 467 S.E.2d 899 (N.C.)] Answer: Foreseeability. The lower court found for the board, and Bobby Murray appealed.

The lower court‘s judgment was affirmed. In order to be excused under § 2-615, a seller of goods must establish that unforeseeable events not under its control prevented it from performing its contract duties. No clause in the parties‘ contract conditioned Bobby Murray‘s performance on its ability to obtain bus chassis from GM. Even if GM was contemplated by the parties as Bobby Murray‘s exclusive source, the record reflects that Bobby Murray assumed the risk of its failure to supply the vehicles, as it was foreseeable that GM might not supply the bus chassis.

Foreseeability under § 2-615 is an objective standard; it matters not whether the seller thought a certain event would or would not occur but rather what contingencies were reasonably foreseeable at the time the contract was made. Cancellation of chassis orders

by GM was a risk reasonably foreseeable by Bobby Murray.

Bobby Murray also argues that it should be excused because of intervening governmental

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regulations. Generally, governmental regulations do not excuse performance under a contract where a party has assumed the risk of such regulations. Bobby Murray, by terms of the parties‘ agreement, accepted responsibility for keeping abreast of governmental regulations bearing on the contract. In addition, Bobby Murray knew of the new emission standards well before delivery was due but said nothing to the school district to let them know, and the absence of fault is an important part of a § 2-615 defense. [Alamance County Board of Education v. Bobby Murray Chevrolet, Inc., 465 S.E. 2d 306 (N.C. App.); rev. denied, 467 S.E. 2d 899 (N.C.)] 4.

The Home Shopping Club ordered 12,000 Care Bear lamps from Ohio International, Ltd. When the lamps arrived, they had poor painting and staining, elements were improperly glued and could come loose (a danger to the children with the lamps in their rooms), and they overheated very easily (another danger for children and a fire hazard). Home Shopping Network notified International and gave it three months to remedy the problems and provide different lamps. After three months, Home Shopping Network returned all lamps and notified International that it was pulling out of the contract. Could they do so, or had too much time passed? [Home Shopping Club, Inc. v. Ohio International, Ltd., 27 U.C.C. Rep. Serv. 2d 433 (Fla. Cir. Ct.)] Answer: Revocation of acceptance. The court held that the shopping club had given the seller enough time to try and fix the defects, that the fixes were not forthcoming and that the buyer certainly had the right of revocation of acceptance if the right of rejection had expired. The buyer is excused from taking and paying for the defective Care Bear lamps.

[Home Shopping Club, Inc. v. Ohio International, Ltd., 27 UCC Rep. Serv. 2d 433 (Fla. Cir. Ct.)]

5.

Lafer Enterprises sold Christmas decorations to B. P. Development & Management Corp., the owners and operators of the Osceola Square Mall. The package of decorations was delivered to Osceola Square Mall prior to Thanksgiving for a total cost of $48,775, which B. P. would pay in three installments. Cathy Trivigno, a manager at B. P. who supervised the installation of the decorations, indicated that she and the Osceola Square Mall merchants were not satisfied with the quality of the decorations, but they needed to be in place for the day after Thanksgiving (the start of the holiday shopping season).

B. P. complained to Lafer about the quality of the decorations but had the decorations installed. B. P. paid the first installment to Lafer but then stopped payment on the last two checks. B. P. claimed that it had rejected the decorations. Lafer claimed breach for nonpayment because B. P. had used the decorations. Did B. P. accept the decorations? [B.

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P. Dev. & Management Corp. v. Lafer Enterprises, Inc., 538 So. 2d 1379 (Fla. App.)] Answer: Acceptance; failure to timely reject. Ms. Trivigno should not have used the decorations if she was rejecting. By using the decorations, BP was accepting by conduct.

The continued use despite complaints was a form of acceptance. [B. P. Dev. & Management Corp. v. Lafer Enterprises, Inc., 538 So. 2d 1379 (Fla. App.)] 6.

Westinghouse Electric Corporation entered into uranium supply contracts with 22 electric utilities during the late 1960s. The contract prices ranged from $7 to $10 per pound. The Arab oil embargo and other changes in energy resources caused the price of uranium to climb to between $45 and $75 per pound. Supply tightened because of increased demand.

In 1973, Westinghouse wrote to the utilities and explained that it was unable to perform on its uranium sales contracts. The utilities needed uranium. Westinghouse did not have sufficient funds to buy the uranium it had agreed to supply, assuming that it could find a supply. One utility executive commented, after totaling up all 22 supply contracts, that Westinghouse could not have supplied the uranium even under the original contract terms. He said, ―Westinghouse oversubscribed itself on these contracts. They hoped that not all the utilities would take the full contract amount.‖ Westinghouse says it is impossible for it to perform. The utilities say that they are owed damages because they must still find uranium somewhere. What damages would the law allow? What ethical issues do you see in the original contracts and in Westinghouse‘s refusal to deliver? Should we excuse parties from contracts because it is so expensive for them to perform? [In re Westinghouse Uranium Litigation, 436 F. Supp. 990 (E.D. Va.)] Answer: Commercial impracticability. In the Westinghouse case, the court ruled that there was some commercial impracticability—that is, the price of gas, the war, the energy markets, the embargo were all events that came together than changed the uranium market fundamentally and in ways that the parties did not anticipate. However, the court also found that Westinghouse had oversubscribed in its uranium sales. It had contracted to sell far too much uranium for what it could deliver in even the best market conditions.

So, there was some portion of each contract excused while Westinghouse was required to make good on other contracts. [In re Westinghouse Uranium Litigation, 436 F. Supp. 990 (E.D. Va.)]

7.

Steel Industries, Inc., ordered steel from Interlink Metals & Chemicals. The steel was to be delivered from a Russian mill. There were political and other issues in Russia, and the mill

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was shut down. Interlink did not deliver the steel to Steel Industries, claiming that it was excused from performance because it could not get the steel from the Russian mill. What would Interlink have to establish to show that it was excused from performing under the doctrine of commercial impracticability? [Steel Industries, Inc. v. Interlink Metals & Chemicals, Inc., 969 F. Supp. 1046 (E.D. Mich.)]

Answer: Commercial impracticability. Interlink would have to show that there was an understanding that the contract was exclusive delivery from the Russian mill, and not just delivery of steel in general. If it was general, no commercial impracticability, because other sources could furnish steel. [Steel Industries, Inc. v. Interlink Metals & Chemicals, Inc., 969 F. Supp. 1046 (E.D. Mich.)]

8.

Spaulding & Kimball Co. ordered 75 cartons of window washers from Aetna Chemical Co. The buyer received them and sold about a third to its customers but later refused to pay for them, claiming that the quality was poor. The seller sued for the price. Would the seller be entitled to the contract price? [Aetna Chemical Co. v. Spaulding & Kimball Co., 126 A. 582 (Vt.)] Answer: Revocation of acceptance. The buyer had accepted the goods but could revoke acceptance if (1) the defects substantially impaired the value of the washers; and (2) the defect was not readily discoverable until after the sales to customers occurred. [Aetna Chemical Co. v. Spaulding & Kimball Co., 126 A. 582 (Vt.)]

9.

Nuco Plastics, Inc., was developing production molds for Universal Plastics, Inc. During the course of the development of the molds, Universal changed specifications and required the use of different materials. Nuco raised the price from $235 per 1,000 parts to $400 per 1,000 parts. Universal refused to pay the additional amount and ended the contract. Nuco was not paid for the molds it had produced and sued for breach of contract and damages.

Universal maintained that Nuco had repudiated the contract by raising the price. Is an attempt to raise the price on a contract a repudiation of the contract? [Nuco Plastics, Inc. v.

Universal Plastics, Inc., 601 N.E.2d 152 (Ohio App.)] Answer: Refusal to pay; change in circumstances. The court held that an attempt to raise the price was a proposal for modification but was not, in itself, a repudiation of the contract. Something more, a statement or refusal to deliver the molds, would be required in order to have a repudiation of the contract. [Nuco Plastics, Inc. v. Universal Plastics, Inc., 601 N.E. 2d 152 (Ohio App.)]

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10. Economy Forms Corp. sold concrete-forming equipment to Kandy. After using the equipment for more than six months, Kandy notified Economy that the equipment was inadequate. Economy Forms alleged that Kandy had accepted the goods. Kandy denied liability. Was there an acceptance? Why or why not? [Economy Forms Corp. v. Kandy, Inc., 391 F. Supp. 944 (N.D. Ga.)] Answer: What constitutes acceptance of goods. Yes. The use of the concrete-forming equipment for more than six months of construction was an act inconsistent with rejection of the goods and constituted an acceptance of the goods. [Economy Forms Corp. v. Kandy, Inc., 391 F. Supp. 944 (N.D. Ga.)] 11. Hornell Brewing Company is a supplier and marketer of alcoholic and nonalcoholic beverages, including the popular iced tea drink, Arizona. In 1992, Stephen A. Spry and Don Vultaggio, Hornell‘s chairman of the board, made an oral agreement for Spry to be the exclusive distributor of Arizona products in Canada. The initial arrangement was an oral agreement, and in response to Spry‘s request for a letter that he needed to secure financing, Hornell provided a letter that confirmed the distributorship.

During 1993 and 1994, Hornell shipped beverages on 10-day credit terms, but between December 1993 and February 1994, Spry‘s credit balances grew from $20,000 to $100,000, and a $31,000 check from Spry was returned for insufficient funds.

In March 1994, Hornell demanded that Spry obtain a line and/or letter of credit to pay for the beverages to place their relationship on a more secure footing. An actual line of credit never came about. Hornell did receive a partial payment by a wire transfer on May 9, 1994.

Spry ordered 30 trailer loads of ―product‖ from Hornell at a total purchase price of $390,000 to $450,000. Hornell learned from several sources, including its regional sales manager, Baumkel, that Spry‘s warehouse was empty; that he had no managerial, sales, or office staff; that he had no trucks; and that his operation was a sham.

On May 10, 1994, Hornell wrote to Spry, telling him that it would extend up to $300,000 of credit to him, net 14 days cash ―based on your prior representation that you have secured a $1,500,000 U.S. line of credit.‖ Spry did not respond to this letter. After some months of futile negotiations by counsel, Hornell filed suit. Has there been a breach? What are the parties‘ rights? [Hornell Brewing Co., Inc. v. Spry, 664 N.Y.S.2d 698 (Sup. Ct.)] Answer: Adequate assurances of performance. Because Hornell had reasonable grounds for doubting performance, it could demand adequate assurances of performance. If those

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assurances were not forthcoming, Hornell had the right to terminate the contract. The ability of Spry to perform under the contract was in doubt from the outset. Spry had no financing in place and had failed to set up the system necessary for distribution of the products. Furthermore, Spry had misled Hornell about the nature of his connections and business, and when that deception came to Hornell‘s attention, it was entitled to demand assurances. When no assurances were forthcoming from Spry, it had the right to end the relationship. Furthermore, its assurances of shipment for cash within 14 days were not unreasonable. [Hornell Brewing Co., Inc. v. Spry, 664 N.Y. S. 2d 698 (Sup. Ct.)] 12. Mark Murray and Ian Peck are art dealers who own separate art galleries located in New York. Robert and Jean Weil reside in Montgomery, Alabama, and are art collectors. Murray and Sam Lehr, a business acquaintance of his, traveled to Montgomery to see the various paintings in the Weils‘ collection, including a painting by Edgar Degas titled Aux Courses, which Murray examined under ultraviolet light. Murray later telephoned Weil and told him that he had spoken with someone who might be interested in purchasing the Degas.

On November 3, 1997, the director of Murray‘s gallery, Stephanie Calman, traveled to the Weils‘ home in Alabama. Calman, on behalf of Murray, and Robert Weil executed an agreement that provided for consignment of the Degas to Murray‘s gallery ―for a private inspection in New York for a period of a week‖ from November 3, ―to be extended only with the express permission of the consignor.‖ Calman returned to New York with the painting the same day.

Murray then showed the Degas to Peck. Peck expressed an interest in purchasing the Degas after seeing it, and the price of $1,125,000 was discussed.

On November 26, 1997, Murray signed an agreement drafted by Weil and retyped on Murray‘s letterhead. Weil signed the agreement on December 1, 1997.

Neither Murray nor anyone else ever paid Weil the $1 million. Nonetheless, Murray maintained possession of the Degas from November 3, 1997, through March 25, 1998, when Weil requested its return.

The Weils filed suit, seeking the price for the painting via summary judgment. Are the Weils entitled to recover? Explain why or why not. [Weil v. Murray, 161 F. Supp. 2d 250 (S.D.N.Y.)] Answer: Rejection. There was no proper rejection of goods and the Weils were entitled to

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collect the price of the painting. Not only did Murray have a reasonable time to inspect the goods, but also it is undisputed that he actually did inspect the Degas. There is no evidence that Murray found the painting to be unsatisfactory or nonconforming. Murray inspected the Degas on at least two occasions, signed the written agreement, and continued to retain possession of the Degas. The right of rejection was not exercised, and Murray had exercised ownership over the painting. [Weil v. Murray, 161 F. Supp. 2d 250 (S.D. N.Y.)] 13. Palmco contracted to supply American Airlines with flatware for its inflight meal service between September 1, 1987, and August 31, 1988. The contract set the prices for the flatware, and also contained a liquidated damages clause in case Palmco made untimely deliveries. Palmco‘s deliveries were late during the duration of the contract. In addition, Palmco failed to deliver certain orders.

American repeatedly explained to Palmco that the late deliveries were causing an inventory shortage. Also, because of Palmco‘s non-deliveries, American had to place spot orders with other flatware suppliers to ensure an adequate flatware inventory for the summer months. The price American paid for flatware under these spot orders was substantially higher than the contract price with Palmco.

In April 1988, Palmco refused to deliver the remaining flatware orders unless American agreed to a 25 percent price increase. American attempted to purchase flatware from other suppliers, but determined that none could meet American‘s demand at the time Palmco‘s deliveries were due. American therefore agreed to the price increase for the remaining flatware orders.

In July 1988, American notified Palmco that it was setting off its damages for Palmco‘s late and non-deliveries against its outstanding account balance. In response, Palmco refused to deliver American‘s remaining orders—30,000 dozen knives.

Palmco filed suit against American for its failure to pay for the flatware American had received, as well as the 30,000 dozen knives Palmco did not deliver to American. Palmco claims that it did not deliver the 30,000 dozen knives because American failed to provide adequate assurance of payment. American counterclaimed, asserting that Palmco had breached the contract. American sought damages for late and non-deliveries, and duress damages for the 25 percent price increase.

Evaluate all the actions that the parties took during the course of the contract and

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determine who breached and who owes what to whom. [Palmco Corp. v. American Airlines, Inc., 983 F.2d 681 (5th Cir.)] Answer: Adequate assurance of performance; repudiation. Focus the discussion on whether each party complied with the provisions and responsibilities under repudiation, demand for assurances, etc. The following additional information can help with that discussion.

American gave proper notice to Palmco, because the issue is the contract by failing to deliver the knives, then American matter of law based upon the undisputed facts of this case.

The first breach—for late deliveries—about which American complained occurred on February 3, 1988. Six weeks later, American wrote a letter to Palmco, stating that its performance under the contract was unacceptable, and that American intended to hold Palmco to the terms of the contract. Palmco does not dispute that this letter—dated April 11, 1988—was timely. Rather, Palmco claims that the letter was inadequate because it did not inform Palmco that its late deliveries constituted a breach of contract. The last paragraph of the letter states: For at least the past five months you have consistently failed to meet your delivery date obligations. As we have made clear this is totally unacceptable to American Airlines. We insist that you fulfill all of your contractual obligations.

This language, though not explicit, nevertheless sufficed to inform Palmco that its late deliveries constituted a breach of contract. Consequently, we find that American gave timely and adequate notice of breach.

Paragraph VIII of the contract obligated American to buy any ―inventory in transit and in process‖ at the time of American's cancellation of the contract. The parties do not dispute that the 30,000 dozen knives were in transit when the contract was cancelled.

American, however, contends that it is not obligated to pay for the knives, because Palmco initially breached the contract by failing to deliver the knives.

Palmco argues that it rightfully withheld delivery of the knives because American failed to respond to Palmco's request for adequate assurance of payment of outstanding invoices. ―When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until

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he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return.‖ This letter—constituting a notice of offset—precludes Palmco from claiming that American's intention of withholding payment provided reasonable grounds for insecurity.

Because Palmco had no reasonable grounds for insecurity, Palmco breached the contract when it failed to deliver the knives. American was not obligated to pay for the knives.

The court summarized the damage awards as follows: (1) American is not obligated to buy the 30,000 dozen knives in Palmco's possession when American cancelled the contract; (2) Palmco is entitled to attorneys' fees for the amount it recovered as an offset against American's damage award; and (3) Palmco is not entitled to additional attorneys' fees for the post-suit, pre-trial payments it recovered from American.

However, we REVERSE the magistrate judge's judgment and render judgment that: (1) American is entitled to recover, in addition to its cover damages, $81,584.00 in liquidated damages; (2) American is entitled to recover $52,631.00 in additional duress damages; and (3) American is entitled to receive $80,529.00 additional attorneys' fees for its additional recoveries.

[Palmco Corp. v. American Airlines, Inc., 983 F.2d 681 (5th Cir. 1993)] 14. Harry Ulmas made a contract to buy a new car from Acey Oldsmobile. He was allowed to keep his old car until the new car was delivered. The sales contract gave him a trade-in value of $650 on the old car but specified that the car would be reappraised when it was actually brought to the dealer. When Ulmas brought the trade-in to the dealer, an Acey employee took it for a test drive and said that the car was worth between $300 and $400.

Acey offered Ulmas only $50 for his trade-in. Ulmas refused to buy from Acey and purchased from another dealer, who appraised the trade-in at $400. Ulmas sued for breach of contract on the grounds of violation of good faith. Was he right? [Ulmas v. Acey Oldsmobile, Inc., 310 N.Y.S.2d 147 (N.Y. Civ.)] Answer: Good faith in performance. Yes. There is an assumption that if the car is in similar

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condition, the dealer would honor the original estimate. The $300 to $400 Acey offered was probably acceptable but the $50 was not a good faith price for the trade-in. [Ulmas v.

Acey Oldsmobile, Inc., 310 N.Y. S. 2d 147 (N.Y. Civ.)] 15. Catherine Joseph, who does business as Metro Classics, sold clothing to Jackson Hole Traders, a corporation owned by David and Elizabeth Speaks. Jackson Hole Traders is located in Jackson, Wyoming, and sells clothing for men and women through a retail store and mail-order catalog business. The clothing Joseph sold was specially manufactured for Jackson Hole Traders and had a total contract price of $50,000 with net 30 terms.

When the clothing items were shipped between July and September 1994, approximately 900 items were sent. Elizabeth Speaks complained about the quality of some of the clothing items when they arrived and was given a credit of $1,096 for returned merchandise. However, Jackson Hole Traders did not pay $33,000 of the total Joseph bill despite its being well past the net 30-day period for payment. When Joseph demanded payment, Elizabeth Speaks boxed up approximately 350 items of the clothing and sent them back, demanding a credit for revocation of acceptance. Joseph filed suit for payment, alleging that it was too late for revocation of acceptance. The trial court found for Joseph, and the Speakses appealed. Explain what the court could decide in the case.

[Jackson Hole Traders, Inc. v. Joseph, 931 P.2d 244 (Wyo.)] Answer: Revocation of acceptance. The Speakses breached the contract when they failed to pay for the garments that had been sent to them and that they had accepted for resale.

They could not revoke acceptance after so much time had passed, and they had offered the goods for sale. They sent the goods back, not because they were defective, but because they were unable to make the payments or sell the merchandise. [Jackson Hold Traders, Inc. v. Joseph, 931 P. 2d 244 (Wyo.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 26: Remedies for Breach of Sales Contracts

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 238

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Questions and Case Problems .......................................................................................................... 238 End of Chapter: CPA Questions and Answers ................................................................................. 246 Answers to AICPA Questions ............................................................................................................ 247

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Firwood Manufacturing Co. had a contract to sell General Tire 55 Model 1225 postcure inflators (PCIs). PCIs are $30,000 machines used by General Tire in its manufacturing process. The contract was entered into in 1989, and by April 1990 General Tire had purchased 22 PCIs from Firwood. However, General Tire then closed its Barrie, Michigan, plant. Firwood reminded General Tire that it still had the obligation to purchase the 33 remaining PCIs. General Tire communicated to Firwood that it would not be purchasing the remaining ones. Firwood then was able, over a period of three years, to sell the remaining PCIs. Some of the PCIs were sold as units, and others were broken down and sold to buyers who needed parts. Firwood‘s sales of the remaining 33 units brought in $187,513 less than the General Tire contract provided, and Firwood filed suit to collect the resale price difference plus interest. Can Firwood recover? Why or why not? [Firwood Manufacturing Co., Inc. v. General Tire, Inc., 96 F.3d 163 (6th Cir.)] Answer: Statute of limitations. Firwood's resale may have taken three years, and the contract goods may have been sold as parts, but Firwood acted in good faith in trying to mitigate damages because there simply was no market for PCIs at the time of General Tire's breach. Firwood acted in good faith and pursued buyers diligently over that threeyear period. While the time period may be less than optimal and the sale of the goods as parts not always desirable, Firwood did the best it could given the market following the breach. Firwood was awarded the contract price difference of $187,513 and $100,476 in interest. [Firwood Manufacturing Co., Inc. v. General Tire, Inc., 96 F. 3d 163 (6th Cir.)]

2.

Soon after Gast purchased a used auto from a Chevrolet dealer, he experienced a series of mechanical problems with the car. Gast refused to make further payments on the bank note that had financed the purchase. The bank took possession of the automobile and sold it. Gast then brought an action against the dealer, alleging that he had revoked his acceptance. Was Gast correct? Explain your answer. [Gast v. |Rodgers-Dingus Chevrolet, 585 So. 2d 725 (Miss.)]

Answer: Revocation of acceptance. Gast has attempted to revoke acceptance. Gast can do

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so if the mechanical problems substantially impair the value of the car. That Gast has a bank note does not have any impact on his defenses because under the FTC rule, his rights cannot be waived under the contract. [Gast v. Rodgers-Dingus Chevrolet, 585 So. 2d 725 (Miss.)]

3.

Formetal Engineering submitted to Presto a sample and specifications for precut polyurethane pads to be used in making air-conditioning units. Formetal paid for the goods as soon as they were delivered but subsequently discovered that the pads did not conform to the sample and specifications in that there were incomplete cuts, color variances, and faulty adherence to the pad‘s paper backing. Formetal then informed Presto of the defects and notified Presto that it would reject the pads and return them to Presto, but they were not returned for 125 days. Presto argued that it was denied the right to cure because the goods were not returned until some 125 days after Formetal promised to do so. Was there a breach of the contract? Did the buyer (Formetal) do anything wrong in seeking its remedies? [Presto Mfg. Co. v. Formetal Engineering Co., 360 N.E.2d 510 (Ill. App.)] Answer: Rejection of improper tender. Yes. Formetal immediately notified Presto of the defects. Presto had the right to repossess the goods but failed to do so. Additionally, Presto showed no evidence that it wished to cure the defect. [Presto Mfg. Co. v. Formetal Engineering Co., 360 N.E. 2d 510 (Ill. App.)]

4.

Emily Lieberman and Amy Altomondo were members of the Alpha Chi Omega (AXO) sorority at Bowling Green State University. They negotiated with Johnathan James Furlong for the purchase of custom-designed sweaters for themselves and their sorority sisters for a total price of $3,612. Lieberman and Altomondo paid Furlong a $2,000 deposit.

When Lieberman and Altomondo saw the sweaters, they realized that Furlong had made color and design alterations in the lettering imprinted on the sweaters as part of their custom design. Altomondo, as president of AXO, called Furlong and told him that the sweaters were unacceptable and offered to return them. Furlong refused, stating that any changes were immaterial. Altomondo refused to pay the balance due and demanded the return of the $2,000 deposit. Furlong filed suit for breach of contract. What should the court do with the case and why? [Furlong v. Alpha Chi Omega Sorority, 657 N.E.2d 866 (Ohio Mun. Ct. 1993)] Answer: Seller breach through defective products. The sorority rejected the sweaters within a reasonable time after delivery and notified the seller. The seller breached the contract.

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The sorority is entitled to cancel the contract, recover the amounts it paid, and hold the sweaters until recovery. The sweaters were altered without authorization and there is a breach of contract. Finally, and alternatively, Furlong should have entered into a contract that gave him discretion to make design changes without AXO‘s consent. These sweaters, as Furlong himself admits (and describes), were to be ―custom-designed‖ for AXO. Thus, they were to be printed according to AXO‘s specifications, not according to Furlong‘s discretion.

The sorority is entitled to a full refund of its deposit and any additional damages it experienced in defending this suit and seeking to collect the amounts it is due. [Furlong v.

Alpha Chi Omega Sorority, 657 N.E. 2d 866 (Ohio. Mun. Ct. 1993)] 5.

McNeely entered into a contract with Wagner to pay $250,000 as a lump sum for all timber present in a given area that Wagner would remove for McNeely. The contract estimated that the volume in the area would be 780,000 board feet. Wagner also had provisions in the contract that made no warranties as to the amount of lumber and that he would keep whatever timber was not harvested if McNeely ended the contract before the harvesting was complete. The $250,000 was to be paid in three advances. McNeely paid two of the three advances but withheld the third payment and ended the contract because he said there was not enough timber. Wagner filed suit for the remaining one-third of the payment. McNeely said Wagner could not have the remaining onethird of the payment as well as the transfer; he had to choose between the two remedies. Is he correct? [Wagner v.

McNeely, 38 U.C.C. 2d 1176 (Or.)] Answer: Types of remedies—sellers. Yes, McNeely is correct. Wagner must choose between remedy for misrepresentation: offset for lumber not there or halting performance and not paying the remaining one-third. He can‘t have lumber and lop off one-third. [Wagner v.

McNeely, 38 UCC 2d 1176 (Or.)]

6.

Brown Machine Company, a division of Kvaerner U.S., Inc., entered into a contract to supply a machine and tools to Hakim Plast, a food container–producing company based in Cairo, Egypt, to enable Hakim to meet its growing demand for plastic containers. The plastic containers were for customers to use in the ice cream distribution industry. It was understood that the equipment would be ready for delivery before the busy summer ice cream season. Brown Machine was not able to meet the twice extended deadline. It attempted to obtain another extension, but Hakim Plast refused without additional consideration. Brown refused to provide the requested consideration. Hakim Plast declared the contract breached on September 25, 1994. Brown then sold the equipment

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and brought suit for breach of contract, requesting damages for the loss of the sale.

Hakim Plast countersued for Brown‘s breach seeking out-of-pocket expenses and consequential damages for loss of business. Discuss who breached the contract and determine what possible damages might be recovered. [Kvaerner U.S., Inc. v. Hakim Plast Co., 74 F. Supp. 2d (E.D. Mich.)]

Answer: Consequential damages; remedies. The issue for this Court is who breached the contract of sale between these two merchants. To make that determination it is necessary to determine the terms of the contract. Especially important is the delivery date. The Court determines that the contract delivery date originally was 25-27 weeks from when the contract was formed on November 1, 1993. This date was extended twice by the parties, which resulted in a final delivery date of September 25, 1994. The equipment was not ready for delivery as of that date.

The final question concerning liability is who was at fault for this delay. The Court determines the fault was that of Brown Machine, who was unable to meet the requirements of the contract to produce the containers to match the samples provided by Hakim Plast. Therefore, Brown Machine's claim for damages fails.

Hakim Plast is entitled to their out of pocket expenses as a measure of damages. In addition, Hakim Plast would be entitled to consequential damages, because it has shown the limitation on consequential damages in the original contract, while valid, when written, has been waived by the second extension of delivery date. However, the fact it was unable to prove what business was lost means the award of damages for a loss of business component would be too speculative. [Kvaerner U.S., Inc. v. Hakim Plast Co., 74 F. Supp. 2d 709 (E.D. Mich.)]

7.

Sonya Kaminski purchased from Billy Cain‘s Cornelia dealership a truck that was represented to her to be a 1989 Chevrolet Silverado pickup. However, subsequent incidents involving repair of the truck and its parts, as well as a title history, revealed that the truck was a GMC rather than a Chevrolet. Sales agents at the Cornelia dealership misrepresented the truck‘s character and sold the truck to Kaminski as a Chevrolet.

Kaminski filed suit for intentional fraud and deceit under the Georgia Fair Business Practices Act (FBPA) and for breach of express warranty. The jury awarded Kaminski $2,823.70 for breach of express warranty and $50,000 punitive (exemplary) damages. The judge added damages under the FBPA of $10,913.29 in actual damages and $9,295 in attorney fees and court costs. The dealership appealed. Must the dealership pay the

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damages? Why or why not? [Billy Cain Ford Lincoln Mercury, Inc. v. Kaminski, 496 S.E.2d 521 (Ga. App.)] Answer: Damages; remedies of buyer. The judgment of the lower court is affirmed. A buyer can collect both incidental and consequential damages. Incidental expenses here included renting a vehicle to get to work. The buyer here was entitled to all forms of damages for the breach, including compensatory, consequential, and incidental damages. The punitive damages were for fraud because the evidence showed that the dealership knew that the truck‘s make and model were not correct. [Billy Cain Ford Lincoln Mercury, Inc. v. Kaminski, 496 S.E. 2d 521 (Ga. App.)] 8.

Mrs. Kirby purchased a wheelchair from NMC/ Continue Care. The wheelchair was customized for her and her home. When the wheelchair arrived, it was too wide to fit through the doorways in her home. What options does Mrs. Kirby have? [Kirby v. NMC Continue Care, 993 P.2d 951 (Wyo.)] Answer: Breach of contract. Mrs. Kirby could reject the wheelchair and sue for breach of contract. She might also try breach of warranty in that it did not meet specifications and perhaps there was a warranty for a particular purpose. However, the court held that the best remedy was for breach of contract with the wheelchair returned, her money refunded and her right to go elsewhere to cover and recover the price difference for a proper wheelchair. [Kirby v. NMC Continue Care, 993 P. 2d 951 (Wyo.)]

9.

Wolosin purchased a vegetable and dairy refrigerator case from Evans Manufacturing Corp. When Evans sued Wolosin for the purchase price, Wolosin claimed damages for breach of warranty. The sales contract provided that Evans would replace defective parts free of charge for one year; it also stated, ―This warranty is in lieu of any and all other warranties stated or inferred, and of all other obligations on the part of the manufacturer, which neither assumes nor authorizes anyone to assume for it any other obligations or liability in connection with the sale of its products.‖ Evans claimed that it was liable only for replacement of parts. Wolosin claimed that the quoted clause was not sufficiently specific to satisfy the limitation-of-remedies requirement of U.C.C. §2-719. Provide some insight on this issue for the parties by discussing damage limitation clauses under the UCC. [Evans Mfg. Corp. v. Wolosin, 47 Luzerne County Leg. Reg. 238 (Pa.)] Answer: Limitation of remedies under Article 2. The quoted clause was sufficiently specific to communicate the intention of the seller, and the remedy provided was accordingly exclusive by virtue of UCC § 2-719. [Evans Mfg. Corp. v. Wolosin, 47 Luzerne County Leg.

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Reg. 238 (Pa.)] 10. McInnis purchased a tractor and scraper as new equipment of the current model year from Western Tractor & Equipment Co. The written contract stated that the seller disclaimed all warranties and that no warranties existed except those stated in the contract. Actually, the equipment was not the current model but that of the prior year. The equipment was not new but had been used for 68 hours as a demonstrator model, after which the hour meter had been reset to zero. The buyer sued the seller for damages. The seller‘s defense was based on the ground that all liability for warranties had been disclaimed. Was this defense valid? [McInnis v. Western Tractor & Equipment Co., 388 P.2d 562 (Wash.)]

Answer: Distinction between liability for fraud and liability for breach of warranty. No. The seller knowingly sold the equipment under the misrepresentations that it was new and that it was the current model. This was fraudulent, and the disclaimer of liability for breach of warranty did not affect the liability of the seller for fraud.

The code does not alter or affect preexisting rules of law relating to fraud. (See UCC § 1-103). [McInnis v. Western Tractor & Equipment Co., 388 P. 2d 562 (Wash.)]

11. Elmore purchased a car from Doenges Brothers Ford. The car had been placed with the dealership by a dealership employee as part of a consignment arrangement. Elmore was unable to obtain title to the car because the Environmental Protection Agency had issues with the car‘s compliance with emissions equipment requirements. Elmore was unable to drive the car. He brought suit because he was forced to sell the car for $10,300 less than he paid because of the title defect and the fact that only a salvage dealer would purchase it. Because he lost his transportation, he was out of work for eight months and experienced a $20,000 decline in income. What damages could Elmore recover under the UCC? [Elmore v. Doenges Bros. Ford, Inc., 21 P.3d 65 (Okla. App.)] Answer: Consequential damages. The jury awarded Elmore $25,000 which was about $5,000 less than he asked for, but the court held that was in the jury‘s discretion because, for example, they might have seen him able to work sooner than he did. The breach in the contract was a breach of the warranty of title and Elmore was entitled to collect the consequential damages from that breach. [Elmore v. Doenges Bros. Ford, Inc., 21 P. 3d 65 (Okla. App.)] 12. On August 21, 1992, Miguel A. Diaz Rodriguez (Diaz) entered into a contract with Learjet to buy a Model 60 jet aircraft for $3,000,000 with a $250,000 deposit made on execution

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of the contract; $750,000 payment on September 18, 1992; $1,000,000 180 days before delivery of the aircraft; and the balance due on delivery of the aircraft. Diaz paid the $250,000 deposit but made no other payments.

In September 1992, Diaz said he no longer wanted the aircraft and asked for the deposit to be returned. Learjet informed Diaz that the $250,000 deposit was being retained as liquidated damages because their contract provided as follows: Learjet may terminate this Agreement as a result of the Buyer’s failure to make any progress payment when due. If this Agreement is terminated by Learjet for any reason stipulated in the previous sentence, Learjet shall retain all payments theretofore made by the Buyer as liquidated damages and not as a penalty and the parties shall thenceforth be released from all further obligations hereunder. Such damages include, but are not limited to, loss of profit on this sale, direct and indirect costs incurred as a result of disruption in production, training expense advance and selling expenses in effecting resale of the Airplane.

After Diaz breached the contract, Circus Circus Enterprises purchased the Learjet Diaz had ordered with some changes that cost $1,326. Learjet realized a $1,887,464 profit on the sale of the aircraft to Circus Circus, which was a larger profit than Learjet had originally budgeted for the sale to Diaz.

Diaz filed suit seeking to recover the $250,000 deposit.

Discuss whether the liquidated damage clause was enforceable under the law.

[Rodriguez v. Learjet, Inc., 946 P.2d 1010 (Kan. App.)] Answer: Liquidated damages. The lower court‘s judgment was affirmed. Diaz challenged the reasonableness of the liquidated damages clause. The $250,000 deposit as a liquidated damages clause in a contract in this price range was not unreasonable. Also, the seller was the one that lost its profits on a second sale that it would have made had Diaz not breached. The ―lost volume‖ provision of the UCC permits nonbreaching sellers to recover the lost profits on a contract in which the other remedy sections do not compensate for the breach by the buyer. The evidence indicates that the lost profit from the Diaz contract would have been approximately $1.8 million. [Rodriguez v. Learjet, Inc., 946 P.2d 1010 (Kan. App. 1997)] 13. Ramtreat Metal Technology provided for a ―double your money back‖ remedy in its

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contracts for the sale of its metal drilling assemblies. A buyer filed suit seeking consequential damages and cost of replacement. Ramtreat said that its clause was a limitation of remedies. Could Ramtreat limit its remedies to ―double your money back‖?

[Adcock v. Ramtreat Metal Technology, Inc., 44 U.C.C. Rep. Serv. 2d 1026 (Wash. App.)] Answer: Damage limitations. The court held that the damage limitation was reasonable and enforceable. The court upheld the seller‘s provision and enforced the damage limitation to ―double your money back.‖ [Adcock v. Ramtreat Metal Technology, Inc., 44 UCC Rep. Serv. 2d 1026 (Wash. App.)] 14. Lululemon ordered Luon fabric for its famous black yoga pants from a supplier. The fabric was made into yoga pants, which were then sold as Lululemon pants, which resulted in a wave of customer complaints because the fabric was see-through. Lululemon took the pants back from customers and issued refunds. However, following this glitch in its supply chain, Lululemon began a downward spiral that saw its income and share price drop.

Lululemon also struggled to get products back onto the shelf because of difficulty in replacing the Luon fabric. What types of damages could Lululemon recover for this fabric issue?

Answer: Rejection of improper tender. Lululemon is entitled to damages for the defective fabric. It would be excused from payment and could return any fabric not yet used.

Lululemon would also not have to accept any future defective shipments. There would be incidental damages for shipping costs, even things such as costs of signage explaining why there is a shortage in the supply of yoga pants. Consequential damages are a possibility. The damages here are not the traditional consequential damages that we see— such as a penalty for late delivery. There are earnings and shareholder losses that result from lack of inventory. If Lululemon can make direct connections between the loss of the fabric source and these financial indicators, the suit could be a huge one. However, a court would need to determine which types of damages would be enforceable and whether there were any limitations on recovery.

15 Joseph Perna purchased a 1981 Oldsmobile at a traffic auction conducted by Locascio. The car had been seized pursuant to action taken by the New York City Parking Violation Bureau against Jose Cruz. Perna purchased the car for $1,800 plus tax and towing fees ―subject to the terms and conditions of any and all chattel mortgages, rental agreements, liens, conditional bills of sale, and encumbrances that may be on the motor vehicle of the above judgment debtor.‖ The Olds had 58,103 miles on it at the time of Perna‘s purchase.

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On May 7, 1993, Perna sold the car to Elio Marino, a coworker, for $1,200. The vehicle had about 65,000 miles on it at the time of this sale.

During his period of ownership, Marino replaced the radiator ($270), repaired the power steering and valve cover gasket ($117), and replaced a door lock ($97.45). He registered and insured the vehicle. In February 1994, Marino‘s son was stopped by the police and arrested for driving a stolen vehicle. The son was kept in jail until his arraignment, but the charges were eventually dropped. The Oldsmobile was never returned to Marino, who filed suit for breach of contract because he had been given a car with a defective title. He asked for damages that included the costs of getting his son out of jail and having the theft charges dropped. Is he entitled to those damages? [Marino v. Perna, 629 N.Y.S.2d 669 (N.Y. Cir.)] Answer: Consequential damages. The damages for breach of warranty (in this case, the breach of the warranty of title) are the difference between the value of the goods as they are, and their value had they been as warranted. The value of the car if as warranted is $1,200. While Marino had driven the car for some time, he had added value through the repair work. Marino could not recover the consequential damages related to the arrest of his son. Neither Perna nor Locascio had any knowledge that there was a problem with the title to the car, and as such, the damages experienced as a result of Marino's son's arrest were not foreseeable. [Marino v. Perna, 629 N.Y. S. 2d 669 (N.Y. Cir.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

On April 5, 1987, Anker, Inc., furnished Bold Corp. with Anker‘s financial statements dated March 31, 1987. The financial statements contained misrepresentations that indicated that Anker was solvent when in fact it was insolvent. Based on Anker‘s financial statements, Bold agreed to sell Anker 90 computers, ―F.O.B.—Bold‘s loading dock.‖ On April 14, Anker received 60 of the computers. The remaining 30 computers were in the possession of the common carrier and in transit to Anker. If, on April 28, Bold discovered that Anker was insolvent, then with respect to the computers delivered to Anker on April 14, Bold may: a.

Reclaim the computers upon making a demand.

b.

Reclaim the computers irrespective of the rights of any third party.

c.

Not reclaim the computers since 10 days have elapsed from their delivery.

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Solution and Answer Guide:

d.

2.

Not reclaim the computers since it is entitled to recover the price of the computers.

On February 15, Mazur Corp. contracted to sell 1,000 bushels of wheat to Good Bread, Inc., at $6.00 per bushel with delivery to be made on June 23. On June 1, Good advised Mazur that it would not accept or pay for the wheat. On June 2, Mazur sold the wheat to another customer at the market price of $5.00 per bushel. Mazur had advised Good that it intended to resell the wheat. Which of the following statements is correct? a.

Mazur can successfully sue Good for the difference between the resale price and the contract price.

3.

b.

Mazur can resell the wheat only after June 23.

c.

Good can retract its anticipatory breach at any time before June 23.

d.

Good can successfully sue Mazur for specific performance.

Lazur Corp. entered into a contract with Baker Suppliers, Inc., to purchase a used word processor from Baker. Lazur is engaged in the business of selling new and used word processors to the general public. The contract required Baker to ship the goods to Lazur by common carrier pursuant to the following provision in the contract: ―FOB Baker Suppliers, Inc., loading dock.‖ Baker also represented in the contract that the word processor had been used for only 10 hours by its previous owner. The contract included the provision that the word processor was being sold ―as is,‖ and this provision was in a larger and different type style than the remainder of the contract. Assume that Lazur refused to accept the word processor even though it was in all respects conforming to the contract and that the contract is otherwise silent. Under the UCC Sales Article: a.

Baker can successfully sue for specific performance and make Lazur accept and pay for the word processor.

b.

Baker may resell the word processor to another buyer.

c.

Baker must sue for the difference between the market value of the word processor and the contract price plus its incidental damages.

d.

Baker cannot successfully sue for consequential damages unless it attempts to resell the word processor.

[return to top] Answers to AICPA Questions 1.

On April 5, 1987, Anker, Inc., furnished Bold Corp. with Anker‘s financial statements dated March 31, 1987. The financial statements contained misrepresentations that indicated that Anker was solvent when in fact it was insolvent. Based on Anker‘s financial statements,

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Bold agreed to sell Anker 90 computers, ―F.O.B.—Bold‘s loading dock.‖ On April 14, Anker received 60 of the computers. The remaining 30 computers were in the possession of the common carrier and in transit to Anker. If, on April 28, Bold discovered that Anker was insolvent, then with respect to the computers delivered to Anker on April 14, Bold may: a.

Reclaim the computers upon making a demand.

b.

Reclaim the computers irrespective of the rights of any third party.

c.

Not reclaim the computers since 10 days have elapsed from their delivery.

d.

Not reclaim the computers since it is entitled to recover the price of the computers.

(b) A seller who discovers that an insolvent buyer has received goods on credit may reclaim the goods by making a demand for their return within ten days after receipt of the goods by the buyer. This ten-day limitation, however, does not apply if the buyer made a written misrepresentation of its solvency within three months prior to its receipt of the goods. Anker‘s fraudulent financials constitute a written misrepresentation of solvency; therefore, Bold may demand return of goods even though 14 days have passed. Answer (b) is incorrect because the seller‘s right to reclaim the goods is subject to the rights of a third party who purchases the goods in good faith from the insolvent buyer. Answer (c) is incorrect because the ten-day limitation does not apply when the buyer (Anker) provides the seller (Bold) with a written misrepresentation of solvency (the financial statements) within three months prior to receipt of the goods. Answer (d) is incorrect because Anker may make a demand for the goods rather than sue for damages.

2.

On February 15, Mazur Corp. contracted to sell 1,000 bushels of wheat to Good Bread, Inc., at $6.00 per bushel with delivery to be made on June 23. On June 1, Good advised Mazur that it would not accept or pay for the wheat. On June 2, Mazur sold the wheat to another customer at the market price of $5.00 per bushel. Mazur had advised Good that it intended to resell the wheat. Which of the following statements is correct? a.

Mazur can successfully sue Good for the difference between the resale price and the contract price.

b.

Mazur can resell the wheat only after June 23.

c.

Good can retract its anticipatory breach at any time before June 23.

d.

Good can successfully sue Mazur for specific performance.

(a) By advising Mazur on June 1 that it would not accept or pay for the wheat, Good was engaged in anticipatory repudiation. Anticipatory repudiation occurs when a party renounces the duty to perform the contract before the party‘s obligation to perform arises. Anticipatory repudiation discharges the nonrepudiating party

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(Mazur) from the contract and allows this party to sue for breach immediately. In this situation, Mazur could successfully sue Good for the difference between the resale price and the contract price on June 2. Answer (b) is incorrect because Mazur was discharged from the contract on June 1 and would not have to wait until after June 23 to resell the wheat. Answer (c) is incorrect because Good would only be allowed to retract its anticipatory breach if Mazur had ignored this breach and awaited performance at the appointed date. Answer (d) is incorrect because specific performance is only allowed for unique goods or for other situations in which monetary damages are not appropriate.

3.

Lazur Corp. entered into a contract with Baker Suppliers, Inc., to purchase a used word processor from Baker. Lazur is engaged in the business of selling new and used word processors to the general public. The contract required Baker to ship the goods to Lazur by common carrier pursuant to the following provision in the contract: ―FOB Baker Suppliers, Inc., loading dock.‖ Baker also represented in the contract that the word processor had been used for only 10 hours by its previous owner. The contract included the provision that the word processor was being sold ―as is,‖ and this provision was in a larger and different type style than the remainder of the contract. Assume that Lazur refused to accept the word processor even though it was in all respects conforming to the contract and that the contract is otherwise silent. Under the UCC Sales Article: a.

Baker can successfully sue for specific performance and make Lazur accept and pay for the word processor.

b.

Baker may resell the word processor to another buyer.

c.

Baker must sue for the difference between the market value of the word processor and the contract price plus its incidental damages.

d.

Baker cannot successfully sue for consequential damages unless it attempts to resell the word processor.

(b) A seller has the right to resell goods to another if the buyer refuses to accept the goods upon delivery. Answer (a) is incorrect because specific performance is not a remedy available to the seller. Baker cannot force Lazur to accept the word processor. Answer (c) is incorrect because Baker has a couple of additional remedies available. Baker can recover the full contract price plus incidental damages if he is unable to resell the identified goods. Alternatively, if the difference between the market value and contract price is inadequate to place Banker in as good a position as performance would have, then Banker can sue for lost profits plus incidental damages. Answer (d) is incorrect because Baker could sue for consequential damages that Lazur had reason to know Baker would incur as a result of Lazur‘s

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 27: Negotiable Instruments: Types, Parties, Transfer, and Liability

breach. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 27: Negotiable Instruments: Types, Parties, Transfer, and Liability

Table of Contents Answers to Questions and Case Problems ...................................................................................... 250

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Abby Novel signed a note with the following on it: ―Glen Gallwitz 1-8-2002 loaned me $5,000 at 6 percent interest a total of $10,000.00.‖ The note did not contain a payment schedule or a time for repayment.

Abby used the $10,000 as start-up money for her business and says that she orally agreed to repay the loan out of the proceeds from her first 1,000-product sales. Abby did not make any payments. Glen passed away and his son, as executor of his estate, demanded that Abby repay the $10,000 plus 6 percent interest for a total of $14,958 (the amount due as of April 2010). The trial court granted judgment for the estate. Abby has appealed, alleging that she repaid the note through the care she gave for Glen. The estate maintains that the instrument was a negotiable promissory note and that it is entitled to collect the amount due in cash. Who is correct and why? [Gallwitz v. Novel, 2011 WL 303253 (Ohio App.)] Answer: Negotiability; unconditional promise to pay. The court held that there was no payment schedule or time for repayment, but that what that means is that the note is payable on demand and the demand for payment could come at any time, including years later through the estate of Glen. The court held that there was enough in the simple statement to find that there was a negotiable promissory note that was due and owing and that the estate was not subject to various defenses that Abby tried to raise such as that she had furnished care as a way of paying off the note. [Gallwitz v. Novel, 2011 WL

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303253 (Ohio App.)] 2.

Charter Bank of Gainesville had in its possession a note containing the following provision: ―This note with interest is secured by a mortgage on real estate, of even date herewith, made by the maker hereof in favor of said payee…. The terms of said mortgage are by this reference made a part hereof.‖ When the bank sued on the note, it said that it was a holder of a negotiable instrument. Is this instrument negotiable? [Holly Hill Acres, Ltd. v.

Charter Bank of Gainesville, 314 So. 2d 209 (Fla. App.)] Answer: Requirements of negotiability. No. The bank is not a holder in due course. The mortgagor‘s promissory note incorporated the terms of the mortgage into the note, thereby making the note nonnegotiable. Payment of the note may be subject to certain conditions that are contained in the mortgage. Because the note was not negotiable, the bank could not be a holder in due course. [Holly Hill Acres, Ltd. v. Charter Bank of Gainesville, 314 So. 2d 209 (Fla. App.)]

3.

The state of Alaska was a tenant in a large office building owned by Univentures, a partnership. The state made a lease payment of $28,143.47 to Univentures with state treasury warrant No. 21045102. Charles LeViege, the managing partner of Univentures, assigned the warrant to Lee Garcia. A dispute then arose among the Univentures partners, and the company notified the state that it should no longer pay LeViege the rent. The state placed a stop payment order on the warrant. Garcia claimed that he was a holder of a negotiable instrument and that the state owed him the money. The state claimed that a warrant did not qualify as a negotiable instrument. The warrant was in writing, was signed by the governor of the state, provided a definite sum of $28,143.47, and stated that ―it will be deemed paid unless redeemed within two years after the date of issue.‖ The warrant stated that it was ―payable to the order of Univentures.‖ Does the warrant meet the requirements for a negotiable instrument? [National Bank v. Univentures, 824 P.2d 1377 (Alaska)] Answer: Holder in due course; defenses and negotiability. Yes. A holder in due course takes a negotiable instrument free of all but a very limited class of defenses that the original payor may have against the original payee. The warrant satisfies the requirements to be a negotiable instrument.

Note that under § 3-104(b) an ―instrument‖ is meant to mean a negotiable instrument throughout Article 3.

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Univentures was decided under pre-revision Article 3. The Article 3 sections cited in this case have the following current equivalents: Old Article 3

Current Article 3

§ 3-302(1)

§ 3-302(a)

§ 3-306 (as cited)

generally § 3-306, but also § 3-305

§ 3-104(1)

§ 3-104(a)

§ 3-109(a)

§ 3-108(b)

§ 3-110(a)

§ 3-109(b)

§ 3-105(1)(g)

§ 3-106(b)(ii)

[National Bank v. Univentures, 824 P. 2d 1377 (Alaska)] 4.

George S. Avery signed a letter regarding the unpaid balance on a $20,000 promissory note owed to Jim Whitworth in the form of a letter addressed to Whitworth stating: ―This is your note for $45,000.00, secured individually and by our Company for your security, due February 7, 1984.‖ The letter was signed: ―Your friend, George S. Avery.‖ It was typed on stationery with the name of Avery‘s employer, V & L Manufacturing Co., Inc., printed at the bottom and the words ―George Avery, President‖ printed at the top. Avery says he is not personally liable on the note. The court granted summary judgment for Whitworth and Avery appealed. Who is liable? [Avery v. Whitworth, 414 S.E.2d 725 (Ga. App.)] Answer: Personal liability of person signing in a representative capacity. From the court‘s opinion: ―We affirm the trial court's grant of summary judgment to plaintiff. Even though the stationary [sic] on which the note was typed showed defendant served as president of the corporation, the note itself was signed in an individual and not a representative capacity. Thus, contrary to defendant's argument, this case is squarely governed by the holding in Southern Oxygen Supply Co. v. de Golian, 230 Ga. 405, 197 S.E. 2d 374 (1973). In Southern Oxygen, the Supreme Court held the promissory note in question did not show the signer executed the note in his representative capacity as president of a corporation even though the address and (approximate) name of the corporation were printed on the document. It is the form of the signature on the note, and not other printed information appearing on the page, that governs the capacity in which the signer executes the note. " A court may take judicial notice that the signature of an individual on the face of a note, at the bottom on the right, without limiting or descriptive words before or after it, is the universal method of signing a contract to assume a personal obligation . . . ." Id. at 407, 197 S.E.2d 374, quoting Bostwick Banking Co. v. Arnold, 227 Ga. 18, 22, 178 S.E. 2d 890 (1970). See also Yeomans v. Coleman, & c. Drug Co., 167 Ga. App. 646, 307 S.E. 2d 121

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Solution and Answer Guide:

(1983).

The note in this case named the company which defendant represented but did not show he signed the note in a representative capacity and, thus, the trial court did not err in finding the defendant personally liable for the note. See Blayton v. Ford Motor Credit Co., 118 Ga. App. 517, 164 S.E. 2d 262 (1968). Pursuant to OCGA § 11-3-403(2)(b), when an instrument names the person represented (in this case, a corporate entity) but does not show that the representative signed in a representative capacity, the signer is personally obligated except as otherwise established by parol evidence between the immediate parties.

In an odd decision, the court held the officers personally liable because the promissory note unambiguously created personal liability of signors, and parol evidence was not admissible to establish the intent of the parties regarding liability, despite signors' signing "as its President" and "as its Secretary," in light of statutory presumption that signor is personally liable, and where signature block did not contain any reference to corporation, there was joint and several language for the undersigned in the note, separate corporate guaranty would have been meaningless if corporation was liable on note, and references to the corporation in note did not concern direct repayment of loan. [Avery v. Whitworth, 414 S.E. 2d 725 (Ga. App.)] 5.

Northwest Harvest Products, Inc., fell behind on its trade account with Major Products Company, Inc., and Major requested a note for the debt. Northwest sent a $79,000 corporate note. The balance on the note was incorrect, and Northwest sent a second corporate note for $79,361.89. After further discussion between the parties, Major sent a $78,445.24 note. The Chief Executive Officer of Northwest at that time signed the note ―Donald H. Eoll CEO,‖ attached a Post-It brand fax transmittal memo indicating that the note came from Donald Eoll at Northwest, and sent the note via facsimile. The note went unpaid, and Major sued both Eoll and Northwest for the debt. Is the CEO personally liable on the note? What are the parol evidence factors in this case? [Major Products Co., Inc. v.

Northwest Harvest Products, Inc., 979 P.2d 905 (Wash. App.)] Answer: Signatures and personal liability. Only the facsimile copy of the note was presented at trial, and the court below found that the writing on the Post-It, coupled with the signature, identified Northwest as the principal on the note. The trial court thus held that Eoll was not personally liable for the debt because he signed the note as an agent for Northwest. Major appealed.

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The court held that Eoll was personally liable on the note. The Post-It note was separate from the document and anything that Eoll and Major wanted to be part of the promissory note should have been written on the promissory note. Without the Post-It, there is no indication of capacity on the promissory note, which leaves Eoll liable personally on that note. [Major Products Co., Inc. v. Northwest Harvest Products, Inc., 979 P. 2d 905 (Wash.

App.)] 6.

Lloyd and Mario Spaulding entered into a contract to purchase property from Richard and Robert Krajcir. The two Spaulding brothers signed a promissory note to the Krajcir brothers with the following language: ―The amount of $10,000 [is] to be paid sellers at the time of the initial closing [delivery of the deed]; plus, the principal amount payable to sellers at the time of the final indorsement of the subject H.U.D. loan.‖ In litigation over the note, the Spauldings said it was not a negotiable instrument. The lower court found it to be a negotiable promissory note and the Spaulding partners appealed. Is the note negotiable? [Krajcir v. Egid, 712 N.E.2d 917 (Ill. App.)] Answer: Negotiability. The note is not negotiable for two reasons. First, there are no words of negotiability because the note is ―payable to sellers.‖ Second, the note is not payable at a definite time because the time of the final endorsement from HUD is unknown. [Krajcir v.

Egid, 712 N.E. 2d 917 (Ill. App.)]

7.

Smith has in his possession the following instrument: September 1, 2003 I, Selma Ray, hereby promise to pay Helen Savit One Thousand Dollars ($1,000) one year after date. This instrument was given for the purchase of Two Hundred (200) shares of Redding Mining Corporation, Interest 6%.

Selma Ray (signature).

What is this instrument? Is it negotiable?

Answer: Type of instrument and negotiability. The instrument is a promissory note. The reference to the purchase of stock shares does not affect negotiability. There is a sum certain and the note is payable at a definite date. However, there is one problem. It is a promissory note and there are no words of negotiability. The note reads ―Pay to.‖ Only a check can use those words on the front of the instrument and still be negotiable. The note

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needs to read ―Pay to the order of‖ or ―Pay to bearer.‖ 8.

A note from Mark Johnson with HealthCo International as payee for $28,979.15 included the following language: [p]ayable in _________, Successive Monthly Installments of $ Each, and in 11 Successive Monthly Installments of $2,414.92 Each thereafter, and in a final payment of $2,415.03 thereafter. The first installment being payable on the _________day of ______ 20 ______, and the remaining installments on the same date of each month thereafter until paid.

Johnson signed the note. Is it negotiable? [Barclays Bank, P.L.C. v. Johnson, 499 S.E.2d 769 (N. C. App.)] Answer: Negotiability. Not payable at a definite time; not negotiable. [Barclays Bank, P.L.C. v. Johnson, 499 S.E. 2d 769 (N.C. App.)]

9.

The text of a handwritten note stated simply that ―‗I Robert Harrison owe Peter Jacob $25,000 . . .,‘ /s/ Robert Harrison.‖ Peter Jacob sought to use the handwritten note as a negotiable promissory note. Can he? [Jacob v. Harrison, 49 U.C.C. Rep. Serv. 2d 554 (Del. Super.)]

Answer: Negotiability. No, the note is not a negotiable note. Although a promise to pay could be legally implied from such 6acknowledgement, Revised § 3-103(a)(9) indicates that for a document to be a ―promise,‖ and thus a ―negotiable instrument,‖ the obligor must also undertake to pay the obligation. Such an undertaking did not exist on the face of the document at issue here. [Jacob v. Harrison, 49 UCC Rep. Serv. 2d 554 (Del. Super.)]

10. William Potts was employed by Jemoli Holdings, Inc., to liquidate assets of defunct companies. Potts had the authority to sign checks for Jemoli. Potts had a personal investment account with Raymond James Financial Services. When the stock market had its 2000 crash due to the dot-com bubble, Potts had difficulty meeting his margin calls. He began giving checks from Jemoli to Raymond James to cover the margin calls. When a representative questioned Mr. Potts about the Jemoli checks, he assured the representative that Jemoli was him, and that it was his firm. Over four months, Potts wrote checks totaling $1.5 million to Raymond James to cover loans and to make more investments. When Jemoli‘s principals discovered the embezzlement, they brought suit to recover the funds from Raymond James. Raymond James says it was an HDC of the checks and not subject to Jemoli‘s claims for breach of fiduciary duty by its agent, Potts. Who is

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correct about the HDC status of Raymond James and why? [Jemoli Holding, Inc. v.

Raymond James Financial, Inc., 470 F.3d 14 (1st Cir.)] Answer: Forgery; fraud. A holder loses status as holder in due course only if holder had knowledge of drawer's fiduciary status, not just warning clues. In this case there were questions, but not actual knowledge of any kind of problem with the checks because he owned the company. [Jemoli Holding, Inc. v. Raymond James Financial, Inc., 470 F. 3d 14 (1st Cir.)] 11. G.C. Vincent was an employee of Porter County Development Corporation (PCDC). Vincent had three personal credit cards through Citibank. Vincent diverted checks to the PCDC, deposited them into his personal checking account, and issued checks drawn upon that personal account to pay part of the outstanding balance of his three Citibank-held credit card accounts. Citibank was unaware that Vincent used misappropriated funds to pay his credit card balance. PCDC filed suit to have Citibank return the embezzled funds. Citibank moved for summary judgment on the grounds that it was an HDC. The trial court granted summary judgment and PCDC appealed. Who should prevail on appeal and why? [Porter County Development Corp. v. Citibank (South Dakota), N.A., 855 N.E.2d 306 (Ind. App.)] Answer: Forgery; fraud. The court held that while PCDC might have a cause of action against its bank for processing the checks Vincent stole, Citibank was a holder in due course that took the payments from the personal checking account of Vincent in good faith and without any notice that there was anything untoward about the checks or the source of funds. The purpose of the HDC doctrine is to allow the free flow of instruments without parties having to check back to original sources. [Porter County Development Corp. v. Citibank (South Dakota), N.A., 855 N.E. 2d 306 (Ind. App.)] 12. Jane bought a string of pearls from Grantham Jewelers. Jane wrote a check for $1,760 to pay for the pearls. When Jane had the pearls appraised for insurance purposes, she learned from the appraiser that the pearls were fake. Jane stopped payment on the check.

However, Grantham had transferred the check to Jim Holub, who had then transferred the check back to Grantham. Is Grantham a HDC? Answer: Defenses; holder in due course. Grantham could not be a holder in due course, both because it did not give value and also because it was aware of the problems in the original transaction. Grantham tried to ship the instrument through and improve its status—it cannot do so—you can‘t take away knowledge by taking back from someone you transferred the instrument to.

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13. Calhoun/Johnson Company d/b/a Williams Lumber Company (Williams) sold building materials to Donald Miller d/b/a Millercraft Construction Company (Millercraft) on credit.

Miller had signed a personal guaranty for the materials. Miller requested lien waivers from Williams for four of his projects and asked for them from Fabian Boudreau, Williams‘s credit manager. Fabian refused to grant the waivers because Miller was $28,000 delinquent on his account. Miller agreed to bring his account current with the exception of $11,000 for which he signed a no-interest promissory note. Miller obtained the lien waivers and then defaulted on the note. Williams brought suit for payment, and Williams said there was lack of consideration and that the note was not valid. He said he must give value to be able to recover on the note. Was he correct? [Miller v. Calhoun/Johnson Co., 497 S.E.2d 397 (Ga. App.)] Answer: Value/holder in due course. Miller‘s failure of consideration argument lacks merit.

Under OCGA § 11-3-408, ―no consideration is necessary for an instrument or obligation thereon given in payment of or as security for an antecedent obligation of any kind.‖ Here, the promissory note was created to settle Miller‘s antecedent obligation, notwithstanding Miller‘s subsequent denials that any such obligation existed. Although Miller testified that when he signed the note, ―I did not feel like I owed Williams Brothers any money,‖ and that ―I agreed to sign the note under protest,‖ such assertions are not supported by any corroborative evidence. Although Miller may well have had an opinion that Williams had miscalculated the outstanding balance, he failed to offer any evidence to support his belief. Conclusory statements in affidavits unsupported by factual evidence are insufficient to avert summary judgment. Thus, Miller could not avail himself of the defense of failure of consideration. [Miller v. Calhoun/Johnson Co., 497 S.E. 2d 397 (Ga. App.)] 14. Benton, as agent for Savidge, received an insurance settlement check from Metropolitan Life Insurance Co. He indorsed it ―For deposit‖ and deposited it in Bryn Mawr Trust Co. in Savidge‘s account. What were the nature and effect of this indorsement? [Savidge v.

Metropolitan Life Ins. Co., 110 A.2d 730 (Pa.)] Answer: ―For deposit‖ indorsement as restrictive. The indorsement ―for deposit‖ was restrictive and made the indorsee an agent for collection—in this case, of the person in whose name the account stood [UCC § 3-205(c), 4-201(1)]. [Savidge v. Metropolitan Life Ins. Co., 110 A. 2d 730 (Pa.)] 15. Would a bank be liable to a customer who indorsed a check ―For deposit only into account #071698570‖ if that check were deposited into the wrong account? What if the customer‘s

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 28: Checks, Banks, and Funds Transfers

indorsement was ―For deposit only‖? Would any account qualify? Would any bank qualify?

[Qatar v. First American Bank of Virginia, 885 F. Supp. 849 (E.D. Va.)] Answer: Restrictive indorsement. In the case, the court held the bank would be liable for depositing the check into the wrong account. It is a violation of a restrictive indorsement to not comply with the account number. [Qatar v. First American Bank of Virginia, 885 F. Supp. 849 (E.D. Va.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 28: Checks, Banks, and Funds Transfers

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 258 Questions and Case Problems .......................................................................................................... 258

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

William Elias was the former owner of Direct Lending, a subprime mortgage company purchased by EA Management. Sometime after the sale, Elias went to Chase Bank and had three cashier‘s checks drawn to third parties and payable out of Direct Lending accounts in the amount of $191,251.31. When the new owners of Direct Lending checked their account balances online, they discovered the withdrawal for the three cashier‘s checks. The treasurer went to the bank and stopped payment on all three cashier‘s checks. Elias brought suit against the bank for wrongful dishonor and consequential damages to his businesses as a result of the dishonor. Can Elias recover? Be sure to explain which Article 4 provisions apply and why. [EA Management v. JP Morgan Chase, N.A., 655 F.3d 573 (6th Cir.)] Answer: Cashier’s checks; bank dishonors; wrongful withdrawal. First, Chase was entirely within its rights—and indeed its obligations—when it complied with Direct Lending's order to stop payment. Chase was both the payor bank and the depository bank for these

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checks. See M.C.L. § 440.4105(b), (c). Direct Lending issued the stop-payment order to Chase (in its capacity as payor bank) on the morning after Elias had deposited the checks with Chase. Elias does not allege in his complaint that any of the events recited in M.C.L. § 440.4303(1) had occurred by that time, which for our purposes means that the stoppayment order was timely. Chase was therefore correct to comply with the order, and indeed could have been liable to Direct Lending if it had not. See id. § 440.4403(1), (3).

That Chase stopped payment on the deposited checks in its capacity as the payor bank means that it did not get paid for those checks in its capacity as the depository bank. And, that in turn, knocks the bottom out of Elias's claim that Chase was required to honor the cashier's checks. A cashier's check is a negotiable instrument. See id. § 440.3104(3), (6).

Article 3 of the Code applies to negotiable instruments. Id. § 440.3102(1). Section 440.3305—which is part of Article 3 as enacted in Michigan—provides that ―the right to enforce the obligation of a party to pay an instrument is subject to [,]‖ among other things, ―[a] defense of the obligor stated in another section of this article or a defense of the obligor that would be available if the person entitled to enforce the instrument were enforcing a right to payment under a simple contract.‖ Id. § 440.3305(1)(b). (Some holders in due course are not subject to those defenses, see id. § 440.3305(2); but Elias does even not allege that he is a holder in due course with respect to the cashier's checks.) [EA Management v. JP Morgan Chase, N.A., 655 F. 3d 573 (6th Cir.)] 2.

Helen was a very forgetful person, so she had placed her bank code (PIN number) on the back of her debit card. A thief stole Helen‘s card and was able to take $100 from an ATM on the day of the theft. That same day, Helen realized that the card was gone and phoned her bank. The following morning, the thief withdrew another $100. For how much, if anything, is Helen responsible? Why? Answer: Consumer liability. Helen would pay $50. A consumer who notifies the bank within two days after learning of a loss or theft of a card is limited to a maximum liability of $50. Failure to notify within this time increases the consumer‘s liability to $500.

3.

Adam Paul Strege (APS) opened a checking account at U.S. Bank. Just below his signature card for the account, he wrote, ―Call if I bounce a check.‖ APS bounced several checks, and each time U.S. Bank covered those checks but it did not notify APS of the bounced check status. The result was that APS continued to write checks and U.S. Bank had to request funds from him to cover the overdrafts in his account. APS refused to pay the amount due because he argued that U.S. Bank had breached its agreement with him to report all bounced checks. Discuss whether U.S. Bank had the obligation to notify APS of the

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bounced checks. [APS v. U.S. Bank, 2009 WL 4723311 (D. Minn.)]

Answer: Overdrafts; notice of dishonor; notification. The bank's failure to call the customer when he had bounced a check, when agreement between bank and customer did not contain a term requiring bank to call customer when his account was overdrawn, did not constitute a breach of the parties' contract under Minnesota law. While the customer introduced a new provision to the bank's offer by writing, ―call if I bounce a check‖, below his signature, this was not a counteroffer because customer did not expressly condition his acceptance on the bank's acquiescence to this change, nor could such a condition be inferred from the language of customer's modification. Rather, this provision was a proposal that customer made, while simultaneously accepting the bank's agreement in full, which the parties never adopted, so the bank was under no legal obligation to notify customer when he bounced a check. [APS v. U.S. Bank, 2009 WL 4723311 (D. Minn.)]

4.

Arthur Odgers died, and his widow, Elizabeth Odgers (Elizabeth Salsman by remarriage), retained Breslow as the attorney for her husband‘s estate. She received a check payable to her drawn on First National City Bank. Breslow told her to deposit it in her husband‘s estate. She signed an indorsement ―Pay to the order of Estate of Arthur J. Odgers.‖ Breslow deposited this check in his trustee account in National Community Bank, which collected the amount of the check from the drawee, First City National Bank. Thereafter, Elizabeth, as administratrix of the estate of Arthur J. Odgers, sued National Community Bank for collecting this check and crediting Breslow‘s trustee account with the proceeds. Was National Community Bank liable? Explain. [Salsman v. National Community Bank, 246 A.2d 162 (N.J. Super.)]

Answer: Bank liability; indorsements. The bank was held to be negligent because Mrs. Odgers had indorsed the check to the estate, not Breslow. The bank should have inquired as to why Breslow was placing an estate check into the trust account of another. [Salsman v. National Community Bank, 246 A. 2d 162 (N.J. Super.)]

5.

Shipper was ill for 14 months. His wife did not take care of his affairs carefully, nor did she examine his bank statements as they arrived each month. One of Shipper‘s acquaintances had forged his name to a check in favor of himself for $10,000. The drawee bank paid the check and charged Shipper‘s account. Shipper‘s wife did not notify the bank for 13 months after she received the statement and the forged check. Can she compel the bank to reverse the charge? Why or why not?

Answer: Time limitations. No. A depositor must notify the bank of a forged signature

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within one year from the time the bank statement is received in order to hold the bank liable for its failure to discover the forged drawer signature.

6.

Ann Weldon maintained an account at Trust Company Bank. James Weldon, her son and a garment broker, purchased textile goods from Sportswear Services for resale to another corporation known as Thicket Textiles. Sportswear demanded certified funds from James Weldon before it would ship the goods. When James Weldon requested a certified check from Trust Company, Trust Company officer Sweat informed James that if it issued a certified check, payment could not be stopped even if the merchandise delivered was not as promised under the terms of the contract.

Ann Weldon then obtained a $16,319.29 cashier‘s check drawn on her account and payable to Sportswear. James had deposited his funds into her account to cover the check.

The check was delivered to Sportswear, and the goods were shipped the next day, but they were defective.

Ann Weldon went to Trust Company Bank to issue a stop payment order, and the bank, believing that the check had not yet been delivered to Sportswear, did so for $25. James Weldon then notified Sportswear of the stop payment order. After Trust Company dishonored the cashier‘s check, Sports-wear‘s bank was in contact with the bank and informed it that the check had already been delivered to Sportswear. Trust Company honored the check and credited Ann Weldon‘s account with the $25 stop payment fee.

Ann filed suit because Trust Company did not stop payment. Should payment have been stopped? Why or why not? [Weldon v. Trust Co. Bank of Columbus, 499 S.E.2d 393 (Ga. App.)] Answer: Stop payments. There are two classes of checks. There are ordinary personal checks on which the drawee is not liable until they are accepted or paid. Cashier's checks, certified checks, and bank drafts are different; these checks operate more as assignments of funds. Stop payment orders are not valid after a bank has accepted or certified the item or paid the item in cash. The courts treat both cashier's checks and certified checks the same.

The UCC provides a special role for certified checks, but it does not accord cashier's checks a similar status; a cashier's check is nothing more than a negotiable instrument issued by a bank. The bank, as the drawer and drawee, can stop payment, as against a nonholder in due course. The rule is that once money is withdrawn from a bank customer's account and a cashier's check is issued in the payee's name, the check becomes the payee's property.

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The bank did nothing wrong, and there was no conversion of a customer's funds in honoring the check. [Weldon v. Trust Co. Bank of Columbus, 499 S.E. 2d 393 (Ga. App.)] 7.

Gloria maintains a checking account at First Bank. On the third day of January, the bank sent her a statement of her account for December accompanied by the checks that the bank had paid. One of the checks had her forged signature, which Gloria discovered on the 25th of the month when she prepared a bank reconciliation. On discovering this, Gloria immediately notified the bank. On January 21, the bank had paid another check forged by the same party who had forged the December item. Who must bear the loss on the forged January check?

Answer: Alteration by same wrongdoer. Gloria must bear the loss. She did not discover and report the forgery on the December item within fourteen days after receipt from the bank of her December statement and paid checks.

Authors‘ Comment: The bank would be liable for the loss sustained on the December check. The bank is chargeable with the duty of recognizing the signature of its depositor.

Gloria reported the first forgery on the 25th of the month and thus complied with the one-year limitation.

8.

Dean bought a car from Cannon. As payment, Dean gave him a check drawn on South Dorchester Bank of Eastern Shore Trust Co. Cannon cashed the check at the Cambridge Bank of Eastern Shore Trust Co. The drawee bank refused payment when the check was presented on the ground that Dean had stopped payment because of certain misrepresentations made by Cannon. Will Eastern Shore Trust Co. succeed in an action against Dean for payment? [Dean v. Eastern Shore Trust Co., 150 A. 797 (Md.)] Answer: Liability to holder for stopping payment. Yes. A stop payment order in some cases makes the depositor liable to the holder of the check. A depositor is liable for stopping payment to any holder in due course unless payment was stopped for a reason that may be asserted against such a holder as a defense. A personal or limited defense may not be asserted against a holder in due course. Here, Cannon‘s fraud was fraud in the inducement and was not valid against the Eastern Shore Trust Company, a holder in due course. [Dean v. Eastern Shore Trust Co., 150 A. 797 (Md.)]

9.

John G. Vowell and his wife, now deceased, had a checking account and a savings/moneymarket account with Mercantile Bank of Arkansas. In June 1997, Dr. Vowell and his wife allowed their daughter, Suzan Vowell, now also deceased, and her boyfriend to move in

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with them at their home. At that time, they knew that Suzan and her boyfriend had been involved with drugs, alcohol, writing bad checks, and stealing. They also knew that Suzan had stolen checks from them in the past and forged either Dr. Vowell‘s or his wife‘s signatures. They took precautions by hiding Mrs. Vowell‘s purse, which contained their checkbook, under the kitchen sink.

Beginning in June 1997, Suzan forged Mrs. Vowell‘s signature on 42 checks, drawn on both accounts, and committed nine unauthorized ATM withdrawals in the aggregate amount of $12,028.75. Suzan found her mother‘s purse hidden under the kitchen sink and stole the checkbooks and ATM card from the purse. She apparently had access to the personal identification number (PIN) for the accounts because the number was identical to the home security system code.

The Vowells received the following statements from the bank for the checking and savings accounts: Date of Transaction

Amount

Statement date covering

July 9, 1997

$230.00

June 6–July 7, 1997

August 8, 1997

$1,235.25

July 8–August 6, 1997

August 23, 1997

$5,140.00

July 23–Aug 21, 1997

September 9, 1997

$1,423.50

Aug 7–Sept 7, 1997

September 26, 1997 $4,000.00

Aug 22–Sept 22, 1997

On September 15, 1997, Dr. Vowell had Mercantile freeze their accounts and begin investigating the alleged forgeries and other unauthorized transactions pursuant to its policy. Suzan was arrested subsequently when she tried to use the ATM card again.

The bank refused to credit the Vowells‘ account because it maintained that their negligence in handling their daughter caused the losses. The court found that the bank was liable for only $6,014.38, one-half of the entire sum of Suzan Vowell‘s unauthorized bank transactions and forgeries. The bank appealed. Can the Vowells recover? How much and why? [Mercantile Bank of Arkansas v. Vowell, 117 S.W.3d 603 (Ark. App.)] Answer: Forgery; reviewing bank statements. The appellate court found that neither the Vowells nor the bank were negligent in their behavior. However, the court noted that with the Vowells‘ agreement with the bank and the time limitations in the UCC, they could not recover for those items for which they could have prevented, had they inspected their bank statements. The wrongdoer in this case was the same person and most of the losses could have been prevented just with a simple inspection of the checking and savings

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account statements. The amount that Dr. Vowell recovered was reduced to $1,725, the losses that were incurred during the time frame after the first notice was received and before the next losses occurred. [Mercantile Bank of Arkansas v. Vowell, 117 S.W. 3d 603 (Ark. App.)] 10. Bogash drew a check on National Safety Bank and Trust Co. payable to the order of Fiss Corp. At the request of Fiss Corp., the bank certified the check. The bank later refused to make payment on the check because of a dispute between Bogash and the corporation over the amount due the corporation. Fiss sued the bank on the check. Can Fiss recover?

[Fiss Corp. v. National Safety Bank and Trust Co., 77 So. 2d 293 (N.Y. City Ct.)] Answer: Effect of certification of check at the request of the holder. Judgment was for the corporation. When a check is certified at the request of the holder, all other parties are discharged from liability, and the bank becomes absolutely liable to the holder. The bank cannot refuse to make payment for any reason [UCC § 3-411(1)]. [Fiss Corp. v. National Safety Bank and Trust Co., 77 So. 2d 293 (N.Y. City Ct.)] 11. Rovell wrote a check to Pretty Eyes Detective Agency for $10,000 too much ($38,250). A staff member for Rovell gave a stop payment order and then issued a new check ($27,284.50). But the staff member was unsure of the check number. Pretty Eyes cashed both checks, Rovell‘s account was overdrawn, and he sued the bank. Is the check valid?

Who gets the funds? Is it possible for Rovell to recover from the bank? [Rovell v. American National Bank, 232 B.R. 381, 38 U.C.C. 2d 896 (N.D. Ill. 1998)] Answer: Stop payment orders. A stop payment order requires certain information and the bank had warned Rovell‘s staff member not to reissue the check. Rovell must bear the loss.

[Rovell v. American National Bank, 232 B.R. 381, 38 UCC 2d 896 (N.D. Ill.)] 12. Norris, who was ill in the hospital, was visited by his sister during his last days. Norris was very fond of his sister and wrote a check to her that she deposited in her bank account.

Before the check cleared, Norris died. Could the sister collect on the check even though the bank knew of the depositor‘s death? Explain. [In re Estate of Norris, 532 P.2d 981 (Colo.)]

Answer: Payment after depositor‘s death. Yes. The bank may continue to pay checks for ten days after the death of the drawer, even though it has notice of the death. This is true unless the bank is ordered to stop payment by a person claiming an interest in the account. This ten-day payment period allows the holders of checks drawn shortly before

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the drawer‘s death to cash them without filing a claim with the court. [In re Estate of Norris, 532 P. 2d 981 (Colo.)]

13. Scott D. Leibling gave his bank, Mellon Bank, an oral stop payment order. Nineteen months later, the check emerged and Mellon Bank honored it. Leibling has filed suit against Mellon Bank for acting unreasonably under the circumstances. Is Mellon Bank liable to Leibling for paying the 19-month-old check when there was an oral stop payment order? Discuss your reasons for your answer. [Leibling, P.C. v. Mellon, PSFS (NJ) N.A., 710 A.2d 1067, 35 U.C.C. 2d 590 (N.J. Super.)]

Answer: Bank payment of stale check. Mellon Bank acted in good faith when, without consulting customer, it honored a check that was presented for payment 19 months after it was issued and after the expiration of an oral stop payment order. Section 4-404 provides that a bank can charge its customer's account for a check presented more than 6 months after its date as long as it does so in good faith. The bank used an adequate computer system for processing checks, and its payment of the check was fair and in accordance with reasonable commercial standards. It was not liable for honoring the stale check. [Leibling, P.C. v. Mellon, PSFS (N.J.) N.A., 710 A. 2d 1067, 35 UCC 2d 590 (N.J. Super.)]

14. Hixson paid Galyen Petroleum Co. money he owed by issuing three checks to Galyen. The bank refused to cash the three checks because of insufficient funds in the Hixson account to pay all three. Galyen sued the bank. What was the result? Why? [Galyen Petroleum Co. v.

Hixson, 331 N.W.2d 1 (Neb)] Answer: Dishonor of check. Judgment was for the bank. When a bank has not certified a check, the payee cannot collect from the bank when it refuses to pay the check when presented to it. The check does not operate as an assignment of whatever money exists in the account. The bank was not required to pay the payee as much money as existed in the drawer‘s account. [Galyen Petroleum Co. v. Hixson, 331 N.W. 2d 1 (Neb.)] 15. Alma Evans began a series of transactions shortly before her death including creating a trust that named John Hieber as trustee. She also executed bank documents enabling Hieber to withdraw money from her accounts to fund the trust. Unfortunately, Alma died before the trust was funded. Following her death Hieber went to Uptown National Bank in order to withdraw the money from her bank account and place it into the trust. He claimed that he had authority as the trustee of the trust. Uptown refused to honor the request to withdraw funds because Alma had died and it needed legal documents that would allow him to have access to her accounts, such as letters of administration from the

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 29: Nature of the Debtor-Creditor Relationship

probate court. Since the trust did not yet exist without any principal, he had no authority as a trustee. Could the bank legally refuse to allow withdrawals from Alma‘s account?

[Hieber v. Uptown National Bank of Chicago, 557 N.E.2d 408 (Ill. App.)] Answer: Death of customer and bank obligations. The court held that (1) the trust did not survive settlor‘s death, where the settlor died before checks she had drafted to the fund trust were accepted for payment by the bank, and (2) the bank was not obligated to give written notice of dishonor of checks to trustee, who was also the payee. [Hieber v. Uptown National Bank of Chicago, 557 N.E.2d 408 (Ill. App.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 29: Nature of the Debtor-Creditor Relationship

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 266 Questions and Case Problems .......................................................................................................... 266 End of Chapter: CPA Questions and Answers ................................................................................. 274 Answers to AICPA Questions ............................................................................................................ 276

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

First Interstate Bank issued a letter of credit in favor of Comdata Network. Comdata provides money to truckers on the road by way of cash advances through form checks written by truckers. When Comdata enters into a business relationship with a trucking company, it requires a letter of credit. This requirement is to secure advances made on behalf of the trucking company. One of the trucking companies defrauded the bank that issued the letter of credit. Comdata demanded that the bank make payment to it under the letter of credit for cash advances that the trucking company had not repaid. The bank, alleging fraud by the trucking company, refused. Comdata filed suit. Can Comdata force payment? [Comdata Network, Inc. v. First Interstate Bank of Fort Dodge, 497 N.W.2d 807 (Iowa App.)]

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Solution and Answer Guide:

Answer: Letters of credit and payment. A letter of credit constitutes an enforceable obligation by the issuer in favor of the beneficiary. The duty created in the letter of credit is wholly independent of the underlying contract between the issuer‘s customer and the beneficiary. Misconduct by the trucking company was not relevant to this dispute between Comdata and the bank. The claim of Comdata on the letter of credit was not subject to defenses normally applicable to third party contracts. Judgment was affirmed.

Article 5 of the UCC governs the letter of credit transaction. However as pre-revision § 5102(3) aptly points out, the ―Article deals with some but not all the rules and concepts of letters of credit as such rules or concepts have developed prior to this act and hereafter develop.‖ Thus, unlike other commercial transaction law that have a strong UCC presence, letters of credit are a hybrid creature of statutory and common law. Under revised Article 5 and in relation to Comdata, an issuer must honor the presentation that complies with the terms and conditions of the letter of credit. § 5-108. [Comdata Network, Inc. v. First Interstate Bank of Fort Dodge, 497 N.W. 2d 807 (Iowa App.)] 2.

LaBarge Pipe & Steel Company agreed to sell PVF $143,613.40 of 30-inch pipe provided that PVF obtain a letter of credit for $144,000, with the letter of credit entitling LaBarge to payment if PVF did not pay for the pipe within 30 days of invoice. PVF obtained the letter of credit from First Bank but received only a facsimile copy of it. The letter of credit required LaBarge to submit the original of the letter of credit for a demand of payment.

PVF did not pay within 30 days and LaBarge submitted a facsimile copy of the letter of credit and requested payment. First Bank denied the request for payment and LaBarge filed suit against First Bank for failure to pay. LaBarge argued that it was not disputed that PVF had not paid on the contract and First Bank was required to pay on the letter of credit.

How would you explain First Bank‘s rights to LaBarge? [LaBarge Pipe & Steel Co. v. First Bank, 550 F.3d 442 (5th Cir.)] Answer: Letter of credit payment. First Bank had no choice. Although there was a clear non-payment by the buyer, the bank has to honor the paperwork demands of the letter of credit. Without the original, LaBarge was not entitled to payment under the terms of the letter of credit. There is significance in having the originals of agreements despite the fact that faxes are recognized as acceptable for forming the contract in the first place. [LaBarge Pipe & Steel Co. v. First Bank, 550 F. 3d 442 (5th Cir.)]

3.

On August 1, 1987, Dori Leeds signed a ―guarantee of credit‖ with Sun Control Systems,

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Solution and Answer Guide:

which guaranteed ―the prompt payment, when due, of every claim of [Sun Control Systems] against [Dori Leeds dba ‗Blind Ambitions‘].‖ At the time she signed the guarantee of credit, Blind Ambitions was in the business of installing window treatments and installed only Faber brand blinds, which were purchased from Sun Control Systems. In 1991, Sun Control Systems sold and assigned all of its assets to Faber. Shortly thereafter, Dori assigned her interest in Blind Ambitions to David and Judith Leeds, who continued to do business as Blind Ambitions. In 1994 and 1995, Blind Ambitions made credit purchases from Faber and did not pay under the terms of those contracts. Faber brought suit against Dori Leeds as the guarantor of credit for Blind Ambitions. Dori refused to pay on the grounds that she was acting as a personal guarantor for her business, not for Blind Ambitions. Is she correct? [Faber Industries, Ltd. v. Dori Leeds Witek, 483 S.E.2d 443 (N.C. App.)] Answer: Suretyship defenses. Dori's promise was original and specific to her business. It was not a general guaranty of credit. The plain language in the guaranty of credit was one intended to cover Dori Leeds while she owned and operated Blind Ambitions. The language did not cover the business itself and thereby carry Dori's liability as a guarantor to any subsequent owners or operators. She was in essence a personal guarantor for her sole proprietorship and not a guarantor for a separate entity. [Faber Industries, Ltd. v. Dori Leeds Witek, 483 S.E. 2d 443 (N.C. App.)] 4.

Fern Schimke‘s husband, Norbert, was obligated on two promissory notes in favor of Union National Bank. Some time prior to his death, Union National Bank prepared a guaranty contract that was given to Norbert for his wife to sign. She signed the guaranty at the request of her husband without any discussion with him about the provisions of the document she was signing. On Norbert‘s death, the bank brought suit against Fern on the basis of the guaranty. Fern argued that because there was no consideration for the guaranty, she could not be liable. Is Fern correct? Must there be consideration for a guarantor to be responsible for payment? [Union Nat’l Bank v. Fern Schimke, 210 N.W.2d 176 (N.D.)] Answer: Defense to enforcement. Judgment for Fern Schimke. The guarantee contract was executed by Schimke at a subsequent time to the incurring of the debt involved. The bank gave her no separate consideration in return for the guarantee. Therefore, Schimke was not liable. [Union Nat'l Bank v. Fern Schimke, 210 N.W. 2d 176 (N.D.)]

5.

In May 1989, Alma Equities Corp., owned by its sole shareholder and president, Lewis Futterman, purchased a hotel and restaurant in Vail, Colorado, from Alien for $3,900,000.

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Solution and Answer Guide:

Alma paid $600,000 in cash to Alien, and Alien provided a purchase money loan to Alma for the remaining amount of the sale price, with the loan secured by a deed of trust on the hotel and restaurant. The hotel and restaurant did not do well, and Futterman negotiated a friendly foreclosure on the property in 1991, whereby Alma would continue to operate the hotel and restaurant on a lease basis, with Futterman providing a personal guaranty for the lease. Alma failed to make the lease payments for the months of November and December 1991 and, following an unlawful detainer action filed by Alien for possession of the hotel and restaurant, was forced into bankruptcy. Alien turned to Futterman for satisfaction on the lease payments. Futterman said he should not have been forced to pay because Alien‘s unlawful detainer forced Alma into bankruptcy. Was Futterman correct?

Did he have a defense? [Alien, Inc. v. Futterman, 924 P.2d 1063 (Colo.)]

Answer: Suretyship defenses. No, a surety is there precisely because there can be bankruptcies. [Alien, Inc. v. Futterman, 924 P. 2d 1063 (Colo.)]

6.

Crown Corporation has borrowed $16,000,000 from Third Bank. Third Bank required four sureties for the loan. The sureties are as follows: Andover

$4,000,0000

Busch

$8,000,0000

Chapman

$2,000,0000

Davidson

$2,000,0000

Crown has defaulted on the loan after paying back $4,000,000. How much will each surety be required to pay? What if Busch was bankrupt? How much would Andover, Chapman, and Davidson have to pay?

Answer: Suretyship payment. Add the total sureties together and compute their shares: A

25%

B

50%

C

12.5%

D

12.5%

12,000,000 total A pays 3,000,000 B pays 6,000,000

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Solution and Answer Guide:

C and D pay 1,500,000 each If B is bankrupt, determine the share by using 12,000,000—A pays 25%; C and D split 3,000,000 or 1,500,000 each.

7.

Tri County Truck & Diesel borrowed $165,000 from Security State Bank and pledged its inventory as security for the loan. In addition, Fred and Randelle Burk agreed to act as sureties for the loan. Tri County defaulted on the loan and Security Bank repossessed the collateral. The inventory was damaged while Security Bank held it, and as a result, the sale of the inventory brought only $5,257.50 at a public auction. The Burks raised the defense of the damages as a setoff to their surety amount for the remainder of the loan. Security Bank said the Burks could not raise the damages as a defense because the Burks were sureties and had guaranteed the full amount of the loan. The trial court granted summary judgment for Security Bank, and the Burks appealed. What should the court do? [Security State Bank v. Burk, 995 P.2d 1272 (Wash App.)] Answer: Suretyship payment and defenses. The court held that: (1) principals could assert bank's failure to dispose of corporation's collateral in a ―commercially reasonable‖ manner, as required under Article 9 of Washington version of Uniform Commercial Code (UCC), as an affirmative defense, even though guarantee waived any defenses arising from bank's ―unjustified impairment‖ of collateral, and (2) fact issue as to whether disposition of collateral was commercially reasonable precluded summary judgment. [Security State Bank v. Burk, 995 P. 2d 1272 (Wash. App.)]

8.

Aldo (CFO), Bruno (VP), and Consuelo (CEO) are sureties in the amounts of $60,000, $120,000, and $180,000 (respectively) for their corporation‘s (WaxBrite) loan of $300.000.

What would the sureties owe if WaxBrite has paid $120,000 of the debt? Suppose that Aldo has gone bankrupt leaving Bruno and Consuelo to pay. How much would each of them have to pay then?

Answer: Suretyship payment. First scenario: ALDO

60,000/360,000 = 1/6 X 180,000 = $30,000

BRUNO 120,000/360,000 = 1/3 X 180,000 = $60,000 CONSUELO

180,000/360,000 = 1/2 X 180,000 = $90,000

Second scenario: Because Aldo is bankrupt, we take him out of the denominator BRUNO

120,000/300,000 = 2/5 X 180,000 = $72,000

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Solution and Answer Guide:

CONSUELO 9.

180,000/300,000 = 3/5 X 180,000 = $108,000

Ribaldgo Argo Consultores entered into a contract with R. M. Wade & Co. for the purchase of irrigation equipment. Ribaldgo obtained a letter of credit from Banco General, a bank with its principal place of business in Quito, Ecuador. The letter of credit required that Wade submit certain documents to obtain payment. The documents were submitted through Citibank as correspondent bank for Banco General. However, the documents were incomplete, and Citibank demanded additional information required under the letter of credit. By the time Wade got the documents to Citibank, more than 15 days had expired, and the letter of credit required that Wade submit all documentation within 15 days of shipping the goods to obtain payment. Citibank refused to authorize the payment. Wade filed suit. Must Citibank pay? Why or why not? [Banco General Runinahui, S.A. v. Citibank International, 97 F.3d 480 (11th Cir.)] Answer: Letters of credit. Citibank cannot pay on the letter of credit. A bank can only pay according to the terms of the letter of credit. If the bank cannot comply completely with the letter of credit, it must not release funds because it then has liability for failure to honor the parties' requirements for payments. The bank cannot waive the time requirements or the lack of documentation. Only the parties can alter the terms of the letter of credit, the requirements for its payment and the banks obligations under those terms. Citibank cannot pay because the time has expired and there is a breach that the parties must attend to, not Citibank. [Banco General Runinahui, S.A. v. Citibank International, 97 F. 3d 480 (11th Cir.)]

10. Hugill agreed to deliver shingles to W. I. Carpenter Lumber Co. and furnished a surety bond to secure performance of the contract. After a breach of the contract by Hugill, Carpenter brought suit to recover its loss from the surety, Fidelity & Deposit Co. of Maryland. The surety denied liability on the grounds that there was concealment of (a) the price to be paid for the shingles and (b) a material advance to the contractor equal to the amount of the profit that he would make by performing the contract. Decide. [W. I. Carpenter Lumber Co. v. Hugill, 270 P.94 (Wash.)]

Answer: Defenses of the surety. Judgment for the surety. The concealment of the price of the shingles was not significant in that it would not lead to any loss or prejudice. The advance was prejudicial, as it equaled the profit the contractor would make by performing, thereby depriving him of an incentive to complete the contract and depriving the surety of a fund that would be available in case of the contractor‘s default. [W. I. Carpenter Lumber Co. v. Hugill, 270 P. 94 (Wash.)]

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Solution and Answer Guide:

11. Donaldson sold plumbing supplies. The St. Paul- Mercury Indemnity Co., as surety for him, executed and delivered a bond to the state of California for the payment of all sales taxes.

Donaldson failed to pay, and the surety paid the taxes that he owed and then sued him for the taxes. What was the result? [St. Paul-Mercury Indemnity Co. v. Donaldson, 83 S.E.2d 159 (S.C.)] Answer: Subrogation. Judgment for the St. Paul-Mercury Indemnity Company. After paying the principal‘s debt, the surety was subrogated to all rights of the state, as creditor, against the principal. [St. Paul-Mercury Indemnity Co. v. Donaldson, 83 S.E. 2d 159 (S.C.)] 12. Paul owed Charles a $1,000 debt due September 1. On August 15, George, for consideration, orally promised Charles to pay the debt if Paul did not. On September 1, Paul did not pay, so Charles demanded $1,000 from George. Is George liable? Why or why not?

Answer: Creation of the relation. No. The statute of frauds requires that promises to pay the debt of another (contract of guaranty) must be in writing to be enforceable in court.

Because no such writing exists, George is not liable.

13. First National Bank hired Longdon as a secretary and obtained a surety bond from Belton covering the bank against losses up to $100,000 resulting from Longdon‘s improper conduct in the performance of his duties. Both Longdon and the bank signed the application for the bond. After one year of service, Longdon was promoted to teller, and the original bond remained in effect. Shortly after Longdon‘s promotion, an audit revealed that Longdon had stolen $50,000. He was arrested and charged with embezzlement.

Longdon had only $5,000 in assets at the time of his arrest. (a) If the bank demands a payment of $50,000 from Belton, what defense might Belton raise to deny any obligation to the bank? (b) If Belton fully reimburses the bank for its loss, can Belton recover from Longdon?

Answer: a.

Defenses of the surety. Belton could argue that the original contract was modified without the surety‘s consent when Longdon‘s position with the bank changed.

b.

Rights of the surety. Belton, after paying the bank, is entitled to indemnity from Longdon.

14. Jack Smith was required by his bank to obtain two sureties for his line of credit of

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272

Solution and Answer Guide:

$100,000. Ellen Weiss has agreed to act as a surety for $50,000, and Allen Fox has agreed to act as a surety for $75,000. Smith has used the full $100,000 in the line of credit and is now in bankruptcy. What is the maximum liability of Weiss and Fox if the bank chooses to collect from them for Smith‘s default? How should the $100,000 be allocated between Weiss and Fox? Answer:Rights of contribution; surety. The co-sureties contribute their pro rata share of the debt, but they are never liable for more than they agreed to. Formula is: Amount co-surety guaranteed Total amount of surety‘s pledge x Amount of debt up or default Ellen Weiss:

50,000 125,000 x 100,000 = 2/5 x 100,000 = $40,000

Allen Fox:

75,000 125,000 x 100,000 = 3/5 x 100,000 = $60,000

15. Industrial Mechanical had a contract with Free Flow Cooling, Ltd., a British company. Free Flow owed Industrial $171,974.44 for work Industrial had performed on a construction project in Texas. Free Flow did not pay Industrial, and Industrial filed suit against Siemens Energy & Automation as a surety on the debt. Industrial alleges that Siemens is a surety based on a fax it received from Siemens on January 27, 1994. The fax is handwritten and states: ―We have received preliminary notices and we like [sic] to point out that the contract we have signed does not allow for such action to recourse [sic] with the customer.

Please advise all subcontractors and suppliers that the only recourse that they will have is against Siemens.‖ The fax was signed ―kind regards‖ by Arnold Schultz, Siemens‘s senior project manager for the Texas construction project. Nowhere in the fax did Siemens guarantee the debt of any specified entity or state that Siemens was agreeing to indemnify anyone or pay the obligations on behalf of anyone else. The fax failed to identify the principal debtor whom Siemens purportedly agreed to indemnify and failed to state that Siemens agreed to answer for that entity‘s debt. Can Industrial collect the amount of Free Flow‘s debt from Siemens? Why or why not? [Industrial Mechanical, Inc. v.

Siemens Energy & Automation, Inc., 495 S.E.2d 103 (Ga. App.)] Answer:Creation of surety relationship. No, Industrial cannot collect the debt from Siemens. Nowhere in the fax did Siemens guarantee the debt of any specified entity or state that Siemens was agreeing to indemnify anyone or pay the obligations on behalf of anyone else. This fax failed to identify the principal debtor whom Siemens purportedly

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Solution and Answer Guide:

agreed to indemnify and failed to state that Siemens agreed to answer for that entity's debt. In the absence of these essential terms, the fax does not constitute a contract of guaranty as a matter of law. Thus, despite Industrial's claim that the fax constituted a "written indemnity contract," it is apparent that as a matter of contract law, no guaranty exists and that even if it did, Siemens did not guarantee the indebtedness of Free Flow, who was not Siemens' "customer." [Industrial Mechanical, Inc. v. Siemens Energy & Automation, Inc., 495 S.E. 2d 103 (Ga. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Marbury Surety, Inc., agreed to act as a guarantor of collection of Madison‘s trade accounts for one year beginning on April 30, 1980, and was compensated for same.

Madison‘s trade debtors are in default in payment of $3,853 as of May 1, 1981. As a result: a.

Marbury is liable to Madison without any action on Madison‘s part to collect the amounts due.

b.

Madison can enforce the guaranty even if it is not in writing because Marbury is a del credere agent.

c.

The relationship between the parties must be filed in the appropriate county office because it is a continuing security transaction.

d.

Marbury is liable for those debts for which a judgment is obtained and returned unsatisfied.

2.

Queen paid Pax and Co. to become the surety on a loan that Queen obtained from Squire.

The loan is due, and Pax wishes to compel Queen to pay Squire. Pax has not made any payments to Squire in its capacity as Queen‘s surety. Pax will be most successful if it exercises its right to: a. Reimbursement (indemnification)

3.

b.

Contribution

c.

Exoneration

d.

Subrogation

Which of the following defenses by a surety will be effective to avoid liability? a.

Lack of consideration to support the surety undertaking.

b.

Insolvency in the bankruptcy sense of the debtor.

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Solution and Answer Guide:

c.

Incompetency of the debtor to make the contract in question.

d.

Fraudulent statements by the principal debtor that induced the surety to assume the obligation and that were unknown to the creditor.

4.

For each of the numbered words or phrases, select the one best phrase from the list a through j. Each response may be used only once.

Correct Matches (1) Indemnity contract

a. Relationship whereby one

1=e

person agrees to answer for the debt or default of another.

(2) Suretyship contract

b. Requires certain contracts to

2=a

be in writing to be enforceable.

(3) Surety

c. Jointly and severally liable to

3=d

creditor.

(4) Third-party

d. Promises to pay debt on

beneficiary

default of principal debtor.

(5) Co-surety

e. One party promises to

4=f 5=c

reimburse debtor for payment of debt or loss if it arises.

(6) Statute of frauds

f. Receives intended benefits of a

6=b

contract.

(7) Right of contribution

g. Right of surety to require the

7=h

debtor to pay before surety pays.

(8) Reimbursement

h. Upon payment of more than

8=i

his/her proportionate share, each co-surety may compel other cosureties to pay their shares.

(9) Subrogation

i. Upon payment of debt, surety

9=j

may recover payment from debtor.

(10) Exoneration

j. Upon payment, surety obtains

10 = g

same rights against debtor that creditor had.

5.

When a principal debtor defaults and a surety pays the creditor the entire obligation, which of the following remedies gives the surety the best method of collecting from the debtor? a.

Exoneration

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Solution and Answer Guide:

6.

b.

Contribution

c.

Subrogation

d.

Attachment

Which of the following bonds are an obligation of a surety? a. Convertible bonds b.

Debenture bonds

c.

Municipal bonds

d.

Official bonds

[return to top] Answers to AICPA Questions 1.

Marbury Surety, Inc., agreed to act as a guarantor of collection of Madison‘s trade accounts for one year beginning on April 30, 1980, and was compensated for same.

Madison‘s trade debtors are in default in payment of $3,853 as of May 1, 1981. As a result: a.

Marbury is liable to Madison without any action on Madison‘s part to collect the amounts due.

b.

Madison can enforce the guaranty even if it is not in writing because Marbury is a del credere agent.

c.

The relationship between the parties must be filed in the appropriate county office because it is a continuing security transaction.

d.

Marbury is liable for those debts for which a judgment is obtained and returned unsatisfied.

(d) Marbury Surety, Inc., agreed to act as a guarantor of collection. As such, Marbury is not required to indemnify the obligee, Madison, until the obligee has exhausted collection efforts. Ordinarily, this point is reached when the obligee has exhausted legal remedies and a judgment against the obligor debtor has been returned unsatisfied. In contrast, in a guarantor of payment agreement, the guarantor-surety is primarily liable on the debt with the obligor. No separate demand need be made on the guarantor-surety after the obligor‘s default. Upon default, both obligor and guarantor of payment are liable. Surety and guaranty agreements are not within the purview of Article 9; thus, there are no filing or recording requirements. Finally, Marbury is not a del credere agent because it is not guaranteeing payment for products sold on credit.

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Solution and Answer Guide:

2.

Queen paid Pax and Co. to become the surety on a loan that Queen obtained from Squire.

The loan is due, and Pax wishes to compel Queen to pay Squire. Pax has not made any payments to Squire in its capacity as Queen‘s surety. Pax will be most successful if it exercises its right to: a.

Reimbursement (indemnification)

b.

Contribution

c.

Exoneration

d.

Subrogation

(c) Under the right of exoneration, the surety may sue to compel the principal debtor to pay the obligation owed by the creditor when the debtor has sufficient assets to do so and is wrongfully withholding payment. In this case, where Pax has not yet made any payments to Squire, the appropriate action is to seek the right of exoneration against Queen. Answer (a) is incorrect because the right to reimbursement would be the appropriate action only if Pax had already made payments to Squire. Answer (b) is incorrect because the right of contribution applies to one co-surety who has paid more than his proportionate share of the debtor‘s obligation and can therefore take action against the other co-sureties. Answer (d) is incorrect because the right of subrogation applies only in cases where the surety has already paid the creditor.

When this occurs, the surety obtains the same rights that the creditor had against the debtor (i.e., the surety stands in the shoes of the creditor).

3.

Which of the following defenses by a surety will be effective to avoid liability? a.

Lack of consideration to support the surety undertaking.

b.

Insolvency in the bankruptcy sense of the debtor.

c.

Incompetency of the debtor to make the contract in question.

d.

Fraudulent statements by the principal debtor that induced the surety to assume the obligation and that were unknown to the creditor.

(a) A suretyship agreement is a contract which must be supported by consideration.

When the suretyship agreement is contemporaneous with the primary contract, there is no need for separate consideration. The surety may exercise any real defenses on the contract which are available to the debtor. Thus, fraud, duress, illegality, forgery, etc., will discharge both surety and debtor. However, the surety may not rely on the debtor‘s personal defenses (e.g., incapacity, insolvency, or death) to avoid the suretyship obligation. The surety is also discharged from liability if the surety agreement was procured by duress or fraudulent misrepresentation by the creditor. Thus, if the creditor fraudulently contracts with the debtor or fraudulently

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Solution and Answer Guide:

procures the suretyship agreement itself, the agreement is voidable.

4.

For each of the numbered words or phrases, select the one best phrase from the list a through j. Each response may be used only once.

1)

Indemnity contract

2)

Suretyship contract

3)

Surety

4)

Third-party beneficiary

5)

Co-surety

6)

Statute of frauds

7)

Right of contribution

8)

Reimbursement

9)

Subrogation

10) Exoneration a.

Relationship whereby one person agrees to answer for the debt or default of another.

b.

Requires certain contracts to be in writing to be enforceable.

c.

Jointly and severally liable to creditor.

d.

Promises to pay debt on default of principal debtor.

e.

One party promises to reimburse debtor for payment of debt or loss if it arises.

f.

Receives intended benefits of a contract.

g.

Right of surety to require the debtor to pay before surety pays.

h.

Upon payment of more than his/her proportionate share, each co-surety may compel other co-sureties to pay their shares.

5.

i.

Upon payment of debt, surety may recover payment from debtor.

j.

Upon payment, surety obtains same rights against debtor that creditor had.

(1)

e

(6)

b

(2)

a

(7)

h

(3)

d

(8)

i

(4)

f

(9)

j

(5)

c

(10)

g

When a principal debtor defaults and a surety pays the creditor the entire obligation, which of the following remedies gives the surety the best method of collecting from the debtor? a.

Exoneration

b.

Contribution

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 30: Consumer Protection

c.

Subrogation

d.

Attachment

(c) When a surety pays a debt, s/he takes over all legal rights of the creditor against the debtor. These may even be bankruptcy rights, security rights in collateral, and others.

6.

Which of the following bonds are an obligation of a surety? a.

Convertible bonds

b.

Debenture bonds

c.

Municipal bonds

d.

Official bonds

(b) Convertible bonds, municipal bonds, and official bonds are financial instruments, not guarantees of payment. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 30: Consumer Protection

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 279 Questions and Case Problems .......................................................................................................... 279

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

The San Antonio Retail Merchants Association (SARMA) was a credit reporting agency. It was asked by one of its members to furnish information on William Douglas Thompson III. It supplied information from a file that contained data on William III and on William Daniel Thompson Jr. The agency had incorporated information related to William Jr. into the file relating to William III so that all information appeared to relate to William III. This was a negligent mistake because each William had a different Social Security number, which should have raised a suspicion that there was a mistake. In addition, SARMA should have

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used a number of checkpoints to ensure that incoming information would be put into the proper file. William Jr. had bad credit standing. Because of its mistake, SARMA gave a bad report on William III, who was denied credit by several enterprises. The federal Fair Credit Reporting Act makes a credit reporting agency liable to any consumer about whom it furnishes a consumer report without following reasonable procedures to ensure maximum possible accuracy of information. William III sued SARMA for its negligence in confusing him with William Jr. Is SARMA liable? [Thompson v. San Antonio Retail Merchants Ass’n, 682 F.2d 509 (5th Cir.)] Answer: Credit reporting. Under the Fair Credit Reporting Act, the agency is liable to ―any consumer‖ for negligence failure to comply with ―any requirement imposed‖ by the act.

One of the requirements imposed by the act is that the agency ―shall follow reasonable procedures to assure maximum possible accuracy of information concerning the individual about whom the report relates.‖ The lower court found that the agency was negligent in failing to exercise reasonable care in programming its computer system and failing to employ reasonable procedures designed to compare the social security numbers of the two individuals. The lower court also awarded $10,000 in actual damages based on humiliation to William III. The judgment was affirmed. [Thompson v. San Antonio Retail Merchants Ass'n, 682 F. 2d 509 (5th Cir.)] 2.

Colgate-Palmolive Co. ran a television commercial to show that its shaving cream, Rapid Shave, could soften even the toughness of sandpaper. The commercial showed what was described as the sandpaper test. Actually, what was used was a sheet of Plexiglas on which sand had been sprinkled. The FTC claimed that this was a deceptive practice. The advertiser contended that actual sandpaper would merely look like ordinary colored paper and that Plexiglas had been used to give the viewer an accurate visual representation of the test. Could the FTC prohibit the use of this commercial? [Federal Trade Commission v.

Colgate-Palmolive Co., 380 U.S. 374] Answer: Advertising regulation. The commercial made television viewers believe that they were seeing with their own eyes an actual test, and this would tend to persuade them more than it would if they knew that they were seeing merely an imitation of a test. To that extent, the use of the mockup without disclosing its rue character was deceptive. It therefore could be prohibited by the FTC. [Federal Trade Commission v. Colgate-Palmolive Co., 380 U.S. 374]

3.

Sharolyn Charles wrote a check for $17.93 to a Poncho‘s Restaurant on July 4, 1996, as

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Solution and Answer Guide:

payment for a meal she had there. The check was returned for insufficient funds. Poncho‘s forwarded the check to Check Rite for collection.

On July 19, Check Rite sent a letter to Charles, stating that ―[t]his is an attempt to collect a debt‖ and requesting total payment of $42.93—the amount of the check plus a service charge of $25. On August 7, Check Rite sent a second letter, requesting payment of $42.93 and advising Charles that failure to pay the total amount due might result in additional liability for damages and attorneys‘ fees, estimated at $242.93.

Check Rite subsequently referred the matter to the law firm of Lundgren & Associates for collection. On September 8, Lundgren sent a letter to Charles offering to settle within 10 days for a total amount of $127.93—the amount of the check plus a settlement amount of $110. Lundgren further advised that it had made no decision to file suit, that it could later decide to do so, and that Charles‘s potential liability was $317.93. Charles immediately sent to Lundgren a money order in the amount of $17.93. On September 13, Lundgren sent a second letter, repeating the settlement offer made in the September 8 letter.

Lundgren then returned Charles‘s payment on September 14, declining to accept it as payment in full and repeating the settlement offer. On September 19, Lundgren sent a fourth letter to Charles, repeating the settlement offer.

On October 15, 1996, Charles filed suit in federal district court alleging violations of the Fair Debt Collections Practices Act (FDCPA). Lundgren & Associates moved to dismiss the case on grounds that an attempt to collect on a check is not a ―debt‖ governed by FDCPA. The district court dismissed the case; Charles appealed. Should Charles win? Is she protected under the FDCPA? [Charles v. Lundgren & Associates, P.C., 119 F.3d 739 (9th Cir.)] Answer: FDCPA. The court held that the application of the FDCPA was not limited to collections rising out of credit extensions. Any collection of funds, even from a bad check, is covered under the FDCPA. Those who collect on bad checks are under the same FDCPA rules and regulations as collectors for other types of obligations. They are subject to the same prohibitions on abusive conduct. [Charles v. Lundgren & Associates, P.C., 119 F. 3d 739 (9th Cir.)] 4.

Thomas was sent a credit card through the mail by a company that had taken his name and address from the telephone book. Because he never requested the card, Thomas left the card lying on his desk. A thief stole the card and used it to purchase merchandise in several stores in Thomas‘s name. The issuer of the credit card claimed that Thomas was

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liable for the total amount of the purchases made by the thief. Thomas claimed that he was not liable for any amount. The court decided that Thomas was liable for $50. Who is correct? Why? Answer: Credit cards. Thomas is correct. The maximum liability that the holder of a credit card has for its unauthorized use is $50; but in order to impose that liability, certain conditions must be satisfied. The first of these is that the card must have been requested by the holder. Here, the card was unsolicited. It was sent to Thomas through the mail. The issuer of the card therefore cannot recover even the $50 that might have been recoverable. Thus, the issuer recovers nothing.

5.

On May 16, 2003, Sari Smith filed a class-action lawsuit in Cook County, Illinois, against J.M. Smucker Co. on behalf of ―[a]ll purchasers in the United States of America of spreadable fruit products labeled ‗Simply 100% Fruit‘ manufactured, produced, and sold

by J.M. Smucker Co. excluding its directors, officers and employees‖ for consumer fraud, deceptive business practices, unjust enrichment, and breach of warranty, alleging that Smucker‘s Simply 100% Fruit products do not contain 100 percent fruit. The premium jam‘s label indicates that, for example, its Strawberry jam also contains ―fruit syrup, lemon juice concentrate, fruit pectin, red grape juice concentrate and natural flavors.‖ Is the label a form of deceptive advertising?

If you were a Smucker‘s executive, what would you argue in the case on deceptive ads?

[J.M. Smucker Co. v. Rudge, 877 So. 2d 820 (Fla. App.)] Answer: Advertising; deception. A good argument to make is that while all of the ingredients are not strawberries, all of the listed elements are indeed made from fruit. The huge class action suit continues to rumble through the courts with Smuckers winning a few procedural cases on the national size of the class. If it is indeed all fruit products, then the label is not deceptive. [J.M. Smucker Co. v. Rudge, 877 So. 2d 820 (Fla. App.)]

6.

International Yogurt Co. (IYC) developed a unique mix for making frozen yogurt and related products. Morris and his wife purchased a franchise from the company but were not told that a franchise was not a requirement for obtaining the mix—that the company would sell its yogurt mix to anyone. The Morrises‘ franchise business was a failure, and they sold it at a loss after three years. They then sued the company for fraud and for violation of the state Franchise Investment Protection Act and the state Consumer Protection Act for failing to inform them that the mix could be obtained without a franchise. IYC claimed that no liability could be imposed for failing to make the disclosure.

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Was it correct? [Morris v. International Yogurt Co., 729 P.2d 33 (Wash.)]

Answer: Franchises. No, IYC was not correct. Federal law requires advance disclosure about all aspects of the franchise including current operations, financing, earnings, etc. The fact that the mix was available generally as opposed to only through the franchise was a material issue in the earnings potential because of the ease of entry by competitors not burdened with franchise fees. [Morris v. International Yogurt Co., 729 P. 2d 33 (Wash.)]

7.

In December 2008, Corey and Jamie Baker purchased a TV from Best Buy as well as a fouryear service contract for the TV. In November 2010, Best Buy determined that the problems the Bakers were having with the TV could not be fixed, so Best Buy replaced the TV with a comparable model. Best Buy told the Bakers that if they wanted the full protection on the replacement TV, they would need to buy a new four-year policy. The Bakers and others filed suit against Best Buy for consumer fraud and false statements in advertisements because the Bakers felt that the ads depicted the service agreement as being one of full protection for four years. Under the terms of the service contract purchased by the appellants, coverage under the plan was effective from the date the product was purchased and would expire four years from the effective date. But the next paragraph of the service contract adds that ―[o]ur obligations under this Plan will be fulfilled in their entirety if we replace your product.‖ The contract further stated ―Limits of Liability,‖ defining a limit of the lesser of repair or replacements and finally stating that ―[i]n the event . . . we replace the product, we shall have satisfied all obligations under the Plan.‖ What should the court decide? Was there deception, or is the contract clear enough for buyers? Discuss the factors the court will consider in deciding whether there has been consumer fraud. [Baker v. Best Buy Stores, LP, 812 N.W.2d 177 (Minn. App.)] Answer: Deceptive advertising. This case is very similar to an unpublished case from the Eastern District of Kentucky. In that case, the plaintiff purchased a service contract from Best Buy and received a copy of the agreement when he purchased a television set. Crail v.

Best Buy Co., 2007 WL 2726102, at *1 (E.D. Ky. 2007), aff'd, 285 F. Appx. 277 (6th Cir.2008).

The agreement contained a provision stating that ―[t]his Plan is fulfilled when the product is replaced after the expiration of the manufacturer's warranty.‖ Id. The television set malfunctioned following the expiration of the manufacturer's warranty, and the plaintiff obtained a replacement television pursuant to the service contract, which the plaintiff had purchased from Best Buy. Id. Thereafter, the plaintiff filed a class-action complaint alleging that Best Buy's ―premature‖ termination of the warranty coverage in conjunction with the ―replacement in lieu of repair‖ feature of the Plan was unlawful. Id.

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In considering the plaintiff's claims, the court found it necessary to dismiss because it was ―undisputed that plaintiff received the benefit of the bargain . . . . Nowhere in the Plan are there contrary terms that imply that any further coverage applied once such replacement occurred.‖ Id. at *4 (footnote omitted). The court also noted that the plaintiff did not plead ―that the replacement television was of inferior quality or otherwise not a suitable replacement for the television he originally purchased.‖ Id. at *4 n. 1. Therefore, the court determined that the plaintiff had failed to state a claim for breach of contract. Id. at *4.

The decision in Crail is persuasive. As in Crail, appellants purchased a television set and a service contract from Best Buy. The set subsequently malfunctioned after the expiration of the manufacturer's warranty, and Best Buy replaced it pursuant to the terms of the contract. Although the service contract was purchased for a four-year term, the plain language of the contract contains specific language limiting the length of the contract if certain events occur. This unambiguous language provided that the service contract is fulfilled if the television is replaced. The district court correctly concluded that appellants received the benefit of the bargain with Best Buy. Appellants offer several additional arguments on the contract issue, none of which has merit. Essentially, appellants argue that the ―Limits of Liability‖ provision must be read with attention to the repair-and-replacement language of the contract. Appellants claim that the contract is ambiguous because it was reasonable for them to understand that Best Buy would first attempt to repair the television, should it break. But this argument is inconsistent with the plain language of the contract—that respondents have sole discretion in determining whether the television should be repaired or replaced and that their obligations under the service contract are satisfied if the television is replaced.

Appellants contend that this interpretation of the contract gives respondents ―sole discretion‖ to terminate the agreement, which is ―not what [they] bargained for.‖ But in fact, this is the exact content of the bargain. The service contract begins by stating that it is a legal contract and that ―[b]y purchasing it, you understand that it is a legal contract and acknowledge that you have had the opportunity to read the terms and conditions set forth herein.‖ Thus, appellants agreed to the terms of the contract by purchasing it.

Appellants further argue that they reasonably interpreted the service contract to be a contract for insurance under Minn. Stat. § 60A.02, subd. 3 (2010), rather than a service contract under Minn. Stat. § 59B.02, subd. 11 (2010). But the contract repeatedly refers to itself as a service contract and specifically provides that ―[t]his Plan is not a contract for insurance.‖ Moreover, the language of the plan is consistent with a service contract, rather

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than a contract for insurance. Therefore, we conclude that the district court did not err by dismissing appellants' breach-of-contract claim.

Appellants argue that the district court erred by dismissing their consumer-fraud claims because even though the statements in the service contract were ―technically true,‖ the service contract was written in ―a manner that is misleading.‖ But this consumer-fraud argument is a repetition of appellants' breach-of-contract claim, so it fails for the same reasons. Moreover, the complaint alleges that respondents ―have misrepresented that their Service contract expires at the end of a specified term when, under certain circumstances, it expires prior to the specified term.‖ Because the complaint is devoid of any allegation that respondents intended to deceive anyone, the claim is not stated with the requisite particularity. [Baker v. Best Buy Stores, LP, 812 N.W. 2d 177 (Minn. App.)] 8.

The town of Newport obtained a corporate MasterCard that was given to the town clerk for purchasing fuel for the town hall. The town clerk used the card for personal restaurant, hotel, and gift shop debts. The town refused to pay the card charges on the grounds that they were unauthorized. Was the town correct? [MasterCard v. Town of Newport, 396 N.W.2d 345 (Wis. App.)] Answer: Use of credit card for unpermitted purposes. No. The use of the card by the clerk was authorized because the clerk had authority to use the card. The clerk was not authorized to use the card for the purpose for which it was used. This unauthorized purpose, however, did not affect the rightfulness of use with respect to older or the issuer of the card. The town, therefore, was required to pay the credit card charges. [MasterCard v. Town of Newport, 396 N.W. 2d 345 (Wis. App.)]

9.

Stevens purchased a pair of softball shoes manufactured by Hyde Athletic Industries.

Because of a defect in the shoes, she fell and broke an ankle. She sued Hyde under the state consumer protection act, which provided that ―any person who is injured in … business or property … could sue for damages sustained.‖ Hyde claimed that the act did not cover personal injuries. Stevens claimed that she was injured in her ―property‖ because of the money that she had to spend for medical treatment and subsequent care. Decide.

[Stevens v. Hyde Athletic Industries, Inc., 773 P.2d 87 (Wash. App.)] Answer: Consumer protection. Judgment for Hyde Athletic Industries, Inc. ―Business or property‖ denotes a commercial venture or enterprise. Stevens‘s personal injury claim is excluded from consumer protection coverage. [Stevens v. Hyde Athletic Industries, Inc., 773 P. 2d 87 (Wash. App.)]

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10. A consumer made a purchase on a credit card. The card issuer refused to accept the charge, and an attorney then sued the consumer for the amount due. In the complaint filed in the lawsuit, the attorney wrongly stated that interest was owed at 18 percent per annum. This statement was later corrected by an amendment of the complaint to 5 percent. The case against the consumer was ultimately settled, but the consumer then sued the attorney for penalties under the Fair Debt Collection Practices Act, claiming that the overstatement of the interest due in the original complaint was a violation of that act.

The attorney defended on the ground that the act did not apply. Did it? [Green v. Hocking, 9 F.3d 18 (6th Cir.)] Answer: FDCPA. The FDCPA does not apply in this situation. An examination of the FDCPA in context reveals that it was not intended to govern attorneys engaged solely in the practice of law. A contrary result would produce absurd outcomes. For example, 15 U.S.C. § 1692g(b) provides that collection efforts must cease if, within thirty days of receiving a communication, the debtor disputes the amount owed. 15 U.S.C. § 1692c(c) provides that all debt communications must cease once the debtor makes such a request. Read literally, these provisions would mean that, once a creditor initiates a lawsuit, and the consumer responds that he does not owe the amount alleged, or that he wishes to cease communications, it would be unlawful to bring a motion for summary judgment. Or, if an attorney first writes a letter, and the consumer asks that communications cease, it would be unlawful to instigate a lawsuit. Additionally, 15 U.S.C. § 1692c(b) prevents a debt collector from communicating with any third party pertaining to the consumer's debt.

Under this portion of the Act, it would be unlawful for an attorney to communicate with the court or the clerk's office by filing suit. Furthermore, Section 1692e(5) makes it unlawful to threaten "to take any action that cannot legally be taken or that is not intended to be taken." Assuming a lawsuit is brought, and the consumer prevails to any extent, it would appear that the law has been broken, as the creditor threatened to take action that apparently, as a result of the judgment, "cannot legally be taken." These examples demonstrate that appellant's interpretation, that every act by an attorney in litigation should be covered by the Act, is wrong. Neither by cited language, nor by intent, did Congress prevent attorneys from engaging in the normal practice of law. [Green v.

Hocking, 9 F. 3d 18 (6th Cir.)] 11. Classify each of the following activities as proper or prohibited under the various consumer statutes you have studied. a.

Calling a hospital room to talk to a debtor who is a patient there.

b.

Calling a hospital room to sell surgical stockings.

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c.

Rolling back the odometer on one‘s car before selling it privately.

d.

No TILA disclosures on an instant tax refund program in which the lender takes 40 percent of the tax refund as a fee for advancing the money when the taxpayer files the tax return.

Answer: FDCPA. Classify each of the following activities as proper or prohibited under the various consumer statutes you have studied. a.

Calling a hospital room to talk to a debtor who is a patient there—violation of FDCPA

b.

Calling a hospital room to sell surgical stockings—violation of the TCPA

c.

Rolling back the odometer on your car before you sell it privately—violation of federal law that prohibits tampering with the odometer. It is irrelevant that you are selling privately and not a dealer. You can‘t roll back odometers.

d.

No TILA disclosures on an instant tax refund program in which the lender takes 40% of the tax refund as a fee for advancing the money when the taxpayer files his or her tax return—it is classified as a loan and such a loan would require compliance with all the TILA disclosures

12. Alpha University has an arrangement with Axis Credit Card Company to collect 1 percent on all credit card charges made by students who obtain their cards through booths on the Alpha campus. Do any consumer protection statutes apply to this relationship?

Answer: Credit cards; CARD. The 2009 federal law applies. There are limits on such solicitations by colleges and university. Also, disclosure of fee sharing is required.

13. List three areas in consumer credit cards affected by the CARD Act. Answer: Credit cards; CARD. CARD controls late fees, time of payment, balance transfers, and increases in rate triggering events.

14. The federal government makes low-interest-rate loans available to disabled Americans through a lending program that is handled by banks and credit unions. Would lenders be permitted to ask applicants for proof of disability when they are apply for these types of loans or would that be discrimination? [Lakeview Loan Servicing, LLC v Pendleton, 47 N.E.3d 349 (Ill. App. 2015)] Answer: No, a request for information to prove eligibility for a government program

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 31: Secured Transactions in Personal Property

(women-owned small business loans, minority-owned business loans) is legal. In this case, proof of disability is a requirement for a special program, not a grounds for approving or disapproving the loan. It is a hurdle to entering the loan program. [Lakeview Loan Servicing, LLC v. Pendleton, 47 N.E.3d 349 (Ill. App. 2015)] 15. Rosaria‘s Rugs does not have a credit card processor that recognizes chips. Peter Franke purchased a rug from Rosaria‘s for $1500.00. Peter was using a fake Bank First credit card that did not have a chip. Bank First had issued chip credit cards to all its customers by the end of 2020. Explain who will bear the responsibility for the $1,500 loss and why.

Answer: Under the federal rules for chip cards the loss is allocated to the party least at fault (apart from trying to find Peter and collect from him). Bank First had its chip program fully in place. Rosaria‘s was the party lacking the technology designed to prevent fraud, so it would bear the loss. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 31: Secured Transactions in Personal Property

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 288 Questions and Case Problems .......................................................................................................... 288 End of Chapter: CPA Questions and Answers ................................................................................. 297 Answers to AICPA Questions ............................................................................................................ 299

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

On October 22, 2001, Benjamin Ritchie executed a promissory note and mortgage in consideration for a $47,000 loan from WaMu. The mortgage covered both real estate located at 1790 Mount Mariah Road, Carlisle, Kentucky, and a manufactured home to be situated on the real property. The mortgage was properly filed in the Nicholas County Clerk‘s Office on October 31, 2001.

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Ritchie used the proceeds of the loan to purchase a manufactured home, which was subsequently rendered a total loss as a result of heavy fire damage. As the named loss payee on the insurance policy for the home, WaMu received and released the insurance proceeds to the Debtor to purchase a replacement manufactured home. WaMu failed, however, to record its lien on the certificate of title to the replacement manufactured home.

On January 20, 2006, WaMu initiated a foreclosure action on the property. Ritchie raised the defense that WaMu no longer had a valid lien on the manufactured home. Is Ritchie correct? Explain your answer. [In re Ritchie, 416 B.R. 638 (6th Cir.)] Answer: Security interest; perfection; validity. The failure to perfect on the title does not eliminate the security interest because of the underlying loan documents. WaMu would step into secured creditor from perfected secured creditor, but it did not lose its status because the security interest had attached; it was just not perfected. [In re Ritchie, 416 B.R. 638 (6th Cir.)] 2.

In 1983, Carpet Contracts owned a commercial lot and building, which it operated as a retail carpet outlet. In April of 1983, Carpet Contracts entered into a credit sales agreement with Young Electric Sign Corp. (Yesco) for the purchase of a large electronic sign for the store. The cost of the sign was $113,000, with a down payment of $25,000 and 60 monthly payments of $2,100 each.

In August 1985, Carpet Contracts agreed to sell the property to Interstate. As part of the sale, Carpet Contracts gave Interstate an itemized list showing that $64,522 of the proceeds from the sale would be used to pay for the ―Electronic Sign.‖ The property was transferred to Interstate, and the Carpet Contracts store continued to operate there, but now it paid rent to Interstate. In June 1986, Carpet Contracts asked Yesco to renegotiate the terms of the sign contract. Yesco reduced Carpet Contracts‘ monthly payments and filed a financing statement on the sign at the Utah Division of Corporations and Commercial Code. In December 1986, Interstate agreed to sell the property and the sign to the Webbs, who conducted a title search on the property, which revealed no interest with respect to the electronic sign. Interstate conveyed the property to the Webbs. Carpet Contracts continued its operation but was struggling financially and had not made its payments to Yesco for some time. By 1989, Yesco declared the sign contract in default and contacted the Webbs, demanding the balance due of $26,100. The Webbs then filed suit, claiming Yesco had no priority as a creditor because its financing statement was not filed

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in the real property records where the Webbs had done their title search before purchasing the land. Was the financing statement filed properly for perfection? [Webb v.

Interstate Land Corp., 920 P.2d 1187 (Utah)] Answer: Perfection of a security interest. No. The court held that the sign was not equipment but a fixture. As a fixture, the proper place for the filing of a security interest in it was the recorder's office, where land records are located. The central filing at the Division of Corporations and Commercial Code was not sufficient public notice to give Yesco a perfected interest. The Webbs purchased the property in good faith without notice of any interest of Yesco. Yesco has no priority due to its failure to file in the proper location.

This case predates Revised Article 9. However, the filing requirements under Revised Article 9 are central for all transactions except real property, which are filed according to state laws in the land records. This case, therefore, comes down to a question of fixtures and real property interests. When in doubt, file in both places. [Webb v. Interstate Lane Corp., 920 P. 2d 1187 (Utah)] 3.

McLeod purchased several items from Sears, Roebuck & Co. on credit. The description of the items, in which Sears took a purchase money security interest, was as follows: ―MITER SAW; LXITV-RACDC [a television, videocassette recorder, and compact disc spinner]; 25 UPRIGHT, 28 UPRIGHT [two pieces of luggage]; BRA-CELET, DIA STUDS, RING; 14K EARR, P, EARRINGS, P [diamond bracelet, ring, and earrings]; and 9-INCH E-Z-LIFT [an outdoor umbrella].‖ In a dispute over creditors‘ priorities in McLeod‘s bankruptcy, one creditor argued that the description of the goods was insufficient to give Sears a security interest.

Does the description meet Article 9 standards? [McLeod v. Sears, Roebuck & Co., 41 U.C.C. 2d (Bankr. E.D. Mich.)]

Answer: Creation of security interest; adequacy of description. Because the security interest was a purchase money security interest in consumer goods, the brief descriptions were sufficient to identify the goods for purposes of the creditor‘s security interest. The words used made it sufficiently easy to identify the goods because they were distinctive from other goods that the debtor owned. [McLeod v. Sears, Roebuck & Co., 41 UCC 2d 302 (Bankr. E.D. Mich.)]

4.

When Johnson Hardware Shop borrowed $20,000 from First Bank, it used its inventory as collateral for the loan. First Bank perfected its security interest by filing a financing statement. The inventory was subsequently damaged by fire. Flanders Insurance paid

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Johnson Hardware $5,000 for the loss, but First Bank claimed the proceeds of the insurance. Was First Bank correct? Why or why not?

Answer: Proceeds of collateral. Yes. A security interest exists not only in the collateral, but also in proceeds from the collateral. Proceeds include the cash received by the debtor on the resale of the collateral and the balance owed the debtor by the debtor‘s purchaser.

5.

Consider the following cases and determine whether the financing statements as filed would be valid under Article 9. a.

In re Thriftway Auto Supply, Inc., 159 B.R. 948, 22 U.C.C. Rep. Serv. 2d 605 (W.D. Okla.). The creditor used the debtor‘s corporate trade name, ―Thriftway Auto Stores,‖ not its legal name, ―Thriftway Auto Supply, Inc.‖

b.

In re Mines Tire Co., Inc., 194 B.R. 23, 29 U.C.C. 2d 617 (Bankr. W.D.N.Y). The creditor used the name ―Mines Company Inc.‖ instead of ―Mines Tire Company, Inc.‖

c.

Mountain Farm Credit Service, ACA v. Purina Mills, Inc., 459 S.E.2d 75 (N.C. App.). The creditor filed the financing statement under ―Warren Killian and Robert Hetherington dba Grey Daw Farms‖ in a situation in which the two individuals were partners running Grey Daw Farms as a partnership.

d.

B.T. Lazarus & Co. v. Christofides, 662 N.E.2d 41 (Ohio App.). The creditor filed a financing statement in the debtor‘s old name when, prior to filing, the debtor had changed its name from B.T.L., Inc., to Alma Manufacturing, Inc.

e.

In re SpecialCare, Inc., 209 B.R. 13, 34 U.C.C. 2d 857 (N.D. Ga). The creditor failed to refile an amended financing statement to reflect debtor‘s name change from ―Davidson Therapeutic Services, Inc.‖ to ―SpecialCare, Inc.‖

f.

Industrial Machinery & Equipment Co. Inc. v. Lapeer County Bank & Trust Co., 540 N.W.2d 781 (Mich. App.). The creditor filed the financing statement under the company‘s trade name, KMI, Inc., instead of its legal name, Koehler Machine, Inc.

g.

First Nat’l Bank of Lacon v. Strong, 663 N.E.2d 432 (Ill. App.). Creditor filed the financing statement using the trade name ―Strong Oil Co.‖ instead of the legal name ―E. Strong Oil Company.‖

Answer: Errors in financing statement. a.

The court held that the financing statement was not seriously misleading because difference between two names was slight and trade name could be found by using only slightly broader search on computer system, (affd. 39 F. 3d 1193 (10th Cir. 1994) (unpublished opinion)).

b.

Not seriously misleading.

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c.

Financing statement is not seriously misleading where Grey Dawn Farms is a partnership consisting of these two individuals.

d.

The court held this was a seriously misleading financing statement.

e.

The court held this was seriously misleading; a creditor must always file an amended financing statement when the debtor changes its name.

f.

The court held the use of the trade name was seriously misleading. Generally, filing under the trade name of a debtor is ineffective—need to have the legal name or both.

g.

Again, use of a trade name is seriously misleading.

The answers given were pre-Revised Article, as were all the cases. However, under Revised Article 9, it is doubtful that any of these incorrect names would pull up under an electronic search. As a result, they would all be seriously misleading. Emphasize that the burden has shifted under Revised Article 9 to the parties—they must be certain that the legal name is correct because there is no reasonable person or ―should have known‖ standard with electronic filing.

6.

First Union Bank of Florida loaned money to Dale and Lynn Rix for their purchase of Ann‘s Hallmark, a Florida corporation. First Union took a security interest in the store‘s equipment, fixtures, and inventory and filed the financing statement under the names of Dale and Lynn Rix. Subsequently, the Rixes incorporated their newly acquired business as Michelle‘s Hallmark Cards & Gifts, Inc. When Michelle‘s went into bankruptcy, First Union claimed it had priority as a secured creditor because it had filed its financing statement first. Other creditors said First Union had priority against the Rixes but not against the corporation. Who was correct? What was the correct name for filing the financing statement? [In re Michelle’s Hallmark Cards & Gifts, Inc., 36 U.C.C. 2d 225 (Bankr. M.D. Fla.)] Answer: Financing statement, filing. While Revised Article 9 makes it easier to file, the debtors name must be accurate. The key is notice. Here the court held filing under secured party‘s name was not sufficient to perfect against the corporation. [In re Michelle's Hallmark Cards & Gifts, Inc., 36 UCC 2d 225 (Bankr. M.D. Fla.)]

7.

Rawlings purchased a typewriter from Kroll Typewriter Co. for $600. At the time of the purchase, he made an initial payment of $75 and agreed to pay the balance in monthly installments. A security agreement that complied with the UCC was prepared, but no financing statement was ever filed for the transaction. Rawlings, at a time when he still owed a balance on the typewriter and without the consent of Kroll, sold the typewriter to a neighbor. The neighbor, who had no knowledge of the security interest, used the

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typewriter in her home. Could Kroll repossess the typewriter from the neighbor?

Answer: Status of buyer of collateral from debtor. No. The typewriter was consumer goods.

When no financing statement is filed, a resale by one consumer to another destroys the seller‘s security interest. The second consumer, however, must have no knowledge of the first security interest and must buy for personal, family, or household use.

8.

Expeditors International had a shipping contract with Schwinn Cycling and Fitness, Inc. The contract provided that Expeditors had a security interest in all of the goods it delivered to Schwinn. Expeditor‘s security interest provided that it also had a security interest in the proceeds from the sale of the bikes. Expeditors had delivered goods to Schwinn and Schwinn declared bankruptcy a few days later but before Expeditors had filed its financing statement on the shipped goods. The bankruptcy trustee has claimed that Expeditors was not a perfected secured creditor. Explain whether Expeditors is a perfected secured creditor and decide who has priority in the Schwinn goods. In re Schwinn Cycling and Fitness, Inc., 313 B.R. 473 (D. Colo.)

Answer: Perfected secured creditor. After relinquishing possession of goods to customer, shipping company had temporarily perfected security interest in goods under Colorado's version of Uniform Commercial Code, under which perfected security interest in goods in possession of bailee remained perfected for 20 days without filing of financing statement when goods were surrendered to debtor for sale or exchange. West's C.R.S.A. § 4–9– 312(f)(1), (h).

However, the trucking company did not file and perfect. Debtor's filing of Chapter 11 petition during 20-day period in which shipping company had temporarily perfected security interest in goods which it had shipped prepetition for debtor, pursuant to Colorado's version of Uniform Commercial Code (UCC), did not cause company's security interest to become permanently perfected, and therefore company's failure to timely file financing statement resulted in loss of its perfected status as to goods. West's C.R.S.A. §§ 4–9–312(f)(1), (h), 4–9–313(d). [In re Schwinn Cycling and Fitness, Inc., 313 B.R. 473 (D. Colo.)]

9.

Benson purchased a new Ford Thunderbird automobile. She traded in her old car and used the Magnavox Employees Credit Union to finance the balance. The credit union took a security interest in the Ford. Subsequently, the Ford was involved in a number of accidents and was taken to a dealer for repairs. Benson was unable to pay for the work done. The dealer claimed a lien on the car for services and materials furnished. The Magnavox

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Employees Credit Union claimed priority. Which claim had priority? [Magnavox Employees Credit Union v. Benson, 331 N.E.2d 46 (Ind. App.)] Answer: Repair and storage lien. The dealer who did the repair work will have priority. A lien for repair or storage charges will prevail over any outstanding security interest. Such a common law lien will have priority over any other security interests in the collateral.

[Magnavox Employees Credit Union v. Benson, 331 N.E. 2d 46 (Ind. App.)] 10. Lockovich borrowed money from a bank to purchase a motorboat. The bank took a security interest in it but never filed a financing statement. A subsequent default on the loan occurred, and the debtor was declared bankrupt. The bank claimed priority in the boat, alleging that no financing statement had to be filed. Do you agree? Why? [In re Lockovich, 124 B.R. 660 (W.D. Pa.)] Answer: Perfection of consumer goods. Yes. In this case, the motorboat is a consumer good. With consumer goods, no financing statement must be filed by the creditor to perfect a secured interest in the collateral. The only reason it would be necessary to perfect would be for protection against subsequent purchasers of the collateral. [In re Lockovich, 124 B.R. 660 (W.D. Pa.)] 11. In 1987, the Muirs bought a motor home. In 1988, the Muirs created and Bank of the West acquired and perfected a security interest in the motor home. In 1992, the Muirs entered into an agreement with Gateleys Fairway Motors by which Gateleys would sell the motor home by consignment. Gateleys sold the motor home to Howard and Ann Schultz.

The Schultzes did not know of the consignment arrangement or of the security interest of the bank. Gateleys failed to give the sales money to the Muirs and then filed for bankruptcy. The Schultzes brought suit seeking a declaration that they owned the motor home free of the bank‘s security interest. The trial court granted the Schultzes summary judgment. Who has title to the motor home and why? [Schultz v. Bank of the West, C.B.C., 934 P.2d 421 (Or.)] Answer: Rights of buyers; ordinary course. The court of appeals reversed, noting that the UCC allows a buyer to qualify as a buyer in the ordinary course when the buyer purchases goods from a dealer who only possesses, but does not have legal title to, those goods. A buyer of consignment goods who purchases from a consignment dealer can be a buyer in ordinary course for the purposes of that statute. The Schultzes, as buyers, met the other requirements for being buyers in ordinary course and were such when they purchased the

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consigned motor home at Gateleys. [Schultz v. Bank of the West, C.B.C., 934 P. 2d 421 (Ore.)] 12. On April 18, 2000, Philip Purkett parked his car, on which he owed $213 in payments, in his garage and locked the garage. Later that night, TWAS, Inc., a vehicle repossession company, broke into the garage and repossessed the car without notice to Purkett. To get the car back, Purkett paid a $140 storage fee and signed a document stating that he would not hold TWAS liable for any damages. Did TWAS and Key Bank violate Article 9 requirements on repossession? [Purkett v. Key Bank USA, Inc., 2001 WL 503050, 45 U.C.C. Rep. Serv. 2d 1201 (N.D. Ill.)] Answer: Repossession. The court held that there was more than a trespass; there was breaking and entering because there was a break-in into the garage and a breach of the peace in violation of Article 9 protections. [Purkett v. Key Bank USA, Inc., 2001 WL 503050, 45 UCC Rep. Serv. 2d 1201 (N.D. Ill.)] 13. A borrowed money from B and orally agreed that B had a security interest in equipment that was standing in A‘s yard. Nothing was in writing, and no filing of any kind was made.

Nine days later, B took possession of the equipment. What kind of interest did B have in the equipment after taking possession of it? [Transport Equipment Co. v. Guaranty State Bank, 518 F.2d 373 (10th Cir.)] Answer: Security interest based on possession of collateral. When taking possession of the collateral, B acquired a perfected security interest, with perfection dating from the time of the taking of possession. The fact that possession was taken eliminated the need for a written security agreement. The taking of possession also conferred perfection without filing. Thus, the security interest of B vested and became perfected at the same moment: the moment when B took possession of the collateral. [Transport Equipment Co. v.

Guaranty State Bank, 518 F. 2d 373 10th Cir.)] 14. Cook sold Martin a new tractor truck for approximately $13,000, with a down payment of approximately $3,000 and the balance to be paid in 30 monthly installments. The sales agreement provided that ―on default in any payment, Cook [could] take immediate possession of the property . . . without notice or demand. For this purpose vendor may enter upon any premises on which the property may be.‖ Martin failed to pay the installments when due, and Cook notified him that the truck would be repossessed. Martin left the tractor truck attached to a loaded trailer and locked on the premises of a company in Memphis. Martin intended to drive to the West Coast with the trailer. When Cook

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located the tractor truck, no one was around. To disconnect the trailer from the truck (because he had no right to the trailer), Cook removed the wire screen over a ventilator hole by unscrewing it from the outside with his penknife. He next reached through the ventilator hole with a stick and unlocked the door of the tractor truck. He then disconnected the trailer and had the truck towed away. Martin sued Cook for unlawfully repossessing the truck by committing a breach of the peace. Decide. [Martin v. Cook, 114 So. 2d 669 (Miss.)]

Answer: Extent to which creditor may break and enter in order to repossess property. The Uniform Commercial Code gives the secured party ―in taking possession [the right to] proceed without judicial process if this can be done without breach of the peace‖ (UCC § 9-503). Cook made a proper repossession. He did not damage the truck and did not commit a breach of the peace in entering it or removing the wire screen. The repossession was, therefore, proper and came within the protection of the general rule that repossession may be made in any peaceable manner. [Martin v. Cook, 114 So. 2d 669 (Miss.)]

Authors‘ Comment: Attention is called to Fuentes v. Shevin, 407 US 67, in which UCC § 9-503 was held unconstitutional as a denial of due process in authorizing repossession of collateral by judicial proceeding without notice and hearing. The Mitchell case, cited below, did not overrule the Fuentes case, as is seen in North Georgia Finishing, Inc. v. Di-Chem., Inc., 419 US 601.

When the statute providing for repossession required that the creditor first obtain a court order authorizing seizure of the collateral, the statute was constitutional as applied to a nonnecessary (General Electric Corp. v. Pistone, 326 N.Y. S. 2d 898).

Note also the concept of Blaire v. Pitchess, 5 Cal. 3d 258, 96 Cal. Rptr. 42, 486 P. 2d 242, by which a secured creditor cannot obtain possession of the collateral by a replevin action without first showing the existence of probable cause comparable to that required for the issuance of a search warrant. When the process of repossession through a court action is subject to supervision and control by a judge, it is constitutional even though there is no notice [or hearing, as held necessary in the Fuentes case] (Mitchell v. W. T. Grant Co., 416 US 600). When a creditor repossesses the collateral by self-help without the use of a court action, it is generally held that no state action is involved and that such self-help repossession is constitutional, even though there is no notice or hearing.

15. Kimbrell‘s Furniture Co. sold a new television set and tape player to Charlie O‘Neil and his

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wife. Each purchase was on credit, and in each instance, a security agreement was executed. Later on the same day of purchase, O‘Neil carried the items to Bonded Loan, a pawnbroker, and pledged the television and tape deck as security for a loan. Bonded Loan held possession of the television set and tape player as security for its loan and contended that its lien had priority over the unrecorded security interest of Kimbrell. Who had priority? [Kimbrell’s Furniture Co. v. Sig Friedman, d/b/a Bonded Loan, 198 S.E.2d 803 (S.C.)] Answer: Conflicting security interests. Judgment was for Kimbrell‘s Furniture. Kimbrell had priority through its perfected security interest in the consumer goods effective at the time of attachment. The pawn broker‘s security interest is second in time to Kimbrell‘s perfected security interest. The pawn broker is not a purchaser of the goods or a consumer purchaser because the pawn broker did not buy the goods for personal, family, or household use. [Kimbrell's Furniture Co. v. Sig Friedman, d/b/a Bonded Loan, 198 S.E. 2d 803 (S.C.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

On March 1, Green went to Easy Car Sales to buy a car. Green spoke to a salesperson and agreed to buy a car that Easy had in its showroom. On March 5, Green made a $500 down payment and signed a security agreement to secure the payment of the balance of the purchase price. On March 10, Green picked up the car. On March 15, Easy filed the security agreement. On what date did Easy‘s security interest attach?

2.

a.

March 1

b.

March 5

c.

March 10

d.

March 15

Carr Corp. sells VCRs and videotapes to the public. Carr sold and delivered a VCR to Sutter on credit. Sutter executed and delivered to Carr a promissory note for the purchase price and a security agreement covering the VCR. Sutter purchased the VCR for personal use.

Carr did not file a financing statement. Is Carr‘s security interest perfected? a.

No, because the VCR was a consumer good.

b.

No, because Carr failed to file a financing statement.

c.

Yes, because Carr retained ownership of the VCR.

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d.

3.

Yes, because it was perfected at the time of attachment.

On July 8, Ace, a refrigerator wholesaler, purchased 50 refrigerators. This comprised Ace‘s entire inventory and was financed under an agreement with Rome Bank that gave Rome a security interest in all refrigerators on Ace‘s premises, all future-acquired refrigerators, and the proceeds of sales. On July 12, Rome filed a financing statement that adequately identified the collateral. On August 15, Ace sold one refrigerator to Cray for personal use and four refrigerators to Zone Co. for its business. Which of the following statements is correct? a.

The refrigerators sold to Zone will be subject to Rome‘s security interest.

b.

The refrigerators sold to Zone will not be subject to Rome’s security interest.

c.

The security interest does not include the proceeds from the sale of the refrigerators to Zone.

d.

4.

The security interest may not cover after-acquired property even if the parties agree.

Fogel purchased a television set for $900 from Hamilton Appliance. Hamilton took a promissory note signed by Fogel and a security interest for the $800 balance due on the set. It was Hamilton‘s policy not to file a financing statement until the purchaser defaulted.

Fogel obtained a loan of $500 from Reliable Finance, which took and recorded a security interest in the set. A month later, Fogel defaulted on several loans and one of his creditors, Harp, obtained a judgment against Fogel, which was properly recorded. After making several payments, Fogel defaulted on a payment due to Hamilton, who then recorded a financing statement subsequent to Reliable‘s filing and the entry of the Harp judgment.

Subsequently, at a garage sale, Fogel sold the set for $300 to Mobray. Which of the parties has the priority claim to the set?

5.

a.

Reliable

b.

Hamilton

c.

Harp

d.

Mobray

Under the Secured Transactions Article of the UCC, which of the following items can usually be excluded from a filed original financing statement? a. The name of the debtor. b.

The address of the debtor.

c.

A description of the collateral.

d. The amount of the obligation secured.

6.

Under the Secured Transactions Article of the UCC, which of the following security

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agreements does not need to be in writing to be enforceable? a.

A security agreement collateralizing a debt of less than $500.

b.

A security agreement where the collateral is highly perishable or subject to wide price fluctuations.

c.

A security agreement where the collateral is in the possession of the secured party.

d.

A security agreement involving a purchase money security interest.

[return to top] Answers to AICPA Questions 1.

On March 1, Green went to Easy Car Sales to buy a car. Green spoke to a salesperson and agreed to buy a car that Easy had in its showroom. On March 5, Green made a $500 down payment and signed a security agreement to secure the payment of the balance of the purchase price. On March 10, Green picked up the car. On March 15, Easy filed the security agreement. On what date did Easy‘s security interest attach? a.

March 1

b.

March 5

c.

March 10

d.

March 15

(c) Attachment occurs when (1) value is given by the secured party, (2) the debtor attains rights in the collateral, and (3) the debtor and creditor acknowledge the creation of a security interest by a signed security agreement or by collateral in the possession of the secured party. In this situation, attachment occurred on March 10 because the following occurred on or before that date: (1) Easy picked up the car, (2) the car had been identified to the contract, therefore Green had a right in the property, and (3) Green signed a security agreement. Therefore, answers (a), (c), and (d) are incorrect.

2.

Carr Corp. sells VCRs and videotapes to the public. Carr sold and delivered a VCR to Sutter on credit. Sutter executed and delivered to Carr a promissory note for the purchase price and a security agreement covering the VCR. Sutter purchased the VCR for personal use.

Carr did not file a financing statement. Is Carr‘s security interest perfected? a.

No, because the VCR was a consumer good.

b.

No, because Carr failed to file a financing statement.

c.

Yes, because Carr retained ownership of the VCR.

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d.

Yes, because it was perfected at the time of attachment.

(d) Carr has an automatic PMSI in consumer goods that does not require filing a financing statement for perfection.

3.

On July 8, Ace, a refrigerator wholesaler, purchased 50 refrigerators. This comprised Ace‘s entire inventory and was financed under an agreement with Rome Bank that gave Rome a security interest in all refrigerators on Ace‘s premises, all future-acquired refrigerators, and the proceeds of sales. On July 12, Rome filed a financing statement that adequately identified the collateral. On August 15, Ace sold one refrigerator to Cray for personal use and four refrigerators to Zone Co. for its business. Which of the following statements is correct? a.

The refrigerators sold to Zone will be subject to Rome‘s security interest.

b.

The refrigerators sold to Zone will not be subject to Rome’s security interest.

c.

The security interest does not include the proceeds from the sale of the refrigerators to Zone.

d.

The security interest may not cover after-acquired property even if the parties agree.

(b) Under UCC 9-307, a buyer in the ordinary course of business takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence. Neither Cray nor Zone is subject to the security interest; therefore, answer (a) is incorrect. Answer (d) is incorrect because a security agreement may provide that any or all obligations covered by the agreement are to be additionally secured by property later acquired by the debtor.

Answer (c) is incorrect because unless otherwise provided in the security agreement, the secured party has a continuously perfected security interest in the proceeds that result from the debtor‘s sale or transfer of the collateral.

4.

Fogel purchased a television set for $900 from Hamilton Appliance. Hamilton took a promissory note signed by Fogel and a security interest for the $800 balance due on the set. It was Hamilton‘s policy not to file a financing statement until the purchaser defaulted.

Fogel obtained a loan of $500 from Reliable Finance, which took and recorded a security interest in the set. A month later, Fogel defaulted on several loans and one of his creditors, Harp, obtained a judgment against Fogel, which was properly recorded. After making several payments, Fogel defaulted on a payment due to Hamilton, who then recorded a financing statement subsequent to Reliable‘s filing and the entry of the Harp judgment.

Subsequently, at a garage sale, Fogel sold the set for $300 to Mobray. Which of the parties has the priority claim to the set?

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Solution and Answer Guide:

a.

Reliable

b.

Hamilton

c.

Harp

d.

Mobray

(b) Hamilton took a purchase money security interest in the TV set which would be considered consumer goods in Fogel‘s possession. Consequently, Hamilton‘s security interest was perfected automatically upon attachment. Therefore, Hamilton can defeat Reliable because Hamilton‘s security interest was perfected prior to the time Reliable perfected its security interest by filing. Hamilton can also defeat Harp because Harp‘s judgment was subsequent to Hamilton‘s perfection. Normally Mobray, as a good faith purchaser for personal use, would defeat a prior perfected secured party who gained his/her perfection through automatic perfection by attachment. However, Hamilton engaged in a second method of perfection (filing a financing statement) prior to the sale of the TV set to Mobray, allowing Hamilton to defeat the good faith purchaser for personal use. Therefore, answers (a), (c), and (d) are incorrect.

5.

Under the Secured Transactions Article of the UCC, which of the following items can usually be excluded from a filed original financing statement? a.

The name of the debtor.

b.

The address of the debtor.

c.

A description of the collateral.

d.

The amount of the obligation secured.

(d) UCC requires the first three but the amount is not necessary for privacy reasons.

6.

Under the Secured Transactions Article of the UCC, which of the following security agreements does not need to be in writing to be enforceable? a.

A security agreement collateralizing a debt of less than $500.

b.

A security agreement where the collateral is highly perishable or subject to wide price fluctuations.

c.

A security agreement where the collateral is in the possession of the secured party.

d.

A security agreement involving a purchase money security interest.

(c) Possession is nine points of the law and it also gives a creditor a secured interest.

Answer (a) is incorrect because the $500 issue applies to contracts for the sale of

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goods and is not part of article 9. All goods need a security agreement, regardless of cost if the creditor is to have collateral. Answer (b) is incorrect because the nature of the goods does not control whether there is a valid security interest—what controls is proper creation of the security interest. Answer (d) is incorrect because PMSI, like all security agreements, must be in writing to be valid. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 32: Bankruptcy

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 302 Questions and Case Problems .......................................................................................................... 302 End of Chapter: CPA Questions and Answers ................................................................................. 311 Answers to AICPA Questions ............................................................................................................ 313

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Hall-Mark regularly supplied electronic parts to Peter Lee. On September 11, 1992, Lee gave Hall- Mark a $100,000 check for parts it had received. Hall-Mark continued to ship parts to Lee. On September 23, 1992, Lee‘s check was dishonored by the bank. On September 25, 1992, Lee delivered to Hall-Mark a cashier‘s check for $100,000. Hall- Mark shipped nothing more to Lee after receipt of the cashier‘s check. On December 24, 1992, Lee filed a voluntary petition for bankruptcy. The trustee filed a complaint to have the $100,000 payment to Hall-Mark set aside as a voidable preference. Hall- Mark said it was entitled to the payment because it gave value to Lee. The trustee said that the payment was not actually made until the cashier‘s check was delivered on September 25, 1992, and that Hall- Mark gave no further value to Lee after that check was paid. Who was correct?

[In re Lee, 108 F.3d 239 (9th Cir.)] Answer: Voidable preference. The court held that a transfer by an ordinary check takes place not on the day the check is delivered but on the day it is honored by the bank. The

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personal check, delivered more than 90 days prior to the filing for bankruptcy, was never honored. The cashier‘s check was the transfer, and for Hall-Mark to be entitled to keep it, it had to give new value after it received the cashier‘s check, and it did not because no new shipments were made. The transfer of $100,000 to Hall-Mark was set aside as a voidable preference. [In re Lee, 108 F. 3d 239 (9th Cir.)] 2.

Orso, who had declared bankruptcy, received a structured tort settlement in a personal injury claim he had pending. The settlement would pay him an annuity each year for 30 years because the claim was the result of an auto accident that left him permanently and severely brain damaged with an IQ of about 70. His ex-wife had a pending claim for $48,000 in arrearages on Orso’s $1,000 per month child support payments. His ex-wife wanted the annuity included in the bankruptcy estate. Would this property have been included in Orso’s bankruptcy estate? [In re Orso, 214 F.3d 637 (5th Cir.)] Answer: Bankruptcy estate. Orso‘s payments are non-exempt. Under the terms of the settlement agreements, Orso received regular installments from annuities funded by the debtors. Orso had no control over the annuities, but he was guaranteed to receive monthly payments for at least 30 years, and he retained rights against the tortfeasors if the annuities failed. Such ―installment payments of a debt . . . do not constitute an annuity‖ and are not exempt from property of Orso‘s bankruptcy estate. We reverse and remand with instructions to include the annuities in Orso‘s estate. [In re Orso, 214 F. 3d 637 (5th Cir.)]

3.

Harold McClellan sold ice-making machinery to Bobbie Cantrell‘s brother for $200,000 to be paid in installment payments. McClellan took a security interest in the ice machine but did not perfect it by filing a financing statement. The brother defaulted when he owed $100,000, and McClellan brought suit. With the suit pending, the brother ―sold‖ the ice machine to Bobbie Cantrell for $10. Bobbie then sold the machine to someone for $160,000 and refused to explain what happened to that money. McClellan added Bobbie as a defendant in his suit against her brother. Bobbie then declared bankruptcy. McClellan sought to have the various transfers set aside. The trial court refused to do so, and McClellan appealed. Should the transfers be set aside? Why or why not? [McClellan v.

Cantrell, 217 F.3d 890 (7th Cir.)] Answer: Voidable preferences. There was no voidable preference. Bobbie sold the machine at a time when she was solvent. Her brother sold it to her when he was solvent and had never declared bankruptcy. Although the circumstances may affect Bobbie‘s ability to obtain a discharge, that rule does not require that the transfer of the ice machine be set

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aside. [McClellan v. Cantrell, 217 F. 3d 890 (7th Cir.)] 4.

Okamoto owed money to Hornblower & Weeks- Hemphill, Noyes (a law firm and hereafter Hornblower). Hornblower filed an involuntary bankruptcy petition against Okamoto, who moved to dismiss the petition on the ground that he had more than 12 creditors and the petition could not be filed by only 1 creditor. Hornblower replied that the other creditors‘ claims were too small to count and, therefore, the petition could be filed by one creditor. Decide. [In re Okamoto, 491 F.2d 496 (9th Cir.)] Answer: Procedure for involuntary bankruptcy. The petition could not be filed by only one creditor. Three creditors would be required with an aggregate amount of $16,750 in unsecured debt in order to file a petition. [In re Okamoto, 491 F. 2d 496 (9th Cir.)]

5.

Jane Leeves declared voluntary Chapter 7 bankruptcy. The trustee included the following property in her bankruptcy estate: 

Jane‘s wedding ring



Jane‘s computer for her consulting business that she operated from her home •



Jane‘s car payment from a client in the amount of $5,000 that was received 91 days after Jane filed bankruptcy

After collecting all of Jane‘s assets, the bankruptcy trustee was trying to decide how to distribute the assets. Jane had the following creditors: Mortgage company—owed $187,000 (the trustee sold Jane‘s house for $190,000) 

Expenses of the bankruptcy—$3,000



Federal income taxes—$11,000



Utility bills—$1,000



Office supply store open account—$1,000

The trustee had $11,500 in cash, including the $3,000 additional cash left from the sale of the house after the mortgage company was paid. How should the trustee distribute this money? What if the amount were $14,500; how should that be distributed?

Answer: Priorities. 

Jane‘s mortgage company is owed $187,000. The trustee sold Jane‘s house for $190,000.



Expenses of the bankruptcy—$3,000



Federal income taxes of $11,000



Utility bills of $1,000

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

Office supply store open account owed—$1,000

The trustee has $11,500 in cash, including the $3,000 from the sale of the house. The mortgage company has been paid. The first payment goes to the expenses of the bankruptcy of $3,000, leaving $8,500. The next priority is taxes and the full $8,500 will go to pay the taxes with the utilities and office supply stores receiving nothing.

If the amount were $14,500: $3,000 administration, leaving $11,500; then $11,000 to taxes, leaving $500. The two unsecured creditors enjoy a prorated amount of 50% so each would receive $250.

6.

Kentile sold goods over an extended period of time to Winham. The credit relationship began without Winham‘s being required to furnish a financial statement. After a time, payments were not made regularly, and Kentile requested a financial statement. Winham submitted a statement for the year just ended. Kentile requested a second statement. The second statement was false. Kentile objected to Winham‘s discharge in bankruptcy because of the false financial statement. Should the discharge be granted? Why or why not?

Answer: Effect of discharge. Yes. The false financial statement did not bar the discharge in bankruptcy because the creditor had not relied on it before extending the initial credit to the debtor.

7.

Department of Health & Human Services so that he could complete his education as an osteopathic physician. He works at the International Academy of Life (IAL) in Orem, Utah, for no salary but receives gifts from IAL that total $150,000 per year, or about $12,787 per month. He pays no taxes on these ―gifts‖ and has received them since 2005. Dr. Von Kiel pays all but $1,000 to his ex-wife and nine children for their support. He has given up his practice, taken a vow of poverty, and works at IAL to concentrate on alternative medicine.

He has signed over full authority for the management of his financial affairs to two individuals, who apparently failed to manage wisely. As a result, Dr. Von Kiel filed for bankruptcy in order to be discharged from his HHS loans. HHS says that Dr. Von Kiel should not be discharged because of bad faith. Who is correct and why? [In re Von Kiel, 461 B.R. 323 (E.D. Pa.)] Answer: Discharge. The court refused to grant a discharge because of Dr. Von Kiels‘ deception and evasion, noting:

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For ten years before filing his bankruptcy case, Debtor has been evading taxes and shielding his assets and income from creditors. Under the label of a ministry, Debtor has avoided and evaded his obligation to report his income and file tax returns. He has also kept his assets and income beyond the reach of his creditors, including the United States, to which is owed significant unpaid student loans and probable unpaid taxes. Electing a shield of poverty and maintaining some separation from his family, Debtor exercised complete control over substantial amounts of money by using tax identification numbers that were not his, opening bank accounts (that he controlled) in the names of different entities, and funneling income through a nominally religious entity—all to defraud tax authorities and frustrate his creditors.

The United States Trustee (―UST‖) established at trial that Debtor is not an honest and unfortunate debtor deserving the fresh start afforded by the Bankruptcy Code. I will grant the request of the UST to deny Debtor's discharge in this Chapter 7 case.

This Memorandum Opinion constitutes my findings of facts, my conclusions of law, and my discussion about Plaintiff's adversary proceeding seeking to have Debtor's discharge denied. I find for the Plaintiff/UST and against the Defendant/Debtor. [In re Von Kiel, 461 B.R. 323 (E.D. Pa. 2012)] 8.

Sonia, a retailer, has the following assets: a factory worth $1 million; accounts receivable amounting to $750,000, which fall due in four to six months; and $20,000 cash in the bank.

Sonia‘s sole liability is a $200,000 note falling due today, which she is unable to pay. Can Sonia be forced into involuntary bankruptcy under the Bankruptcy Code? [In re 35th & Morgan Development Corp., 510 B.R. 832 (N.D. Ill.)] Answer: Requirements for involuntary case. Probably Sonia could not be forced into bankruptcy. The courts have ruled that there were two exceptions to this general rule: (1) An order for relief should be granted in the exceptional case of an alleged debtor with a sole creditor who would otherwise be without an adequate remedy under nonbankruptcy law.

(2) If the petitioning creditor makes a showing of special circumstances amounting to fraud, trick, artifice, or scam, an order for relief should be granted.

However, neither of these exceptions is present in the problem. Under the reforms, case is even more solid. [In re 35th & Morgan Development Corp., 510 B.R. 832 (N.D. Ill.)]

9.

Samson Industries ceased doing business and is in bankruptcy proceedings. Among the

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creditors are five employees seeking unpaid wages. Three of the employees are owed $3,500 each, and two are owed $1,500 each. These amounts became due within 90 days preceding the filing of the petition. Where, in the priority of claims, will the employees‘ wage claims fall?

Answer: Priority of claims. The five employees are unsecured creditors and as such will share in the assets of the debtor remaining after the secured creditors‘ claims are satisfied.

However, claims for wages earned within 180 days of filing the petition have rather high priority among unsecured claims, coming only after costs of administering the bankruptcy case and those debts which were incurred after filing, but before appointment of a trustee.

The amount for wage claims is limited to $13,650 per person.

10. Carol Cott, doing business as Carol Cott Fashions, is worried about an involuntary bankruptcy proceeding being filed by her creditors. Her net worth, using a balance sheet approach, is $8,000 ($108,000 in assets minus $100,000 in liabilities). However, her cash flow is negative, and she has been hard pressed to meet current obligations as they mature. She is in fact some $17,000 in arrears in payments to her creditors on bills submitted during the past two months. Will the fact that Cott is solvent in the balance sheet sense result in the court‘s dismissing the creditors‘ petition if Cott objects to the petition? Explain. [Forever Green Athletic Fields, Inc. v. Dawson, 514 B.R. 768 (E.D. Pa.)] Answer: Grounds for relief for involuntary case. No. In an involuntary proceeding, all the creditors need to show is that the debtor is not paying debts as they mature. The balance sheet test is not required. [Forever Green Athletic Fields, Inc. v. Dawson, 514 B.R. 768 (E.D. Pa.)] 11. Kimberly and Timothy Resler purchased a 2015 Lexus on December 29, 2014, from Peterson, an auto dealership in Boise, Idaho. They wanted to take title jointly with their company, Total Maintenance Solutions, LLC (TMS). They signed all of the paperwork for the contract, the loan, and the title that day. The financing arrangement was through Bank of America. When Bank of America received the paperwork, there were problems with the signatures because Mr. Resler needed to sign for himself as well as for TMC and as a guarantor for TMC. The signature issues were finally resolved, and on January 30, 2015, Bank of America sent in the paperwork to the Department of Motor Vehicles in order to record its lien and have a title, that reflected it as a lien holder, issued. The lien was recorded on February 9, 2015, and the title was issued on February 17, 2015.

The Reslers filed for bankruptcy on April 16, 2015, and the trustee sought to set aside the

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Bank of America lien as a voidable preference. Bank of America claimed that it was a perfected creditor and it was for a contemporaneous transaction. The trustee claimed the Bank of America was not a perfected creditor at the time of the sale and the grant of the security interest was within 90 days of the declaration of bankruptcy and had to be set aside as voidable. What should the court decide and why? [In re Resler, 551 B.R. 835 (D. Idaho 2016)] Answer: Voidable preference. The court held that the lien is not perfected in an auto until it is with the DMV or until the title is registered, but no matter which date you take, Bank of America did not make it to perfection within the 30 days permitted under the bankruptcy statute so Bank of America was not perfected outside the 90 days of voidable preference measuring so Bank of America was not a secured creditor. It does not get priority status in the bankruptcy, which means it has to stand in line with other unsecured creditors. The Lexus will be sold, and Bank of America may get nothing. [In re Resler, 551 B.R. 835 (D. Idaho 2016)] 12. Steven and Teresa Hornsby are married and have three young children. On May 25, 1993, the Hornsbys filed a voluntary Chapter 7 petition. They had by that date accumulated more than $30,000 in debt, stemming almost entirely from student loans. They wanted a discharge of their student loans on grounds of undue hardship. The Hornsbys attended a succession of small Tennessee state colleges. Both studied business and computers, but neither graduated. Although they received several deferments and forbearances on the loans, they ultimately defaulted before making any payments. Interest had accumulated on the loans to the extent that Steven was indebted to the Tennessee Student Assistance Corporation (TSAC) for $15,058.52, and Teresa was indebted to TSAC for $18,329.15.

Steven was working for AT&T in Dallas, Texas; he made $6.53 per hour, occasionally working limited overtime hours. Teresa was employed by KinderCare Learning Center.

Although she had begun work in Tennessee, she had transferred to become the director of a child care facility in Dallas. Teresa was earning $17,500 per year with medical benefits at the time of the hearing. In monthly net income, Steven earned approximately $1,083.33, and Teresa earned $1,473.33, amounting to $2,556.66 of disposable income per month.

The Hornsbys‘ reported monthly expenses came to $2,364.90. They operated with a monthly surplus of $191.76 to $280.43, depending on whether Steven earned overtime for a particular month. Under the federal bankruptcy laws, are the Hornsbys entitled to a discharge on their student loans? Explain your answer. [In re Hornsby, 144 F.3d 433 (6th Cir.)]

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Answer: Student loan discharge. The bankruptcy court therefore concluded that the Hornsbys could not pay their loans and maintain a minimal standard of living and discharged the student loan debt totaling $33,387.67. The district court affirmed but found that the bankruptcy court had impermissibly shifted the burden to TSAC in analyzing the Hornsbys‘ future prospects. Following a new hearing on future earnings prospects, the district court affirmed the bankruptcy court‘s findings. The district court‘s decision affirming the order of the bankruptcy court was reversed and the case remanded.

A bankruptcy court can consider the amount of the debt, the rate at which interest is accruing, the debtor‘s claimed expenses and current standard of living, and whether the debtor has attempted to minimize expenses. The Hornsbys do have financial circumstances that qualify for some relief but not for a complete discharge. [In re Hornsby, 144 F. 3d 433 (6th Cir.)] 13. TLC was an Atlanta rhythm, blues, and hiphop band that performed at clubs in 1991. The three-woman group signed a recording contract with LaFace Records. The group‘s first album that LaFace produced, Ooooooohhh on the TLC Tip, sold almost 3 million albums in 1992. The group‘s second album, Crazysexycool, also produced by LaFace, sold 5 million albums through June 1996. The two albums together had six top-of-the-chart singles.

LaFace had the right to renew TLC‘s contract in 1996 following renegotiation of the contract terms. In the industry, royalty rates for unknown groups, as TLC was in 1991, are generally 7 percent of the revenues for the first 500,000 albums and 8 percent for sales on platinum albums (albums that sell over 1 million copies). The royalty rate increases to 9.5 percent for all sales on an eighth album. Established artists in the industry who renegotiate often have royalty rates of 13 percent, and artists with two platinum albums can command an even higher royalty.

The three women in TLC—Tionne Watkins (T-Boz), Lisa Lopes (Left-Eye, who has since died), and Rozonda Thomas (Chili)—declared bankruptcy in July 1995. All three listed debts that exceeded their assets, which included sums owed to creditors for their cars and to Zale‘s and The Limited for credit purchases. Lopes was being sued by Lloyd‘s of London, which claimed she owed it $1.3 million it had paid on a policy held by her boyfriend on his home that was destroyed by fire. Lopes pleaded guilty to one count of arson in the destruction of the home but denied that she intended to destroy it. She was sentenced to five years probation and treatment at a halfway house.

Lopes asked that the Lloyd‘s claim be discharged in her bankruptcy. All three members of

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TLC asked that their contract with LaFace be discharged in bankruptcy because being bound to their old contract could impede their fresh financial starts.

Did the three women meet the standards for declaring bankruptcy? Evaluate whether Lopes‘s Lloyd‘s claim should be discharged. Determine whether the record contract should be discharged.

Answer: Nondischargeable debts. There were certain ethical constraints associated with the declaration of bankruptcy. At the time the bankruptcy rights were created, bankruptcy was viewed as a last resort, an act of desperation when all other remedies had failed.

However, without that moral constraint, the declaration of bankruptcy is quite easy and can be declared without a debtor being in desperate financial circumstances.

Because bankruptcy does accomplish a discharge of obligations, some debtors, particularly those in the recording industry, have begun to use bankruptcy as a means for being excused from their recording contracts in order to negotiate newer contracts with higher royalties and, hence, returns.

The musicians are using bankruptcy to avoid obligations they incurred for the purpose of paying extra to those companies that invested in them before they were successful and hence, unknown, thus requiring greater returns for higher risks.

14. Place the following in order for a bankruptcy proceeding: a.

Order of relief

b.

Collection of bankrupt‘s estate

c.

List of creditors

d.

Petition

e.

Evaluation of claims

f.

Voidable preferences

g.

Discharge

Answer: Administration of bankrupt’s estate. In the order for a bankruptcy proceeding: d—Petition a—Order of relief c—List of creditors b—Collection of bankrupt‘s estate e—Evaluation of claims

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f—Voidable preferences g—Discharge 15. Three general unsecured creditors are owed $45,000 as follows: A, $15,000; B, $5,000; and C, $25,000. After all other creditors were paid, the amount left for distribution to general unsecured creditors was $9,000. How will the $9,000 be distributed?

Answer: Unsecured creditors. A + B + C = $45,000 A = $15,000 = 1/3 x $9,000 or $3,000 $45,000 B = $ 5,000 = 1/9 x $9,000 or $1,000 $45,000 C=

$25,000 = 5/9 x $9,000 or $5,000

$45,000 [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Which of the following statements is correct concerning the voluntary filing of a petition of bankruptcy? a.

If the debtor has 12 or more creditors, the unsecured claims must total at least $16,750.

b.

The debtor must be solvent.

c.

If the debtor has less than 12 creditors, the unsecured claims must total at least $116,750.

d.

2.

The petition may be filed jointly by spouses (AICPA adapted).

On February 28, Master, Inc., had total assets with a fair market value of $1,200,000 and total liabilities of $990,000. On January 15, Master made a monthly installment note payment to Acme Distributors Corp., a creditor holding a properly perfected security interest in equipment having a fair market value greater than the balance due on the note.

On March 15, Master voluntarily filed a petition in bankruptcy under the liquidation

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Solution and Answer Guide:

provisions of Chapter 7 of the federal Bankruptcy Code. One year later, the equipment was sold for less than the balance due on the note to Acme. If a creditor challenged Master‘s right to file, the petition would be dismissed: a.

If Master had less than 12 creditors at the time of filing.

b.

Unless Master can show that a reorganization under Chapter 11 of the federal Bankruptcy Code would have been unsuccessful.

c.

Unless Master can show that it is unable to pay its debts in the ordinary course of business or as they come due.

d. If Master is an insurance company.

3.

A voluntary petition filed under the liquidation provisions of Chapter 7 of the federal Bankruptcy Code: a. Is not available to a corporation unless it has previously filed a petition under the reorganization provisions of Chapter 11 of the federal Bankruptcy Code. b. Automatically stays collection actions against the debtor except by secured creditors for collateral only. c. Will be dismissed unless the debtor has 12 or more unsecured creditors whose claims total at least $16,750. d. Does not require the debtor to show that the debtor’s liabilities exceed the fair market value of assets.

4.

Which following conditions, if any, must a debtor meet to file a voluntary bankruptcy petition under Chapter 7 of the federal Bankruptcy Code?

Insolvency

Three or More Creditors

5.

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

On May 1, 1997, two months after becoming insolvent, Quick Corp., an appliance wholesaler, filed a voluntary petition for bankruptcy under the provisions of Chapter 7 of the federal Bankruptcy Code. On October 15, 1996, Quick‘s board of directors had authorized and paid Erly $50,000 to repay Erly‘s April 1, 1996, loan to the corporation. Erly is a sibling of Quick‘s president. On March 15, 1996, Quick paid Kray $100,000 for inventory delivered that day. Which of the following is not relevant in determining whether the repayment of Erly‘s loan is a voidable preferential transfer? a.

That Erly is an insider.

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b.

That Quick‘s payment to Erly was made on account of an antecedent debt.

c.

Quick’s solvency when the loan was made by Erly.

d.

That Quick‘s payment to Erly was made within one year of the filing of the bankruptcy petition.

[return to top] Answers to AICPA Questions 1.

Which of the following statements is correct concerning the voluntary filing of a petition of bankruptcy? a.

If the debtor has 12 or more creditors, the unsecured claims must total at least $16,750.

b.

The debtor must be solvent.

c.

If the debtor has less than 12 creditors, the unsecured claims must total at least $116,750.

d.

The petition may be filed jointly by spouses (AICPA adapted).

(d) Voluntary bankruptcy petition is a formal request by the debtor for an order of relief.

This voluntary bankruptcy petition may be filed jointly by a husband and a wife.

Answer (b) is incorrect because the debtor in a voluntary bankruptcy petition need not be insolvent but needs to state that s/he has debts. Answers (a) and (c) are incorrect because there is no requirement as to the minimum amount of the debtor‘s liabilities in a voluntary proceeding.

2.

On February 28, Master, Inc., had total assets with a fair market value of $1,200,000 and total liabilities of $990,000. On January 15, Master made a monthly installment note payment to Acme Distributors Corp., a creditor holding a properly perfected security interest in equipment having a fair market value greater than the balance due on the note.

On March 15, Master voluntarily filed a petition in bankruptcy under the liquidation provisions of Chapter 7 of the federal Bankruptcy Code. One year later, the equipment was sold for less than the balance due on the note to Acme. If a creditor challenged Master‘s right to file, the petition would be dismissed: a.

If Master had less than 12 creditors at the time of filing.

b.

Unless Master can show that a reorganization under Chapter 11 of the federal Bankruptcy Code would have been unsuccessful.

c.

Unless Master can show that it is unable to pay its debts in the ordinary course of business or as they come due.

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d. If Master is an insurance company. (d) Most debtors may file a voluntary bankruptcy petition. Among those that may not are insurance companies, banks, and saving and loan associations. Answer (a) is incorrect because the number of creditors is not relevant for a voluntary bankruptcy petition. Answer (b) is incorrect because there is no need to show that a Chapter 11 bankruptcy would have been unsuccessful. Answer (c) is incorrect because the inability of the debtor to pay its debts as they become due is not relevant to a voluntary bankruptcy—the test is simply that the petitioner has debts.

3.

A voluntary petition filed under the liquidation provisions of Chapter 7 of the federal Bankruptcy Code: a.

Is not available to a corporation unless it has previously filed a petition under the reorganization provisions of Chapter 11 of the federal Bankruptcy Code.

b.

Automatically stays collection actions against the debtor except by secured creditors for collateral only.

c.

Will be dismissed unless the debtor has 12 or more unsecured creditors whose claims total at least $16,750.

d.

Does not require the debtor to show that the debtor’s liabilities exceed the fair market value of assets.

(d) The answer is (d). The standard for declaring voluntary bankruptcy is only that the debtor have debts. Answer (a) is incorrect because Chapter 11 is not a prerequisite for a Chapter 7 filing. Answer (b) is incorrect because the automatic stay applies to all creditors. Answer (c) is incorrect because in a VOLUNTARY bankruptcy, the number of creditors is not an issue in declaration because the debtor himself or herself declares bankruptcy.

4.

Which following conditions, if any, must a debtor meet to file a voluntary bankruptcy petition under Chapter 7 of the federal Bankruptcy Code?

Insolvency

Three or More Creditors

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

(d) A debtor may file a voluntary bankruptcy petition without showing that s/he is

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insolvent. The debtor may merely state that s/he has debts. There is also no requirement as to the number of creditors needed. Therefore, answers (a), (b), and (c) are incorrect.

5.

On May 1, 1997, two months after becoming insolvent, Quick Corp., an appliance wholesaler, filed a voluntary petition for bankruptcy under the provisions of Chapter 7 of the federal Bankruptcy Code. On October 15, 1996, Quick‘s board of directors had authorized and paid Erly $50,000 to repay Erly‘s April 1, 1996, loan to the corporation. Erly is a sibling of Quick‘s president. On March 15, 1996, Quick paid Kray $100,000 for inventory delivered that day. Which of the following is not relevant in determining whether the repayment of Erly‘s loan is a voidable preferential transfer? a.

That Erly is an insider.

b.

That Quick‘s payment to Erly was made on account of an antecedent debt.

c.

Quick’s solvency when the loan was made by Erly.

d.

That Quick‘s payment to Erly was made within one year of the filing of the bankruptcy petition.

(c) The trustee in bankruptcy may set aside preferential transfers made within 90 days before the filing of the bankruptcy petition while the debtor is insolvent. The time is extended to the previous 12 months if the preferential transfer was made to an insider. In this question, Quick‘s solvency when the loan was made by Erly is not relevant because this loan was made 13 months before the filing of the petition for bankruptcy. Answer (a) is incorrect. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 33: Insurance

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 315 Questions and Case Problems .......................................................................................................... 316

Answers to the End-of-Chapter Questions

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Solution and Answer Guide:

Questions and Case Problems 1.

Mr. Keyes was injured on April 30, 2010, when he fell off Ms. Thibodeaux‘s roof. Mr. Keyes was cleaning and measuring the roof in preparation for painting when, unbeknownst to him, Ms. Thibodeaux sprayed a section of the metal roof with water. Mr. Keyes slipped on the wet roof and fell, seriously injuring himself. He filed the lawsuit under Ms. Thibodeaux‘s homeowners policy against Lighthouse Property Insurance. Mr. Keyes and Ms. Thibodeaux married in August of 2008 but physically separated four months into the marriage. Mr. Keyes and Ms. Thibodeaux have not divorced. Mr. Keyes testified that he lives in a home he owns with his grandmother and aunt. He stated that he lived in that house prior to marrying Ms. Thibodeaux and returned there after he was kicked out of her home 15 months prior to the accident. The homeowners policy precluded coverage for bodily injury to the named insured and relatives ―who are residents of the insured‘s household.‖ The definitions section of the policy states that the spouse of the name insured is treated as the named insured, if a resident of the same household. Lighthouse has refused coverage for Keyes under its reading of the policy. Keyes disagrees. Decide.

[Keyes v. Thibodeaux, 85 So. 3d 1284 (La. App.)] Answer: Homeowner’s policy. Judgment for Keyes. Since Keyes, although still Thibodeaux‘s spouse, was not residing in her household, the provision excluding from coverage bodily injury to insured and ―relatives who are residents of [insured‘s] household,‖ did not apply to him. [Keyes v. Thibodeaux, 85 So. 3d 1284 (La. App.)]

2.

Cecil Usher owned Belize NY, Inc. (Belize), a small construction company doing business in New York City. Belize purchased a commercial general liability insurance policy from Mount Vernon Fire Insurance Co. The policy‘s first page, entitled ―Policy Declarations,‖ describes the insured as ―Belize N.Y., Inc.‖; it classifies the ―Form of Business‖ as ―Corporation,‖ the ―Business Description‖ as ―Carpentry,‖ and indicates that Belize was afforded commercial liability insurance in the amount of $1,000,000 per occurrence and $2,000,000 in the aggregate for the period June 1, 1995, to June 1, 1996. Two classifications are listed under ―Premium Computation‖ on the Declarations page: ―Carpentry—Interior—001‖ and ―Carpentry—001.‖ The policy makes no further mention of these two terms. Belize performed some $60,000 of demolition work on the United House of Prayer‘s renovation project on 272 West 125th Street in New York City. Belize was thereafter hired to supervise subcontractors working on the job. During that period of time, a person entered the building, shot several people with a firearm, and started a fire.

Seven people died and several others were injured. The estates of the victims sued Belize, Inc., for ―negligence, carelessness and recklessness‖ regarding the fire, and Belize notified

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Solution and Answer Guide:

Mount Vernon of the lawsuit. Mount Vernon refused to defend or indemnify Belize because Belize was not engaging in its carpentry operations in the building at the time of the incident. It asserted that its risk is limited to carpentry operations in accordance with the classifications set forth in the policy. Belize contended that the language of the policy did not provide that the classification ―Carpentry‖ defined covered risks, and exclusions should have been stated in the contract. Decide. [Mount Vernon Fire Insurance Co. v. Belize NY, Inc., 227 F.3d 232 (2d Cir.)] Answer: Interpretations of insurance contracts. Judgment for Belize. Adoption of Mount Vernon‘s argument that its liability extended only to carpentry operations would allow insurance companies to limit the scope of coverage based merely on classifications contained in an insurance policy without alerting the insured to the limitation. Exclusions from coverage must be set forth clearly and unmistakably. The language of the policy did not provide that the classifications ―carpentry‖ defined covered risks. Thus, the insurer was not relieved of its obligation under the contract. [Mount Vernon Fire Insurance Co. v. Belize N.Y., Inc., 227 F. 3d 232 (2d Cir.)] 3.

Gerhard Schillers was assisting his friend J.L. Loethen in removing a transmission from the bed of the Loethens‘ truck on the Loethens‘ property. While Schillers was carrying the transmission down the driveway, he fell and was seriously injured. J.L. was insured under his parents‘ automobile insurance policy with Shelter Mutual Insurance Company, which insured for liability, including ―the loading and unloading‖ of the vehicle. Is Shelter Mutual liable to Schillers for the injury under its motor vehicle liability policy? Decide. [American Family Mutual Ins. Co. v. Shelter Mutual Ins. Co., 747 S.W.2d 174 (Mo. App.)] Answer: Automobile insurance coverage. Schiller‘s injuries were incidental to, and a consequence of, the unloading of the Loethens‘ pickup truck. The injuries would not have occurred if the men had not been unloading the truck. The unloading activity continued until the removed property was put in the place to which it was to be taken. Therefore, Schiller‘s injury was covered by the motor vehicle liability policy issued by Shelter Mutual.

[American Family Mutual Ins. Co. v. Shelter Mutual Ins. Co., 747 S.W. 2d 174 (Mo. App.)]

4.

From the United Insurance Co., Rebecca Foster obtained a policy insuring the life of Lucille McClurkin and naming herself as beneficiary. McClurkin did not live with Foster, and Foster did not inform McClurkin of the existence of the policy. Foster paid the premiums on the policy and upon the death of McClurkin sued the United Insurance Co. for the amount of the insurance. At the trial, Foster testified vaguely that her father had told her that McClurkin was her second cousin on his side of the family. Was Foster entitled to recover

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on the policy? [Foster v. United Ins. Co., 158 S.E.2d 201 (S.C.)] Answer: Insurable interest in life insurance. No. Foster had no insurable interest in the life of McClurkin, and therefore, the contract of insurance was void. Foster could not recover on the policy. [Foster v. United Ins. Co., 158 S.E. 2d 201 (S.C.)] Authors‘ Comment: When the policy is void for lack of insurable interest, the insurer is required to return the premiums that have been paid.

5.

Dr. George Allard and his brother-in-law, Tom Rowland, did not get along after family land that was once used solely by Rowland was partitioned among family members after the death of Rowland‘s father. Rowland had a reputation in the community as a bully and a violent person. On December 17, Allard was moving cattle down a dirt road by ―trolling‖ (leading the cattle with a bucket of feed, causing them to follow him). When he saw a forestry truck coming along the road, he led the cattle off the road onto Rowland‘s land to prevent frightening the cattle. When Rowland saw Allard, Rowland ran toward him screaming at him for being on his land. Allard, a small older man, retreated to his truck and obtained a 12-gauge shotgun. He pointed the gun toward the ground about an inch in front of Rowland‘s left foot and fired it. He stated that he fired the shot in this fashion to bring Rowland to his senses and that Rowland stepped forward into the line of fire. Allard claimed that if Rowland had not stepped forward, he would not have been hit and injured.

Allard was insured by Farm Bureau homeowners and general liability policies, which did not cover liability resulting from intentional acts by the insured. Applying the policy exclusion to the facts of this case, was Farm Bureau obligated to pay the $100,000 judgment against Allard? [Southern Farm Bureau Casualty Co. v. Allard, 611 So. 2d 966 (Miss.)]

Answer: Interpretation of homeowner’s policies. The shooting was covered by the policies because Allard did not intend to shoot or hit Rowland with the shotgun, but only to stop him or bring him to his senses by firing into the ground in front of him. Without the intent to injure Rowland, the policy exclusion on intentional acts did not apply. [Southern Farm Bureau Casualty Co. v. Allard, 611 So. 2d 966 (Miss.)]

Authors‘ Comment: The instructor may wish to pursue a discussion of whether Allard would have a right to pursue an action for bad-faith failure to pay the claim by the insured. The fact that Rowland was struck in the foot by a shotgun blast in a hostile setting is a reasonable basis for the insurer to contest the claim and to test with the aid of a jury whether Allard intended to shoot Rowland. A ―bad-faith failure to pay‖ action would not

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be successful.

6.

Arthur Katz testified for the U.S. government in a stock manipulation case. He also pled guilty and testified against three of his law partners in an insurance fraud case. He received a six-month sentence in a halfway house and a $5,000 fine. Katz was placed in the Federal Witness Protection Program. He and his wife changed their names to Kane and moved to Florida under the program. Both he and his wife obtained new driver‘s licenses and Social Security numbers. Using his new identity, ―Kane‖ obtained two life insurance policies totaling $1.5 million. He named his wife beneficiary. A routine criminal background check on Kane found no criminal history.

From 1984 to 1987, Kane invested heavily in the stock market. On October 17, 1987, the day the stock market crashed, Kane shot and wounded his stockbroker, shot and killed the office manager, and then committed suicide. The insurers refused to pay on the policies, claiming that they never insure persons with criminal records. Mrs. Kane contended that the policies were incontestable after they had been in effect for two years. Decide.

[Bankers Security Life Ins. Society v. Kane, 885 F.2d 820 (11th Cir.)] Answer: Life insurance, incontestability clause. The insurer was liable. Incontestability clauses are strictly construed. Where the statute says that life insurance policies are incontestable after they are in effect after two years, and no exceptions are stated, then the court must apply the statute as written. Kane‘s policies were in effect for over two years and are incontestable. [Bankers Security Life Ins. Society v. Kane, 885 F. 2d 820 (11th Cir.)]

7.

Linda Filasky held policies issued by Preferred Risk Mutual Insurance Co. Following an injury in an automobile accident and storm damage to the roof of her home, Filasky sustained loss of income, theft of property, and water damage to her home. These three kinds of losses were covered by the policies with Preferred, but the insurer delayed unreasonably in processing her claims and raised numerous groundless objections to them. Finally, the insurer paid the claims in full. Filasky then sued the insurer for the emotional distress caused by the bad-faith delay and obstructive tactics of the insurer. The insurer defended that it had paid the claims in full and that nothing was owed Filasky.

Decide. [Filasky v. Preferred Risk Mut. Ins. Co., 734 P.2d 76 (Ariz.)]

Answer: Insurer bad faith. Judgment for Filasky. Filasky‘s claims were within the coverage of the policies issued by the insurer. The insurer could establish no justification for its delay or for its raising objections of no merit. The insurer was therefore guilty of a breach

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of its duty to perform its contract in good faith. Thus, it was liable to Filasky for the emotional distress caused to her by its conduct. [Filasky v. Preferred Risk Mut. Ins. Co., 734 P. 2d 76 (Ariz.)]

8.

Baurer purchased a White Freightliner tractor and agreed that his son-in-law, Britton, could use it in the trucking business. In return, Britton agreed to haul Baurer‘s hay and cattle, thus saving Baurer approximately $30,000 per year. Baurer insured the vehicle with Mountain West Farm Bureau Insurance Company. The policy contained an exclusionary clause that provided: ―We don‘t insure your [truck] while it is rented or leased to others.…

This does not apply to the use of your [truck] on a share expense basis.‖ When the vehicle was destroyed, Mountain West refused to pay on the policy, contending that the arrangement between Baurer and Britton was a lease of the vehicle, which was excluded under the policy. Baurer sued, contending that it was a ―share expense basis‖ allowed under the policy. Is the insurance policy ambiguous? What rule of contract construction applies in this case? Decide. [Baurer v. Mountain West Farm Bureau Ins., 695 P.2d 1307 (Mont.)]

Answer: Interpretation of insurance contracts. The policy is ambiguous. The insurance company argues that the truck was not insured "while it is rented or leased to others". The clause further provided that the exclusion did not apply to use of the truck in "a share expense basis," which Baurer relied on. Deciding for Baurer the court determined that the truck was covered by the policy because the relationship between the parties could be construed as being either a renting out of the truck or a cooperative use of the truck on a share expense basis. Ambiguous language in an insurance policy is construed in a way that is most favorable to the insured. This rule of interpretation particularly applies to exclusionary clauses. Such a construction of the language in this case would result in the conclusion that the tractor was destroyed while used on a share expense basis. [Baurer v.

Mountain West Farm Bureau Ins., 695 P. 2d 1307 (Mont.)]

9.

American Tooling Center (ATC) is a tool and die manufacturer in Michigan. It also utilizes Chinese sources, who bill ATC for their work. In March, ATC received an email invoice purportedly from one of its Chinese vendors for payment, giving direction to send payment to a different account than usual. ATC transferred some $834,000 in a series of wires tied to subsequent invoices before it realized it was the victim of an imposter. ATC sought recovery from its Travelers business insurance policy computer fraud provision which stated: ―The company will pay the insured for the insured‘s direct loss of… money… directly caused by computer fraud.‖ Travelers denied the claim stating that the loss was not ―direct‖ like hacking or criminal manipulation of a computer‘s control or data and that

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the loss did not arise until ATC discovered the fraud and agreed to pay its Chinese vendor.

Decide. [American Tooling Center v. Travelers Casualty and Surety of America, 2018 WL 3639951 (6th Cir. 2018)] Answer: Contract interpretation. The court agreed with ATC that it suffered a direct loss when its funds left its bank account and were wired to the imposter. And the court countered Travelers contention that it was not ―computer fraud,‖ pointing out that ATC received fraudulent e-mails which led to the transfer of money to the imposter. [American Tooling Center v. Travelers Casualty and Surety of America, 2018 WL 3639951 (6th Cir. 2018)] 10. Marshall Produce Co. had insured its milk-and egg-processing plant against fire. When smoke from a fire near its plant permeated the environment and was absorbed into the company‘s egg powder products, cans of powder delivered to the U.S. government were rejected as contaminated. Marshall Produce sued the insurance company for a total loss, but the insurer contended that there had been no fire involving the insured property and no total loss. Decide. [Marshall Produce Co. v. St. Paul Fire & Marine Ins. Co., 98 N.W.2d 280 (Minn.)]

Answer: Fire coverage without burning of insured property; definition of total loss.

Judgment for Marshall Produce Company. Marshall‘s fire insurance policy covered the damage done to its property by smoke from a remote fire. Fire insurance does not require that the object insured be burnt. There was a total loss of the canned egg powder because it was not fit for use as such. The fact that the cans of egg powder still existed did not mean that a total loss had not occurred. [Marshall Produce Co. v. St. Paul Fire & Marine Ins. Co., 98 N.W. 2d 280 (Minn.)]

11. Amador Pena, who had three insurance policies on his life, wrote a will in which he specified that the proceeds from the insurance policies should go to his children instead of to Leticia Pena Salinas and other beneficiaries named in the policies. He died the day after writing the will. The insurance companies paid the proceeds of the policies to the named beneficiaries. The executor of Pena‘s estate sued Salinas and the other beneficiaries for the insurance money. Decide. [Pena v. Salinas, 536 S.W.2d 671 (Tex. App.)] Answer: Change of beneficiary. Decision for Leticia Salinas and the other beneficiaries named in the policies. The test for determining whether the requirements of a life insurance policy to change the beneficiary have been met is not strict compliance, but substantial compliance. In essence, this means that the policy defines the method by

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which the insured may change the beneficiary and that the insured must substantially comply with that method in order to change the beneficiary. Mr. Pena made no effort in accordance with the means set forth in the policy to change the names of the beneficiaries, and as such, the test of substantial compliance was not met. [Pena v. Salinas, 536 S.W. 2d 671 (Tex. App.)] 12. Spector owned a small automobile repair garage in rural Kansas that was valued at $80,000. He purchased fire insurance coverage against loss to the extent of $48,000. The policy contained an 80 percent coinsurance clause. A fire destroyed a portion of his parts room, causing a loss of $32,000. Spector believes he is entitled to be fully compensated for this loss, as it is less than the $48,000 of fire protection that he purchased and paid for. Is Spector correct?

Answer: Insurer‘s liability, coinsurance. No. Spector is incorrect. Spector will receive $12,000 because the amount of insurance carried ($24,000) is only three-fourths of the amount required ($32,000; that is, 80 percent of $40,000).

13. Carman Tool & Abrasives, Inc., purchased two milling machines, FOB Taiwan, from the Dah Lih Machinery Co. Carman obtained ocean marine cargo insurance on the machines from St. Paul Fire and Marine Insurance Co. and authorized Dah Lih to arrange for the shipment of the two machines to Los Angeles, using the services of Evergreen Lines. Dah Lih booked the machinery for shipment onboard Evergreen‘s container ship, the M/V Ever Giant; arranged for the delivery of the cargo to the ship; provided all of the shipping information for the bill of lading; and was the party to whom the bill was issued. Dah Lih then delivered the bill of lading to its bank, which in turn negotiated it to Carman‘s bank to authorize payment to Dah Lih. After the cargo was removed from the vessel in Los Angeles but before it was delivered to Carman, the milling machines were damaged to the extent of $115,000. Is the insurer liable to Carman? Can the insurer recover from Evergreen?

[Carman Tool & Abrasives, Inc. v. Evergreen Lines, 871 F.2d 897 (9th Cir.)] Answer: Marine insurance; subrogation. This case presents a common shipping transaction following the purchase of heavy industrial machinery in a foreign market. Cargo marine insurance protects the cargo owner, Carman Co. Because the machines were damaged prior to delivery to Carman, the insurer was obligated to pay the insured for the losses in question. The insurer has subrogation rights against the Evergreen Lines for the damage to the goods. [Carman Tool & Abrasives, Inc. v. Evergreen Lines, 871 F. 2d 897 (9th Cir.)] Authors‘ Comment: For an international focus for an advanced class, it may be pointed out

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that containerization has revolutionized the international shipping business in many respects. Sellers may load a container at its factory, and it may then be hauled by a truck tractor to a rail ―intermodal‖ facility and there loaded onto a train. Thereafter, the container may be off-loaded onto a containerized ship for an overseas client. The legal aspects of the shipping of goods by sea are quite complicated. In addition to the law of marine insurance, elements of the law of admiralty, contract, sales of goods, the United Nations Convention on Contacts for the International Sale of Goods (CISG), bailments, letters of credit, and negotiable instruments may all be involved.

In international shipping, the Carriage of Goods by Sea Act of 1936 (COGSA) is of great significance. COGSA allows a carrier to limit its liability for loss or damage to cargo to $500 per package. Carriers have been unsuccessful in courts, arguing that the entire container is to be denominated as a single package. However, very large and expensive packages are often shipped by sea. The court in the Carman case limited the carrier‘s liability to $500 per package, even though the contents of each package greatly exceeded $500. A shipper or consignee should specifically state on the bill of lading the number of packages of goods inside the container to avoid a dispute on the matter of what is a package under the COGSA. 14. Vallot was driving his farm tractor on the highway. It was struck from the rear by a truck, overturned, exploded, and burned. Vallot was killed, and a death claim was made against All American Insurance Co. The death of Vallot was covered by the company‘s policy if Vallot had died from ―being struck or run over by‖ the truck. The insurance company claimed that the policy was not applicable because Vallot had not been struck, the farm tractor had been struck, and Vallot‘s death occurred when the overturned tractor exploded and burned. The insurance company also claimed that it was necessary that the insured be both struck and run over by another vehicle. Decide. [Vallot v. All American Ins. Co., 302 So. 2d 625 (La. App.)] Answer: Interpretation of insurance contracts. Judgment against the insurance company.

Vallot was struck by the truck, even though the actual contact was with the tractor in which he was riding. Words used in a policy are to be given their ordinary meaning. The policy did not limit coverage to the insured as a pedestrian. ―Struck‖ and ―run over‖ were stated as alternatives and not as synonymous terms in the policy. Therefore, it was sufficient to establish death caused either by being struck or by being run over; both were not required. [Vallot v. All American Ins. Co., 302 So. 2d 625 (La. App.)] 15. organic materials at its plant in Adrian, Michigan. The Environmental Protection Agency

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(EPA) sent ADC a formal notification that it was considered a ―potentially responsible party‖ (PRP) for the release of hazardous substances into the soil and groundwater. This notice was called a PRP letter. ADC notified its insurer Travelers of the letter, and Travelers contended that it was not prepared to defend or cover ADC in the matter. The EPA and ADC entered a consent decree wherein ADC agreed to the cleanup activities, spending more than $6 million on the cleanup. ADC brought an action against its insurer, seeking coverage under its general liability insurance policies for the cost of its defense and the cost of cleanup. Travelers responded that its policy language ―defend any suit‖ and ―damages‖ did not apply to this EPA action. Decide. [Anderson Development Co. v.

Travelers Indemnity Co., 49 F.3d 1128 (6th Cir.)] Answer: Business liability insurance: CGL policies. Judgment for ADC. The PRP letter issued by the EPA is the functional equivalent of a ―suit‖ brought in a court of law because the EPA‘s extensive authority to determine and apportion liability allows it to essentially usurp the traditional role of a court. Thus, Travelers had an obligation to defend the insured under the contractual terms used in the policy: ―defend any suit.‖ Travelers is also liable for ―damages‖ as that term is used in the insurance contract because state court decisions hold that EPA-mandated cleanup costs constitute damages. [Anderson Development Co. v.

Travelers Indemnity Co., 49 F. 3d 1128 (6th Cir.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 34: Agency

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 324 Questions and Case Problems .......................................................................................................... 324 End of Chapter: CPA Questions and Answers ................................................................................. 334 Answers to AICPA Questions ............................................................................................................ 335

Answers to the End-of-Chapter Questions Questions and Case Problems

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1.

How does an agent differ from an independent contractor?

Answer: Definition of agent; agent distinguished from others. An agent represents a principal or makes a contract on the principal‘s behalf and is under the control of the principal. The agent may be an independent or a free-lance agent or may be a full-time agent or an employee of the principal. The independent contractor makes a contract to produce a given result but is free from or independent of any control in the doing of the act called for by the contract. The fact that there are contract specifications to be followed or that an architect is checking to determine that the contractor complies with the specifications is not regarded as controlling the independent contractor.

The real estate broker is typically an independent contractor who is not under the control of the property owner or the buyer and merely undertakes to find a buyer or a seller, but does not enter into any contract obligating the broker to produce the buyer or the seller. The contract obligation of the real estate broker is only to use reasonable effort to procure a seller or buyer. As long as such effort is used, no breach of contract occurs if a buyer or seller is not produced.

Typically, the real estate broker does not have authority to make a contract that would bind the principal to the third person. Nothing prevents or bars the principal from giving the real estate broker authority.

2.

Compare authorization of an agent by (a) appointment and (b) ratification.

Answer: Creation of authority by appointment; ratification. The legal result of agency action is the same whether the agent acted initially with authority or whether the person‘s unauthorized action was thereafter ratified. By definition, the distinction exists that appointment is made before the agent acts, and ratification is made after the agent acts.

Both appointment and ratification require the same intent on the part of the principal, although there are situations in which ratification is found by acquiescence, in which the principal probably has no actual intent to ratify. To this extent, ratification is slightly broader than appointment.

Ratification is subject to five conditions discussed in § 39:9(b). Thus, the fact that the principal intended to ratify may not be sufficient. If any one of the five conditions is not satisfied, the ratification is not effective. This means that neither the principal nor the third person acquires rights against the other, although in some instances, an

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assignment or a delegation from the agent or a novation entered into by the parties will remedy the situation.

3.

Ernest A. Kotsch executed a durable power of attorney when he was 85 years old, giving his son, Ernie, the power to manage and sell his real estate and personal property ―and to do all acts necessary for maintaining and caring for [the father] during his lifetime.‖ Thereafter, Kotsch began ―keeping company‖ with a widow, Margaret Gradl. Ernie believed that the widow was attempting to alienate his father from him, and he observed that she was exerting a great deal of influence over his father. Acting under the durable power of attorney and without informing his father, Ernie created the ―Kotsch Family Irrevocable Trust,‖ to which he transferred $700,000, the bulk of his father‘s liquid assets, with the father as grantor and initial beneficiary and Ernie‘s three children as additional beneficiaries.

Ernie named himself trustee. His father sued to avoid the trust. Ernie defended his action on the ground that he had authority to create the trust under the durable power of attorney.

Decide. [Kotsch v. Kotsch, 608 So. 2d 879 (Fla. App.)] Answer: Extent of durable power of attorney. The expressed intent of the durable power of attorney was to provide for the father‘s maintenance and care. It did not authorize the son to create any other beneficial interests in the father‘s property. It did not authorize the son to make gifts of the father‘s property to the son‘s children. A power of attorney confers no authority to transfer the principal‘s property to the agent himself or herself. The trust is void. [Kotsch v. Kotsch, 608 So. 2d 879 (Fla. App.)] Authors‘ Comment: The son, believing Ms. Gradl exercised a great deal of influence over the father, perhaps anticipated that the father would terminate the durable power of attorney. Although the father was old, he was competent, and he had the right to terminate the durable power of attorney. By transferring the liquid assets to a trust that the father could not revoke, the son sought to avoid the prospect of losing control over these assets on the termination of the power of attorney.

4.

are two separate corporations located at the same business address in Boston. On August 22, Albert Arillotta, a ―partner‖ at IDEC, sent an e-mail to Len Whitehead, Jr., of CSX Transportation expressing an interest in buying ―rail cars as scrap.‖ Arillotta represented himself to be ―from interstate demolition and recovery express‖ in the e-mail. The e-mail address from which he sent his inquiry was ―albert@ recoveryexpress.com.‖ Arillotta went to the CSX rail yard, disassembled the cars and transported them away. Thereafter, CSX sent invoices for the scrap railcars totaling $115,757.36 addressed to IDEC at its Boston office shared with Recovery Express. Whitehead believed Arillotta was authorized to act for

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Recovery Express, based on the e-mail‘s domain name—recoveryexpress.com. Recovery claims that Arillotta never worked for it. Recovery‘s president Thomas Trafton allowed the ―fledgling‖ company to use telephone, fax, and e-mail services at its offices, but never shared anything with IDEC—assets, funds, books of business, or financials with IDEC. CSX sued Recovery for the invoice amount on the doctrine of ―apparent authority.‖ IDEC is now defunct. Recovery claims that Arillotta never worked for it, and it is not liable. [CSX Transportation, Inc. v. Recovery Express, Inc. 415 F.Supp.2d 6 (D. Mass.)]

Answer: Apparent authority. Judgment for Recovery. Issuance of an e-mail address with Recovery‘s domain name to an individual who shared office space with Recovery did not give the individual, Albert Arillotta, apparent authority to enter contracts on Recovery‘s behalf. No reasonable person could conclude that Arillotta had apparent authority on the basis of an e-mail domain name by itself. Given the anonymity of the Internet, the court warned businesses to take additional action to verify purported agent‘s authority to make a deal. [CSX Transportation, Inc. v. Recovery Express, Inc., 415 F.Supp.2d 6 (D. Mass.)]

5.

Paul Strich did business as an optician in Duluth, Minnesota. Paul used only the products of the Plymouth Optical Co., a national manufacturer of optical products and supplies with numerous retail outlets and some franchise arrangements in areas other than Duluth. To increase business, Paul renovated his office and changed the sign on it to read ―Plymouth Optical Co.‖ Paul did business this way for more than three years—advertised under that name, paid bills with checks bearing the name of Plymouth Optical Co., and listed himself in the telephone and city directories by that name. Plymouth immediately became aware of what Paul was doing. However, because Paul used only Plymouth products and Plymouth did not have a franchise in Duluth, it saw no advantage at that time in prohibiting Paul from using the name and losing him as a customer. Paul contracted with the Duluth Tribune for advertising, making the contract in the name of Plymouth Optical Co. When the advertising bill was not paid, the Duluth Tribune sued Plymouth Optical Co. for payment. Plymouth‘s defense was that it never authorized Paul to do business under the name, nor authorized him to make a contract with the newspaper. Decide.

Answer: Authorization by the principal‘s conduct as to third persons. Plymouth was liable.

Strich had apparent authority to make the contract in the name of Plymouth Optical Co. After having permitted Strich to do business in the manner described for three years, Plymouth was estopped from denying that Strich lacked authority to make the advertising contract on its behalf. [Duluth Herald and News Tribune v. Plymouth Optical Co., 286 Minn.

495, 176 N.W. 2d 552]

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6.

Record owned a farm that was managed by his agent, Berry, who lived on the farm. Berry hired Wagner to bale the hay and told him to bill Record for this work. Wagner did so and was paid by Record. By the summer of the following year, the agency had been terminated

by Record, but Berry remained in possession as tenant of the farm and nothing appeared changed. Late in the summer, Berry asked Wagner to bale the hay as he had done the previous year and bill Record for the work. He did so, but Record refused to pay on the ground that Berry was not then his agent. Wagner sued him. Decide. [Record v. Wagner, 128 A.2d 921 (N.H.)] Answer: Effect of termination of authority of the agent on third persons. Judgment for Wagner. Since the agency of Berry had been terminated by the voluntary act of the principal, it was necessary that notice of termination be given to third persons who had dealt with the agent. Since this had not been done, the agent continued to appear to have authority to bind the principal. He therefore could do so in spite of the actual termination of the authority. [Record v. Wagner, 128 A. 2d 921 (N.H.)]

7.

Gilbert Church owned Church Farms, Inc., in Manteno, Illinois. Church advertised its wellbred stallion Imperial Guard for breeding rights at $50,000, directing all inquiries to ―Herb Bagley, Manager.‖ Herb Bagley lived at Church Farms and was the only person available to visitors. Vern Lundberg answered the ad, and after discussions in which Bagley stated that Imperial Guard would remain in Illinois for at least a two-year period, Lundberg and Bagley executed a two-year breeding rights contract. The contract was signed by Lundberg and by Bagley as ―Church Farms, Inc., H. Bagley, Mgr.‖ When Gil Church moved Imperial Guard to Oklahoma prior to the second year of the contract, Lundberg brought suit for breach of contract. Church testified that Bagley had no authority to sign contracts for Church Farms. Decide. [Lundberg v. Church Farms, Inc., 502 N.E.2d 806 (Ill.)] Answer: Authorization by acquiescence. Vern Lundberg had no way of knowing the limitations on Herb Bagley‘s authority. To outsiders Bagley seemed to have full management authority. There would be a breach by the relocation. [Lundberg v. Church Farms, Inc., 502 N.E. 2d 806 (Ill.)]

8.

The Holzmans signed an exclusive listing agreement with the Blum real estate brokerage firm. The contract provided that the Holzmans had an obligation to pay a commission ―if they enter into a written agreement to sell the property to any person during the term of this exclusive listing agreement.‖ The Holzmans entered into a written agreement to sell their house for $715,000 to the Noravians. On the advice of their attorney, the Holzmans included a default provision in this contract stating that in the event of default by the

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Holzmans, the Noravians‘ only remedy would be a refund of their deposit. Subsequently, the Sterns offered $850,000 for the property and the Holzmans canceled their contract with the Noravians and returned their deposit. After the exclusive listing period expired, the Holzmans executed a contract to sell their property to the Sterns at the offered price of $850,000—with the contract calling for the Holzmans to pay half the real estate fee to Blum and half to a cooperating broker. Blum was paid this fee of $21,500. Blum brought suit against the Holzmans seeking the full commission for the Noravian contract under the exclusive listing agreement. Did Blum have a legal obligation or ethical duty to advise the Holzmans when considering the Sterns‘ offer that he believed they were obligated to him for the full commission under the Novarian contract? Decide. [Holzman v. Blum, 726 A.2d 818 (Md. App.)] Answer: Principal’s duties according to terms of the agency contract. Judgment for Blum for the full amount of the Noravian contract less the commission paid in the subsequent sale to the Sterns. Mr. Blum acknowledged that when the Holzmans decided to pursue the Sterns‘ offer, he did not advise them about their obligation to pay the full commission under the Noravian contract. Indeed, Mr. Blum, testified that he was ―advised by…[counsel] not to say anything to the Holzmans‖. However, the exclusive listing agreement clearly addressed the terms and conditions under which the Holzmans would owe the broker fee, and Blum had no legal duty to remind them of the terms of the agreement that they had signed.

In a footnote, the court pointed out that given Mr. Blum‘s testimony as to ―his desire to do the best‖ for the clients, ―it is somewhat surprising that the Broker, in effect, opposed its client‘s desire to obtain the highest possible purchase price for the property. Similarly, in pursuing its contract claim against the Sellers, we assume the Broker fully considered the impact such a suit might have on its reputation as an advocate for its customers‖.

Students may be asked if an agent has an ethical duty to provide all facts relating to the agency that are relevant to the principal‘s interests. Based on the judge‘s comments, students may be asked if the judge thought Mr. Blum was a good businessperson or a good human being. [Holzman v. Blum, 726 A. 2d 818 (Md. App.)] 9.

Tillie Flinn properly executed a durable power of attorney designating her nephew James C. Flanders and/or Martha E. Flanders, his wife, as her attorney in fact. Seven months later, Martha Flanders went to the Capitol Federal Savings and Loan Association office. She had the durable power of attorney instrument, five certificates of deposit, and a handprinted letter identifying Martha as an attorney in fact and stating that Tillie wished to cash her five CDs that Martha had with her. At approximately 10:31 a.m., five checks were given to

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Martha in the aggregate amount of $135,791.34, representing the funds in the five CDs less penalties for early withdrawal. Some of the checks were drawn to the order of Martha individually and some to the order of James and Martha, as individuals. Tillie was found dead of heart disease later that day. The time of death stated on her death certificate was 11:30 a.m. The Flanderses spent the money on themselves. Bank IV, as administrator of Tillie‘s estate, sued Capitol Federal to recover the amount of the funds paid to the Flanderses. It contended that Capitol Federal breached its duty to investigate before issuing the checks. Capitol Federal contended that it did all that it had a duty to do.

Decide. [Bank IV v. Capitol Federal Savings and Loan Ass’n, 828 P.2d 355 (Kan.)] Answer: Durable power of attorney. Judgment for Capitol Federal. Capitol Federal was presented a power of attorney that it is agreed was signed by Tillie, its depositor. Martha Flanders was properly identified as being the Martha Flanders designated as attorney in fact. The request to cash the CDs and the issuance of the checks in the individual name(s) of the attorney(s) in fact were within the scope of the power of attorney. Absent an act or acts amounting to participation in the wrongdoing, Capitol Federal‘s issuance of the checks in the name of the attorneys in fact imposed no liability on Capitol Federal.

Were Tillie incompetent at the time of the request to transfer funds, that incompetence would not defeat the exercise of the durable power of attorney, for its very purpose is to allow the orderly transaction of a person‘s business during contemplated disability or incompetence. [Bank IV v. Capitol Federal Savings and Loan Ass'n, 828 P. 2d 355 (Kan.)] 10. Lew owns a store on Canal Street in New Orleans. He paid a person named Mike and other individuals commissions for customers brought into the store. Lew testified that he had known Mike for less than a week. Boulos and Durso, partners in a wholesale jewelry business, were visiting New Orleans on a business trip when Mike brought them into the store to buy a stereo. While Durso finalized the stereo transaction with the store‘s manager, Boulos and Mike negotiated to buy 2 cameras, 3 videos, and 20 gold Dupont lighters. Unknown to the store‘s manager, Mike was given $8,250 in cash and was to deliver the merchandise later that evening to the Marriott Hotel, where Boulos and Durso were staying. Mike gave a receipt for the cash, but it showed no sales tax or indication that the goods were to be delivered. Boulos testified that he believed Mike was the store owner. Mike never delivered the merchandise and disappeared. Boulos and Durso contended that Lew is liable for the acts of his agent, Mike. Lew denied that Mike was his agent, and the testimony showed that Mike had no actual authority to make a sale, to use a cash register, or even to go behind a sales counter. What ethical principle applies to the conduct of Boulos and Durso? Decide. [Boulos v. Morrison, 503 So. 2d 1 (La.)]

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Solution and Answer Guide:

Answer: Ethical principles of integrity and honesty [Preface]; principal‘s conduct as to third person. Boulos and Durso paid cash for the items and did not pay a sales tax. Delivery to a hotel room was to take place at night. The nature of the products—two cameras, three videotapes and twenty gold lighters—was not such that customers would be unable to carry them from a store. The totality of the circumstances could lead a reasonable person to believe that Boulos and Durso were willing participants in a transaction that violated the ethical principles of integrity and honesty.

The court conducted its analysis of the case under agency law and entered a judgment for Lew. The court determined that no apparent authority existed in this case.

Boulos and Durso had to show that based on the principal‘s holding out of Mike, they reasonably believed that Mike had authority to sell and deliver the merchandise in question. The facts and circumstances of Mike‘s taking cash—with no delivery at the store, but a promise for delivery later that night to a hotel room—and the receipt itself— with no sales tax or proper itemization—should have led them to question Mike‘s authority and good faith. [Boulos v. Morrison, 503 So. 2d 1 (La.)] 11. Martha Christiansen owns women‘s apparel stores bearing her name in New Seabury, Massachusetts; Lake Placid, New York; Palm Beach, Florida; and Palm Springs, California. At a meeting with her four store managers, she discussed styles she thought appropriate for the forthcoming season, advised them as always to use their best judgment in the goods they purchased for each of their respective stores, and cautioned ―but no blue jeans.‖ Later, Jane Farley, the manager of the Lake Placid store, purchased a line of high-quality blue denim outfits (designer jeans with jacket and vest options) from Women‘s Wear, Inc., for the summer season. The outfits did not sell. Martha refused to pay for them, contending that she had told all of her managers ―no blue jeans‖ and that if it came to a lawsuit, she would fly in three managers to testify that Jane Farley had absolutely no authority to purchase denim outfits and was, in fact, expressly forbidden to do so.

Women‘s Wear sued Martha, and the three managers testified for her. Is the fact that Martha had explicitly forbidden Farley to purchase the outfits in question sufficient to protect her from liability for the purchases made by Farley?

Answer: Scope of agent‘s authority, apparent authority. No. Clearly, the express prohibition of ―no blue jeans‖ would communicate to the ordinary person that blue denim outfits were contrary to her principal‘s instructions. Actual authority to purchase denim outfits then was explicitly denied Farley. Yet Martha placed Farley in the position of manager of the store, and each manager made the purchases for each store. Martha thus created in Farley the appearance of authority to purchase denim outfits, and Women‘s

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Wear Inc. had no knowledge of the directive not to buy blue jeans. Martha then was liable for the purchase made by her agent, Farley.

12. Fred Schilling, the president and administrator of Florence General Hospital, made a contract, dated August 16, 1989, on behalf of the hospital with CMK Associates to transfer the capacity to utilize 25 beds from the hospital to the Faith Nursing Home. Schilling, on behalf of the hospital, had previously made a contract with CMK Associates on May 4, 1987. Schilling had been specifically authorized by the hospital board to make the 1987 contract. The hospital refused to honor the 1989 contract because the board had not authorized it. CMK contended that Schilling had apparent authority to bind the hospital because he was president and administrator of the hospital and he had been the person who negotiated and signed a contract with CMK in 1987. Thus, according to CMK, the hospital had held out Schilling as having apparent authority to make the contract. The hospital disagreed. Decide. [Pee Dee Nursing Home v. Florence General Hospital, 419 S.E.2d 843 (S.C.App.)] Answer: Apparent authority. The titles of president and administrator are insufficient to show apparent authority. This is especially so based on the unusual character of the contract in question, that of transferring hospital bed capacity from the hospital to the nursing home. And the fact that Schilling made a prior contract with CMK Associates does not create apparent authority in an agent.

Schilling obtained board approval of the first contract. A principal‘s right to approve the actions of its agent cannot be defeated by the act of delegating to its president the duty of executing one prior contract. Much more is needed for the moving party to establish that the hospital (the principal) held out Schilling as having authority to make such contracts without board approval. [Pee Dee Nursing Home v. Florence General Hospital, 419 S.E. 2d 843 (S.C. App.)] 13. Real estate broker Donald Alley Sr. had a listing contract that gave him the exclusive right to sell Wayman Ellison‘s farm for at least $200,000. Ellison was told that a buyer was found.

The buyer, Cora Myers, who had been paid $585,000 for her small farm because the land was needed for a commercial development, agreed to pay $380,000 for the large Ellison farm. Alley told Ellison that the sale price was $200,000. The buyer paid $380,000, however, and Alley kept the difference. When Ellison later learned of these details, he sued Alley for the $180,000. From a judgment for Ellison, Alley appealed, seeking at least his commission on the sale since he procured a ready, willing, and able buyer. Decide. [Ellison v. Alley, 842 S.W.2d 605 (Tenn)].

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Solution and Answer Guide:

Answer: Agent's duty of loyalty. Alley breached his fiduciary duty to the seller, Wayman Ellison, and he must remit to him the $180,000 secret profit that he wrongfully received from the transaction. A broker whose actions amount to misconduct is not entitled to a commission on the sale. [Ellison v. Alley, 842 S.W. 2d 605 (Tenn.)]

14. Francis Gagnon, an elderly gentleman, signed a power of attorney authorizing his daughter, Joan, ―to sell any of my real estate and to execute any document needed to carry out the sale … and to add property to a trust of which I am grantor or beneficiary.‖ This power was given in case Gagnon was not available to take care of matters personally because he was traveling. When Joan learned that Gagnon intended to sell his Shelburne property to Cosby for $750,000, she created an irrevocable trust naming Gagnon as beneficiary and herself as trustee. Acting then on the basis of the authority set forth in the power of attorney, she conveyed the Shelburne property to herself as trustee of the irrevocable trust, thus blocking the sale to Cosby. When Gagnon learned of this, he demanded that Joan return the Shelburne property to him, but she refused, saying she had acted within the authority set forth in the power of attorney. Did Joan violate any duty owed to Gagnon? Must she reconvey the property to Gagnon? [Gagnon v. Coombs, 654 N.E.2d 54 (Mass. App.)] Answer: Agent‘s duty of loyalty. Joan not only did not have the authority to enter into the transaction, she violated her duty as an agent by making herself a beneficiary of a transaction when, as an agent, she was to act in the interests of her father, not in her own self-interest. [Gagnon v. Coombs, 654 N.E. 2d 54 (Mass. App.)] 15. Daniels and Julian were employed by the Marriott Hotel in New Orleans and were close personal friends. One day after work, Daniels and Julian went to Werlein‘s music store to open a credit account. Julian, with Daniels‘s authorization and in her presence, applied for credit using Daniels‘s name and credit history. Later, Julian went to Werlein‘s without Daniels and charged the purchase of a television set to Daniels‘s account, executing a retail installment contract by signing Daniels‘s name. Daniels saw the new television in Julian‘s home and was informed that it was charged to the Werlein‘s account. Daniels told Julian to continue making payments. When Werlein‘s credit manager first contacted Daniels to inform her that her account was delinquent, she claimed that a money order for the television was in the mail. On the second call, she asked for a ―payment balance.‖ Some four months after the purchase, she informed Werlein‘s that she had not authorized the purchase of the television nor ratified the purchase. Werlein‘s sued Daniels for the unpaid balance. Decide. [Philip Werlein, Ltd. v. Daniels, 536 So. 2d 722 (La. App.)]

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Solution and Answer Guide:

63744_Chapter 34.indd 733 Answer: Agency by ratification. Judgment for Werlein's. Although Daniels did not authorize the purchase of the television set, the evidence shows that she ratified the unauthorized signing of her name to the contract for the purchase of the television set by Julian. Instead of taking immediate action to repudiate what had been done in her name, Daniels simply told Julian to continue making payments. And when contacted by Werlein's credit manager, she replied that a money order was in the mail. Daniels's conduct manifested a clear intent to ratify, and she is bound by the unauthorized signature.

[Philip Werlein, Ltd. v. Daniels, 536 So. 2d 722 (La. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Generally, an agency relationship is terminated by operation of law in all of the following situations except the:

2.

a.

Principal‘s death.

b.

Principal‘s incapacity.

c.

Agent’s renunciation of the agency.

d.

Agent‘s failure to acquire a necessary business license.

Able, on behalf of Pix Corp., entered into a contract with Sky Corp., by which Sky agreed to sell computer equipment to Pix. Able disclosed to Sky that she was acting on behalf of Pix. However, Able had exceeded her actual authority by entering into the contract with Sky. If Pix wishes to ratify the contract with Sky, which of the following statements is correct? a.

Pix must notify Sky that Pix intends to ratify the contract.

b.

Able must have acted reasonably and in Pix‘s best interest.

c.

Able must be a general agent of Pix.

d.

Pix must have knowledge of all material facts relating to the contract at the time it is ratified.

3.

Which of the following actions requires an agent for a corporation to have a written agency agreement? a.

Purchasing office supplies for the principal‘s business.

b.

Purchasing an interest in undeveloped land for the principal.

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Solution and Answer Guide:

4.

c.

Hiring an independent general contractor to renovate the principal‘s office building.

d.

Retaining an attorney to collect a business debt owed the principal.

Simmons, an agent for Jensen, has the express authority to sell Jensen‘s goods. Simmons also has the express authority to grant discounts of up to 5 percent of list price. Simmons sold Hemple a 10 percent discount. Hemple had not previously dealt with either Simmons or Jensen. Which of the following courses of action may Jensen properly take?

5.

a.

Seek to void the sale to Hemple.

b.

Seek recovery of $50 from Hemple only.

c.

Seek recovery of $50 from Simmons only.

d.

Seek recovery of $50 from either Hemple or Simmons.

Ogden Corp. hired Thorp as a sales representative for nine months at a salary of $3,000 per month plus 4 percent of sales. Which of the following statements is correct? a.

Thorp is obligated to act solely in Ogden‘s interest in matters concerning Ogden‘s business.

b.

The agreement between Ogden and Thorp formed an agency coupled with an interest.

c.

Ogden does not have the power to dismiss Thorp during the nine-month period without cause.

d.

The agreement between Ogden and Thorp is not enforceable unless it is in writing and signed by Thorp.

6. Frost‘s accountant and business manager has the authority to: a.

Mortgage Frost‘s business property.

b.

Obtain bank loans for Frost.

c.

Insure Frost’s property against fire loss.

d.

Sell Frost‘s business.

[return to top] Answers to AICPA Questions 1.

Generally, an agency relationship is terminated by operation of law in all of the following situations except the: a.

Principal‘s death.

b.

Principal‘s incapacity.

c.

Agent’s renunciation of the agency.

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Solution and Answer Guide:

d.

Agent‘s failure to acquire a necessary business license.

(c) The agent‘s renunciation of the agency does not automatically terminate by operation of law. The other answers listed do terminate an agency.

2.

Able, on behalf of Pix Corp., entered into a contract with Sky Corp., by which Sky agreed to sell computer equipment to Pix. Able disclosed to Sky that she was acting on behalf of Pix. However, Able had exceeded her actual authority by entering into the contract with Sky. If Pix wishes to ratify the contract with Sky, which of the following statements is correct? a.

Pix must notify Sky that Pix intends to ratify the contract.

b.

Able must have acted reasonably and in Pix‘s best interest.

c.

Able must be a general agent of Pix.

d.

Pix must have knowledge of all material facts relating to the contract at the time it is ratified.

(d) Ratification occurs when there is a subsequent approval by the principal of an agent‘s unauthorized action. In order for ratification to take place, the principal must have knowledge of all material facts regarding the contract. Answer (a) is incorrect because it is not necessary that the principal expressly communicate an intent to be bound. If the principal acts in a manner as to imply ratification (e.g., by taking advantage of the benefits of the contracts), then the principal‘s actions will be interpreted as ratification. Answer (b) is incorrect because it makes no difference whether or not the agent acts reasonably and in the best interest of the principal.

The principal may ratify any contract as long as the requirements for ratification are satisfied. Answer (c) is incorrect because a principal may ratify a contract entered into by any type of agent.

3.

Which of the following actions requires an agent for a corporation to have a written agency agreement? a.

Purchasing office supplies for the principal‘s business.

b.

Purchasing an interest in undeveloped land for the principal.

c.

Hiring an independent general contractor to renovate the principal‘s office building.

d.

Retaining an attorney to collect a business debt owed the principal.

(b) It is generally not necessary for an agent to have a written agency agreement. An exception to the general rule exists if the agent‘s duties will involve the buying and selling of real property, or if the agency agreement is to last more than one year.

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Solution and Answer Guide:

4.

Simmons, an agent for Jensen, has the express authority to sell Jensen‘s goods. Simmons also has the express authority to grant discounts of up to 5 percent of list price. Simmons sold Hemple a 10 percent discount. Hemple had not previously dealt with either Simmons or Jensen. Which of the following courses of action may Jensen properly take? a.

Seek to void the sale to Hemple.

b.

Seek recovery of $50 from Hemple only.

c.

Seek recovery of $50 from Simmons only.

d.

Seek recovery of $50 from either Hemple or Simmons.

(c) Simmons exceeded his express authority when he granted the 10% price discount to Hemple; therefore, Simmons would be liable to Jensen for the amount of damage caused by Simmons‘ breach, $50 [(10% - 5%) x $1,000]. Answers (a), (b), and (d) are incorrect because Hemple had not previously dealt with Simmons or Jensen; therefore, Simmons was acting with apparent authority when he granted the 10% price discount to Hemple. Consequently, Jensen would not be able to void the sale or recover from Hemple.

5.

Ogden Corp. hired Thorp as a sales representative for nine months at a salary of $3,000 per month plus 4 percent of sales. Which of the following statements is correct? a.

Thorp is obligated to act solely in Ogden‘s interest in matters concerning Ogden‘s business.

b.

The agreement between Ogden and Thorp formed an agency coupled with an interest.

c.

Ogden does not have the power to dismiss Thorp during the nine-month period without cause.

d.

The agreement between Ogden and Thorp is not enforceable unless it is in writing and signed by Thorp.

(c) An agent has a fiduciary duty to be loyal to his principal. The agent cannot compete with his principal without the principal‘s consent, and the agent cannot deal for his own interests that are adverse to the principal. Answer (c) is correct because a principal generally has the power to terminate an agency relationship, although he may not have the right. In such a case, the agency may be terminated even though he or she could be liable for breach of the agency contract. However, a principal may not revoke an ―agency coupled with an interest.‖ This type of agency is created when the agent is given an immediate interest in the subject matter of the agency. An ―interest in the subject matter‖ should not be confused with an agent‘s contract for compensation. In this instance, Thorp has not received an ―interest‖; he or she has

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 35: Third Persons in Agency

merely agreed that compensation will be calculated in part as a percentage as sales.

Thus, answer (b) is also incorrect because the right of the agent to receive a percentage of proceeds is not sufficient to constitute an agency coupled with an interest. Answer (d) is incorrect because the agency relationship need not be in writing because it can be performed within one year.

6.

Frost‘s accountant and business manager has the authority to: a.

Mortgage Frost‘s business property.

b.

Obtain bank loans for Frost.

c.

Insure Frost’s property against fire loss.

d.

Sell Frost‘s business.

(c) Frost‘s agent can perform customary business transactions like getting insurance but not extraordinary transactions such as mortgaging property, obtaining loans or selling property. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 35: Third Persons in Agency

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 338 Questions and Case Problems .......................................................................................................... 338 End of Chapter: CPA Questions and Answers ................................................................................. 346 Answers to AICPA Questions ............................................................................................................ 347

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Richard Pawlus was an owner of Dutch City Wood Products, Inc., which did business as ―Dutch City Marketing.‖ Pawlus purchased merchandise from Rothschild Sunsystems from April 24 to June 24 using the designation ―Richard Pawlus Dutch City Marketing‖ on orders and correspondence. In October, Rothschild was notified that Pawlus was acting on behalf

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Solution and Answer Guide:

of the corporation when the merchandise was purchased. Rothschild sued Pawlus for payment for the merchandise. Pawlus contended that he was an agent of the corporation and was thus not personally liable. Decide. [Rothschild Sunsystems, Inc. v. Pawlus, 514 N.Y.S.2d 572 (A.D.)] Answer: Undisclosed principal. Judgment for Rothschild. The contracts were made between April and June. Pawlus did not inform Rothschild until October that he was an agent acting on behalf of Dutch City Wood Products. Because Pawlus did not make known that he was acting as an agent for the corporation at the time the contracts were made, he is liable on the contracts. [Rothschild Sunsystems, Inc. v. Pawlus, 514 N.Y. S. 2d 572 (App. Div.)] 2.

Judith Studebaker was injured when a van owned and driven by James Ferry collided with her vehicle. On the morning of the incident, Ferry made his usual runs for the florist for whom he delivered flowers, Nettie‘s Flower Garden. He had made a slight detour prior to the accident to conduct personal business at a pawnshop and was returning to the flower shop at the time of the accident. Nettie‘s set standards for Ferry‘s dress and conduct, determined his territory, and set standards for his van. Studebaker brought an action against Nettie‘s on a respondeat superior theory on the belief that Ferry was Nettie‘s employee at the time of the accident. Nettie‘s defended that Ferry was an independent contractor, not an employee. Decide. [Studebaker v. Nettie’s Flower Garden Inc., 842 S.W.2d 227 (Mo. App.)] Answer: Respondeat superior. Judgment for Studebaker. Applying a ―right to control‖ test, it is clear that Nettie‘s controlled or had the right to control Ferry at the time of the collision. He was going back to Nettie‘s business at the time of the accident. Moreover, Nettie‘s set the standard for his dress and conduct and determined his territory and set the standards for his van. [Studebaker v. Nettie’s Flower Garden, Inc., 842 S.W. 2d 227 (Mo. App.)]

3.

Lowell Shoemaker, an architect, was hired by Affhouse to work on a land development project. In September Shoemaker contacted Central Missouri Professional Services about providing engineering and surveying services for the project. Central submitted a written proposal to Shoemaker in October. About a week later, Shoemaker orally agreed that Central should proceed with the work outlined in the proposal. When the first phase of the work was completed, a bill of $5,864.00 was sent to Shoemaker. Shoemaker called Central and requested that all bills be sent directly to the owner/developer, Affhouse. When the bills were not paid, Central sued Shoemaker and Affhouse. The trial court entered a

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Solution and Answer Guide:

judgment against Shoemaker for $5,864 and he appealed. Shoemaker acknowledged that he did not disclose the identity of the principal to Central at the time the transaction was conducted, and explained: Q. You never told Mike Bates or Central Missouri Professional Services that you were an agent for Affhouse or any other undisclosed principal?

A. That’s correct. I never did.

Q. Another note I wrote down was that the subject of Affhouse came up in your conversations with Mike Bates of Central Missouri Professional Services after he sent the bill to you?

A. The early part of the year, yes.

Shoemaker contends that since he made clear to Central that he was an architect and not the developer, there was no binding oral contract between Central and him. Decide.

[Central Missouri Professional Services v. Shoemaker, 108 S.W.3d 6 (Mo. App.)] Answer: Undisclosed; partially disclosed principal. It is the agent‘s duty to inform the third party at the time of the making of the contract not only that he or she is acting as an agent but also the identity of the principal in order to protect the agent from personal liability on the transaction.

It is not the third person's duty to seek out the identity of the principal, rather, the duty to disclose the identity of the principal is on the agent. The disclosure of an agency relationship is not complete for the purpose of relieving the agent from personal liability unless it embraces the name of the principal. Otherwise, the third person dealing with the agent understands only that the agent intended to pledge his personal responsibility in support of the contract and for its performance. In this case, Shoemaker failed to disclose to Central that he was acting as an agent and failed to disclose the identity of the principal, Affhouse, to Central at the time of the transaction. The fact that Central knew Shoemaker was an architect and not a developer is immaterial. [Central Missouri Professional Services v. Shoemaker, 108 S.W. 3d 6 (Mo. App.)] 4.

Beverly Baumann accompanied her mother to Memorial Hospital, where her mother was placed in intensive care for heart problems. A nurse asked Baumann to sign various documents, including one that authorized the hospital to release medical information and to receive the mother‘s insurance benefits directly. This form stated: ―I understand I am financially responsible to the hospital for charges not covered by this authorization.‖ Baumann‘s mother died during the course of her hospitalization. The hospital later sued

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Solution and Answer Guide:

Baumann to recover $19,013.42 in unpaid hospital charges based on the form she signed, which the hospital called a ―guarantee of payment.‖ Baumann contended that she signed the document as an agent for her mother and was thus not personally liable. Decide.

[Memorial Hospital v. Baumann, 474 N.Y.S.2d 636 (A.D.)] Answer: Effect of an agent’s signature when acting for a disclosed principal. Judgment for Baumann. She acted as an agent for a disclosed principal, her mother. Unless the contract clearly states otherwise, an agent has no personal liability on a contract for a disclosed principal. [Memorial Hospital v. Baumann, 474 N.Y. S. 2d 636 (A.D.)] 5.

Craig Industries was in the business of manufacturing charcoal. Craig, the corporation‘s president, contracted in the name of the corporation to sell the company‘s plants to Husky Industries. Craig did not have authority from the board of directors to make the contract, and later the board of directors voted not to accept it. Husky Industries sued Craig on the theory that he, as agent for the corporation, exceeded his authority and should be held personally liable for damages. Decide. [Huskey Industries v. Craig, 618 S.W.2d 458 (Mo. App. 1981)] Answer: Unauthorized action by the agent. The president was personally liable. An agent who purports to contract in the name of a principal without, or in excess of, authority to do so is personally liable to the other contracting party for the agent‘s breach of implied warranty of authority. This liability is implied unless the agent manifests that no warranty of authority is made or the other contracting party knows the agent is not authorized.

[Huskey Industries v. Craig, 618 S.W. 2d 458 (Mo. App.)]

6.

Leo Bongers died intestate. Alfred Bongers and Delores Kuhl, Leo‘s nephew and niece, were appointed personal representatives of his estate. Leo left more than 120 antique cars, trucks, and motorcycles. The estate hired Bauer-Moravec to sell the vehicles at auction.

Auctioneer Russ Moravec suggested that the vehicles be sold at an airstrip auction in May, June, or July. The estate rejected this recommendation and insisted that the sale be conducted in January on a farm owned by the estate. On January 30, the auction took place beginning at 9:30 a.m. with temperatures below freezing and some 800 people jammed into the bid barn. One auctioneer had purchased Putnam hitch balls to be used with mylar-type ropes so that small farm tractors could tow the vehicles into and out of the bid barn. One hour into the auction, Joseph Haag was seriously injured when a hitch ball came loose from the drawbar of the tractor towing an antique Studebaker truck. Haag sued the estate, claiming that Bauer-Moravec was acting as agent for the estate and that its negligence in not properly attaching the hitch ball and in using mylar-type tow rope

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Solution and Answer Guide:

rather than chains should be imputed to the estate under the doctrine of respondeat superior. The estate defended that it was not liable for the torts of the auctioneer and its employees because the auctioneer was an independent contractor. Decide. [Haag v.

Bongers, 589 N.W.2d 318 (Neb.)] Answer: Owner’s liability for the acts of an independent contractor. Generally, the employer of an independent contractor is not liable for physical harm caused to another by the acts or omissions of the independent contractor or its employees. However, an exception exists if the employer retains control over the contractor‘s work. The auctioneers served as independent contractors. However, the estate exercised sufficient control over the auction and auctioneers to subject it to liability. It approved the use of tractors to tow the vehicles at the auction. The estate insisted that the auction be heavily advertised, resulting in a shoulder-to-shoulder crowd through which the vehicles were to be towed. Bongers was present at the auction at the time of the accident. [Haag v. Bongers, 589 N.W. 2d 318 (Neb.)] 7.

Branch Structural Solutions, Inc., sued the manager of PMC Chase, LLP, Steven Turnbow, personally for breach of contract for work performed and not paid for amounting to $32,627.50. Mr. Turnbow denied he contracted for the work in his personal capacity and asserts personally he was just an agent for Phil Chase, and therefore is not personal liable.

Mr. Turnbow testified in part: Q. So you agree that this is a legally binding contract?

A. Yes Q. And that contract would have been signed by you individually; is that correct?

A. I was signing for my company.

Q. …Where on this document does it say that you‘re signing for your company?

A. It doesn‘t. …

Q. And is this document addressed to you and signed by you individually? Is that correct?

A. Yes. Q. And nowhere on the document does it say that you‘re signing on behalf of PMC chase?

A. No. Mr. Turnbow contends that he is entitled to produce evidence to show that he intended to bind only his principal. Branch disagrees. Decide. [PMC Chase, LLP v. Branch Structural Sols., Inc., 2020 Tex. App. LEXIS 772.]

Answer: Agent’s obligation to disclose that he is signing in a representative capacity.

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Judgment against Mr. Turnbow. It is well-settled that the law does not presume agency.

When an agent seeks to avoid personal liability on a contract he signs, it is his duty to disclose that he is acting in a representative capacity and the identity of his principal. If a written contract unambiguously shows on its face that it is the obligation of the person who signed it, the signer may not introduce parol evidence to show that he intended to bind only his principal. [PMC Chase, LLP v. Branch Structural Sols., Inc., 2020 WL 467791 (Tex. App.)] 8.

Jason Lasseigne, a Little League baseball player, was seriously injured at a practice session when he was struck on the head by a poorly thrown baseball from a team member, Todd Landry. The league was organized by American Legion Post 38. Claude Cassel and Billy Johnson were the volunteer coaches of the practice session. The Lasseignes brought suit on behalf of Jason against Post 38, claiming that the coaching was negligent and that Post 38 was vicariously liable for the harm caused by such negligence. Post 38 contended that it had no right to control the work of the volunteer coaches or the manner in which practices were conducted and as a result should not be held vicariously liable for the actions of the coaches. Decide. [Lasseigne v. American Legion Post 38, 543 So. 2d 1111 (La. App.)] Answer: Vicarious liability. Judgment for Post 38. It is the right to control the actions of the employee that subjects an employer to liability for tortious acts of an employee acting within the course and scope of employment. In this case, the individual team coaches were not employees of Post 38. Post 38 had no control over the activities of the coaches or the manner in which practices were conducted. [Lasseigne v. American Legion Post 38, 543 So. 2d 1111 (La. App.)]

9.

Moritz, a guest at Pines Hotel, was sitting in the lobby when Brown, a hotel employee, dropped a heavy vacuum cleaner on her knee. When Moritz complained, the employee insulted her and hit her with his fist, knocking her unconscious. She sued the hotel for damages. Was the hotel liable? [Moritz v. Pines Hotel, Inc., 383 N.Y.S.2d 704 (A.D.)] Answer: Vicarious liability of employer for intentional tort of employee. No. The hotel was not vicariously liable for the act of the employee outside of the scope of employment. ―The assault was a sudden, inexplicable act without apparent purpose and completely outside the duties and scope of the assailant‘s employment and is not chargeable to the employer under the doctrine of respondeat superior.‖ [Moritz v. Pines Hotel, Inc., 383 N.Y. S. 2d 704 (App. Div.)]

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10. Steve Diezel, an employee of Island City Flying Service in Key West, Florida, stole a General Electric Credit Corp. (GECC) aircraft and crashed the plane while attempting to take off.

GECC brought suit against Island City on the theory that it had negligently hired Diezel as an employee and was therefore legally responsible for Diezel‘s act of theft. Diezel had a military prison record as a result of a drug offense and had been fired by Island City twice previously but had been immediately reinstated each time. Island City claimed that the evidence was insufficient to establish that it had been negligent in employing Diezel.

Decide. [Island City Flying Service v. General Electric, 585 So. 2d 274 (Fla.)] Answer: Employer‘s liability for negligent hiring. Diezel had a negative employment history and Island City had sufficient notice that Diezel could create problems for them. The failure on the part of an employer to take action when an employee is dangerous is negligence. [Island City Flying Service v. General Electric, 585 So. 2d 274 (Fla.)] Authors‘ Comment: Note that Island City faces an interesting dilemma with respect to the rights Diezel has under the Americans with Disabilities Act (ADA) and its liability for Diezel‘s conduct. If Diezel has a substance abuse problem, it can be classified as a disability. So long as Diezel is able to perform his job with reasonable accommodation, Island City would be engaging in discrimination if it fired Diezel. The EEOC has stated that the facts that an employee might snap and that substance abuse recovery is often tentative are not reasons for termination of an employee with disabilities. In other words, potential exposure for negligence liability is not a valid reason for discrimination.

11. The Bay State Harness Horse Racing and Breeding Association conducted horse races at a track where music for patrons was supplied by an independent contractor hired by the association. Some of the music played was subject to a copyright held by Famous Music Corp. The playing of that music was a violation of the copyright unless royalties were paid to Famous Music. No royalties were paid, and Famous Music sued the association, which raised the defense that the violation had been committed by an independent contractor specifically instructed not to play Famous Music‘s copyrighted material. Decide. [Famous Music Corp. v. Bay State Harness Horse Racing and Breeding Association, Inc., 554 F.2d 1213 (1st Cir.)] Answer: Owner‘s liability for acts of independent contract. Judgment for Famous Music.

The fact that the violations were committed by an independent contractor did not shield the association from liability. A contrary rule would enable an enterprise to violate the copyright laws without liability. [Famous Music Corp. v. Bay State Harness Horse Racing and Breeding Association, Inc., 554 F. 2d 1213 (1st Cir.)]

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12. Steven Trujillo, told by the assistant door manager of Cowboys Bar ―to show up to work tonight in case we need you as a doorman,‖ came to the bar that evening wearing a jacket with the bar logo on it. Trujillo ―attacked‖ Rocky Medina in the parking lot of the bar, causing him serious injury. Prior to working for Cowboys, Trujillo was involved in several fights at that bar and in its parking lot, and Cowboys knew of these matters. Medina sued Cowboys on two theories of liability: (1) respondeat superior and (2) negligent hiring of Trujillo. Cowboys‘s defense was that the respondeat superior theory should be dismissed because the assault was clearly not within the course of Trujillo‘s employment. Concerning the negligent hiring theory, Cowboys asserted that Trujillo was not on duty that night as a doorman. Decide. [Medina v. Graham’s Cowboys, Inc., 827 P.2d 859 (N.M. App.)] Answer: Employer‘s vicarious liability for intentional torts; negligent hiring. The attack by Trujillo on Medina was not within the scope of employment, nor did it further the business of the employer, Cowboys. The respondeat superior claim was thus rejected.

Liability for negligent hiring flows from the duty of the employer to its patrons not to endanger the patrons by negligently hiring violent persons. The fact that Trujillo was on call on the premises at Cowboys‘ request is a sufficient basis to apply the negligent-hiring theory. And Trujillo‘s propensity to engage in fights provided a proper basis to conclude that Cowboys could have reasonably foreseen the danger of Trujillo‘s engaging in a fight while he was on call on the premises. [Medina v. Graham's Cowboys, Inc., 827 P. 2d 859 (N.M. App.)] 13. Neal Rubin, while driving his car in Chicago, inadvertently blocked the path of a Yellow Cab Co. taxi driven by Robert Ball, causing the taxi to swerve and hit Rubin‘s car. Angered

by Rubin‘s driving, Ball got out of his cab and hit Rubin on the head and shoulders with a metal pipe. Rubin sued Yellow Cab Co. for the damages caused by this beating, contending that the employer was vicariously liable for the beating under the doctrine of respondeat superior because the beating occurred in furtherance of the employer‘s business, which was to obtain fares without delay. The company argued that Ball‘s beating of Rubin was not an act undertaken to further the employer‘s business. Is the employer liable under respondeat superior? [Rubin v. Yellow Cab Co., 507 N.E.2d 114 (Ill. App.)] Answer: Respondeat superior; course of employment. Judgment for Yellow Cab Company.

The employee, Ball, did not act within the course of his employment when he got out of his cab and beat Rubin over the head with a metal pipe. It is not an employer-created risk or a risk inherent in the job of taxi driver that a driver will undertake to attack another

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motorist. The attack was a deviation from the conduct generally associated with driving a cab. [Rubin v. Yellow Cab Co., 507 N.E. 2d 114 (Ill. App.)] Authors‘ Comment: You may compare the situation in this case to that of a bartender or bouncer who beats up an individual at the place of employment. The nature of these jobs makes the use of force during work highly probable. Such employer-created risks make the employer liable for the torts of these employees.

14. Brazilian & Colombian Co. (B&C), a food broker, ordered 40 barrels of olives from MawerGulden-Annis (MGA). MGA‘s shipping clerk was later told to make out the bill of lading to B&C‘s customer Pantry Queen; the olives were shipped directly to Pantry Queen. Eight days after delivery, the president of B&C wrote MGA to give it the name of its principal, Pantry Queen, and advised MGA to bill the principal directly. Pantry Queen was unable to pay for the olives, and MGA sued B&C for payment. B&C contended that it was well known to MGA that B&C was a food broker (agent) and the olives were shipped directly to the principal by MGA. It stated that as an agent, it was not a party to the contract and was thus not liable. Decide. [Mawer-Gulden-Annis, Inc. v. Brazilian & Colombian Coffee Co., 199 N.E.2d 222 (Ill. App.)] Answer: Liability of agent when principal is undisclosed. Judgment for MGA. The buyer, B & C, was liable on the purchase contract because it did not disclose (a) the fact that it was acting as an agent or (b) the identity of the principal when it made the contract. The fact that MGA was later told the identity of the principal did not alter the outcome. The identity of the principal must be disclosed when the contract is made so that the third person may determine whether he or she will extend credit to such a principal. [MawerGulden-Annis, Inc. v. Brazilian & Colombian Coffee Co., 199 N.E. 2d 222 (Ill. App.)] [return to top] End of Chapter: CPA Questions and Answers [return to top] 1.

Frey entered into a contract with Cara Corp. to purchase televisions on behalf of Lux, Inc. Lux authorized Frey to enter into the contract in Frey‘s name without disclosing that Frey was acting on behalf of Lux. If Cara repudiates the contract, which of the following statements concerning liability on the contract is not correct? a.

Frey may not hold Cara liable and obtain money damages.

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b.

Frey may hold Cara liable and obtain specific performance.

c.

Lux may hold Cara liable upon disclosing the agency relationship with Frey.

d.

Cara will be free from liability to Lux if Frey fraudulently stated that he was acting on his own behalf.

2.

3.

A principal will not be liable to a third party for a tort committed by an agent: a.

Unless the principal instructed the agent to commit the tort.

b.

Unless the tort was committed within the scope of the agency relationship.

c.

If the agency agreement limits the principal‘s liability for the agent‘s tort.

d.

If the tort is also regarded as a criminal act.

Cox engaged Datz as her agent. It was mutually agreed that Datz would not disclose that he was acting as Cox‘s agent. Instead, he was to deal with prospective customers as if he were a principal acting on his own behalf. This he did and made several contracts for Cox. Assuming Cox, Datz, or the customer seeks to avoid liability on one of the contracts involved, which of the following statements is correct? a.

Cox must ratify the Datz contracts in order to be held liable.

b.

Datz has no liability once he discloses that Cox was the real principal.

c.

The third party can avoid liability because he believed he was dealing with Datz as a principal.

d.

4.

The third party may choose to hold either Datz or Cox liable.

Which of the following statements is (are) correct regarding the relationship between an agent and a nondisclosed principal?

I.

The principal is required to indemnify the agent for any contract entered into by the agent within the scope of the agency agreement.

II.

The agent has the same actual authority as if the principal had been disclosed.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

[return to top] Answers to AICPA Questions 1.

Frey entered into a contract with Cara Corp. to purchase televisions on behalf of Lux, Inc.

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Lux authorized Frey to enter into the contract in Frey‘s name without disclosing that Frey was acting on behalf of Lux. If Cara repudiates the contract, which of the following statements concerning liability on the contract is not correct? a.

Frey may not hold Cara liable and obtain money damages.

b.

Frey may hold Cara liable and obtain specific performance.

c.

Lux may hold Cara liable upon disclosing the agency relationship with Frey.

d.

Cara will be free from liability to Lux if Frey fraudulently stated that he was acting on his own behalf.

(c) If the principal discloses himself and asserts his rights under the contract, he may also sue the third party as long as the contract does not involve personal services, trust, or confidence Specific performance is appropriate only when the subject matter is so unique that the aggrieved party cannot be fairly compensated with money damages; therefore, answer (b) is incorrect. The agent of an undisclosed principal binds himself and has the right to sue the third person in his own name; money damages are the appropriate remedy, 2.

Frey entered into a contract with Cara Corp. to purchase televisions on behalf of Lux, Inc. Lux authorized Frey to enter into the contract in Frey‘s name without disclosing that Frey was acting on behalf of Lux. If Cara repudiates the contract, which of the following statements concerning liability on the contract is not correct? a.

Frey may not hold Cara liable and obtain money damages.

b.

Frey may hold Cara liable and obtain specific performance.

c.

Lux may hold Cara liable upon disclosing the agency relationship with Frey.

d.

Cara will be free from liability to Lux if Frey fraudulently stated that he was acting on his own behalf.

(b) Generally, a principal is not liable to a third party for torts committed by an agent.

The major exception is if the agent is acting within the authority of the principal; i.e., within the scope of the agency relationship. If the agent is acting with the scope of the agency relationship, the principal is liable. Answer (a) is incorrect because the tort must be committed within the scope of the agency relationship for the principal to be liable. An agent‘s instructions from the principal to commit the tort is not within the scope of the agency relationship. Answer (c) is incorrect because the principal cannot limit his/her liability in the agency agreement for torts committed by the agent. Answer (d) is incorrect because the fact that the tort may also be a criminal act does not protect the principal.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 36: Regulation of Employment

3.

Cox engaged Datz as her agent. It was mutually agreed that Datz would not disclose that he was acting as Cox‘s agent. Instead, he was to deal with prospective customers as if he were a principal acting on his own behalf. This he did and made several contracts for Cox. Assuming Cox, Datz, or the customer seeks to avoid liability on one of the contracts involved, which of the following statements is correct? a.

Cox must ratify the Datz contracts in order to be held liable.

b.

Datz has no liability once he discloses that Cox was the real principal.

c.

The third party can avoid liability because he believed he was dealing with Datz as a principal.

d.

The third party may choose to hold either Datz or Cox liable.

(d) As an agent for an undisclosed principal, Datz is solely liable on the contract unless the third party later discovers the identity of the principal, in which case either Datz or Cox may be held liable. Therefore, answers (a) and (b) are incorrect. Answer (c) is incorrect because Cox, as an undisclosed principal, has the right to enforce the contract against the third part as long as it does not involve personal services, trust, or confidence.

4.

Which of the following statements is (are) correct regarding the relationship between an agent and a nondisclosed principal?

I.

The principal is required to indemnify the agent for any contract entered into by the agent within the scope of the agency agreement.

II.

The agent has the same actual authority as if the principal had been disclosed.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

(c) As long as the agent acts within authority, the principal is liable. The agent does have the same authority as a disclosed agent. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 36: Regulation of Employment © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Solution and Answer Guide:

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 350 Questions and Case Problems .......................................................................................................... 350

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Robert Evjen was a full-time employee of Boise Cascade Co. At the same time, he was a full-time student at Chemata Community College. He was laid off as part of a general economy move by the employer. He applied for unemployment compensation. His claim was opposed on the ground that he was not ―available for work‖ because he was going to school. Testimony showed that Evjen never missed work to go to classes, that he could not afford to go to school without working, and that, in case of any conflict between work and school, work came first. The employer countered that he needed to be available for all shifts of suitable work to qualify for unemployment benefits. Decide. [Evjen v. Employment Agency, 539 P.2d 662 (Or. App.)] Answer: Unemployment compensation. Judgment for Evjen. To obtain unemployment benefits, an unemployed individual must prove, among other things, that she or he is ―available for work‖ and is unable to obtain suitable work. A student‘s unavailability for work during school hours is contrary to the concept of ―available for work,‖ which requires availability for all shifts of suitable work. However, Evjen‘s uncontroverted testimony that his education was secondary to his employment was sufficient to overcome either an inference or a presumption of nonavailability. He was available for work and, therefore, entitled to unemployment compensation. [Evjen v. Employment Agency, 539 P. 2d 662 (Or. App.)]

2.

Michael Smyth was an operations manager at Pillsbury Co., and his employment status was that of an employee at will. Smyth received certain e-mail messages at home, and he replied to his supervisor by e-mail. His messages contained some provocative language, including the phrase ―kill the backstabbing bastards‖ and a reference to an upcoming company party as the ―Jim Jones Koolaid affair.‖ Later, Smyth was given two weeks‘ notice of his termination, and he was told that his e-mail remarks were inappropriate and unprofessional. Smyth believes that he is the victim of invasion of privacy because the email messages caused his termination, and the company had promised that e-mail

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Solution and Answer Guide:

communications would not be intercepted and used as a basis for discipline or discharge.

The company denies that it intercepted the e-mail messages and points out that Smyth himself sent the unprofessional comments to his supervisor. Is Smyth entitled to reinstatement and back pay because of the invasion of privacy? [Smyth v. Pillsbury Co., 914 F. Supp. 97 (E.D. Pa.)] Answer: Employee privacy. Employers have wide latitude for monitoring e-mail messages.

The federal statute makes an exception for consent so that Smyth could be monitored.

The court held Smyth‘s termination for his e-mail comments did not violate public policy.

[Smyth v. Pillsbury Co., 914 F. Supp. 97 (E.D. Pa.)] 3.

Michael Hauck claimed that he was discharged by his employer, Sabine Pilot Service, because he refused its direction to perform the illegal act of pumping the bilges of the employer‘s vessel into the waterways. Hauck was an employee at will, and Sabine contends that it therefore had the right to discharge him without having to show cause. Hauck brought a wrongful discharge action against Sabine. Decide. [Sabine Pilot Service, Inc., v.

Hauck, 687 S.W.2d 733 (Tex.)] Answer: Public policy exception to employment-at-will doctrine. Judgment for Hauck.

Employment for an indefinite term may be terminated at will and without cause. Public policy, as expressed in the criminal laws of the state and the United States, requires a narrow exception to this employment-at-will doctrine whereby an employer cannot discharge an employee for refusal to perform an illegal act. [Sabine Pilot Service, Inc. v.

Hauck, 687 S.W. 2d 733 (Tex.)]

4.

Jeanne Eenkhoorn worked as a supervisor at a business office for the New York Telephone Co. While at work, she invented a process for terminating the telephone services of delinquent subscribers. The telephone company used the process but refused to compensate her for it, claiming a shop right. Eenkhoorn then sued for damages on a quasi-contract theory. Decide. [Eenkhoorn v. New York Telephone Co., 568 N.Y.S.2d 677] Answer: Right of employer to use inventions. Judgment for the defendant. An employer has a shop right or an irrevocable license to use an employee‘s invention or idea if the employee, in developing the invention or idea, did so on the employer‘s time and with the employer‘s machinery, material, and money. Eenkhoorn admitted that she developed the work in question while at work during regular business hours, using company data and source material. Such supports the company‘s shop right defense. [Eenkhoorn v. New York Telephone Co., 568 N.Y. S. 2d 677)]

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5.

One Monday, a labor organization affiliated with the International Ladies Garment Workers Union, began an organizational drive among the employees of Whittal & Son. On the following Monday, six of the employees who were participating in the union drive were discharged. Immediately after the firings, the head of the company gave a speech to the remaining workers in which he made a variety of antiunion statements and threats.

The union filed a complaint with the NLRB, alleging that the six employees were fired because they were engaging in organizational activity and were thus discharged in violation of the NLRA. The employer defended its position, arguing that it had a business to run and that it was barely able to survive in the global economy against cheap labor from thirdworld countries. It asserted that the last thing it needed was ―union baloney.‖ Was the NLRA violated?

Answer: Discrimination for union activity. Section 8(a)(3) of the NLRA prohibits discrimination against employees because of their union activity. The company violated this section when it fired the six workers in question. The employer expressed antiunion animus. This, coupled with the firings, would threaten, or coerce the remaining employees exercising their right to form a union in violation of § 8(a)(1). In such a clear-cut case, the NLRB would immediately seek an injunction against the firings under § 10(j) of the act.

Students might be asked whether the employer has the right of free speech to say that ―the last thing it needs is union baloney.‖ The NLRB, under § 8(c) of the act, allows employer free speech, so long as the language contains no threat of reprisal or promise of benefits concerning support for the union. In this case, the firings, coupled with the ―union baloney‖ language, make the employer‘s speech §§ 8(a)(1) and 8(c) violations.

6.

David Stark submitted an application to the maintenance department of Wyman-Gordon Co. Stark was a journeyman millwright with nine years‘ experience at a neighboring company at the time of his application to Wyman-Gordon. Stark was vice president of the local industrial workers‘ union. In his preliminary interview with the company, Ms. Peevler asked if Stark was involved in union activity, and Stark detailed his involvement to her. She informed Stark that Wyman-Gordon was a nonunion shop and asked how he felt about this. Peevler‘s notes from the interview characterize Stark‘s response to this question as ―seems to lean toward third-party intervention.‖ Company officials testified that Stark‘s qualifications were ―exactly what we were looking for,‖ but he was not hired. Stark claimed that he was discriminated against. Wyman-Gordon denied that any discrimination had occurred. Is a job applicant (as opposed to an employee) entitled to protection from antiunion discrimination? On the facts of this case, has any discrimination taken place?

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[Wyman-Gordon Co. v. N.L.R.B., 108 L.R.R.M. 2085 (1st Cir.)] Answer: Discrimination for union activity. Job applicants, as well as employees, are protected from antiunion discrimination. Because Wyman-Gordon officials were aware of Stark‘s union activity, suspicion of discrimination is justified. The questions regarding unions in the interview and Peevler‘s evaluation referring to ―third party intervention,‖ coupled with Stark‘s outstanding qualifications, are sufficient to find that Stark‘s union background was the determinative factor in the decision not to hire. In the absence of a strong countervailing argument from Wyman-Gordon, a finding of discrimination and a § 8(a)(3) violation were required in this case. [Wyman-Gordon Co. v. NLRB, 108 L.R.R.M. 2085 (1st Cir.)] 7.

Armenda Malone and Stephen Krantz were induced to leave other employment and join ABI‘s CD-ROM division as national account managers in part because of a favorable commission agreement at ABI. Their employment relationship with ABI had no set duration, and as such they were employees at will. For the first two quarters of their employment, their commission reports were approved by the president of the division and paid without incident. Thereafter, a new management team took over the division. When the mid-level manager presented third quarter commission reports based on the prior practice to the new vice president, Bruce Lowry, for approval, he was told, ―You got to learn how to f—these people.‖ Lowry then utilized severable variables—some of which the mid-level manager found ―ridiculous‖—to reduce the commission figures. After much discourse that carried on well into the fourth quarter, Lowry announced that a new model for determining commissions would be implemented. Commissions for both the third and fourth quarters, ending in December, were then calculated based on this model. ABI asserts that because Malone and Krantz were employees at will, the employer had the right to interpret or alter how it pays employees as it sees fit. Krantz and Malone left ABI and have sued for what they believe are the full commissions earned in the third and fourth quarters. Present a legal theory on behalf of Malone and Krantz for the payment of back commissions. Assess the strengths and weaknesses of Lowry‘s approach to employee relations. How would you decide this case? [Malone v. American Business Information, Inc., 647 N.W.2d 569 (Neb.)] Answer: Improperly withheld wages and commissions. Employees have a right to compensation according to the terms agreed upon by the parties. Under an at-will employment relationship, the employer can alter the terms of compensation. However, an employer does not have the right to alter the compensation for work that has already been performed or for commissions that have already occurred. The legal theory

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applicable to this case is a breach of contract.

Lowry‘s approach in this case led to the loss of two national account managers. The midlevel manager deemed some of the reductions taken from the commissions owed as ridiculous. In the long run, it is difficult to build a successful organization treating employees unfairly. The best employees will leave, and the remaining employees may very well treat the company as they have been treated. The jury decided the case in favor of the plaintiffs, awarding Krantz $108,802 in unpaid commissions and Malone $75,350, which were upheld on appeal. Under the state‘s Wage Payment and Collection Act, ABI was ordered to pay attorneys fees of not less than 25% of the total recovery. [Malone v.

American Business Information, Inc., 647 N.W. 2d 569 (Neb.)] A company often takes on the demeanor of its executives. Managers who find a way to cut corners on their employees‘ pay may set a tone for their employees to cut corners in their dealings with management and customers, adversely affecting the reputation and financial performance of the company. See Chapter 3, Section 3-2c, ―The Importance of a Good Reputation.‖ See Figure 3-3, Categories of Ethical Behavior. Discuss ―Integrity and Truthfulness‖, ―Promise Keeping‖, and ―Fairness‖ as these mid-range ethical principles apply to the facts of this case.

8.

Jane Richards was employed as the sole crane operator of Gale Corp. and held the parttime union position of shop steward for the plant. On May 15, Richards complained to OSHA concerning what she contended were seven existing violations of the Occupational Safety and Health Act that were brought to her attention by members of the bargaining unit. On May 21, she stated to the company‘s general manager at a negotiating session: ―If we don‘t have a new contract by the time the present one expires on June 15, we will strike.‖ On May 22, an OSHA inspector arrived at the plant, and Richards told her supervisor, ―I blew the whistle.‖ On May 23, the company rented and later purchased two large electric forklifts that were used to do the work previously performed by the crane, and the crane operator‘s job was abolished. Under the existing collective bargaining contract, the company had the right to lay off for lack of work. The contract also provided for arbitration, and it prohibited discipline or discharge without ―just cause.‖ On May 23, Richards was notified that she was being laid off ―for lack of work‖ within her classification of crane operator. She was also advised that the company was not planning on using the crane in the future and that, if she were smart, she would get another job. Richards claimed that her layoff violated the National Labor Relations Act, the Occupational Safety and Health Act, and the collective bargaining agreement. Was she correct?

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Answer: Discipline for union activity; discipline for filing charges with OSHA. The evidence indicated that the layoff of Richards for lack of work was a pretext. There was no reduction of work, but simply the substitution of two new machines for the crane. The facts did not indicate that there was economic justification for the new machines, which were not new technology. To the contrary, two employees would be required to do the work formerly done by Richards. In view of the stated facts, it seems clear that the compelling reason for the layoff was Richards‘s union activity. It is a violation of the National Labor Relations Act to discriminate against an employee because of the employee‘s union activity. Richards advised the company that the union would strike if a new contract was not reached, as was her right. Also, because Richards was informed of the alleged OSHA violations through her union position, this would give a second reason for the National Labor Relations Board to require that Richards be reinstated to her job with full back pay.

The Occupational Health and Safety Act served as an independent source of protection for Richards. It was a violation of this act to discriminate against an employee for notifying OSHA of possible violations of the act.

Finally, the current collective bargaining agreement provided that no employee should be disciplined or discharged without just cause. The collective bargaining agreement had an arbitration clause. On the facts of this case, Richards was not properly laid off because the evidence of a pretext was compelling.

In the alternative, if the layoff was considered discipline by the employer, just cause did not exist. Richards would have been entitled to reinstatement with full back pay by an arbitrator under the collective bargaining agreement.

9.

Virgil Deemer and Thomas Cornwell, employees at a Whirlpool Corporation plant, refused to comply with a supervisor‘s order that they perform maintenance work on certain mesh screens located some 20 feet above the plant floor. Twelve days before a fellow employee had fallen to his death from the screens. Because they refused to do the work assigned them, they were told to punch out and go home; reprimands were placed in their files.

Should employees be able to pick and choose what work they will perform? Do Deemer and Cornwell have any recourse? [Whirlpool v. Marshall, 445 U.S. 1] Answer: OSHA protection against discrimination. OSHA inspectors cannot be present around the clock in every workplace to enforce the act. Thus, each worker has the power to make a good-faith decision that there is danger. In the unusual circumstances that Deemer and Cornwell faced, when in good faith and without reasonable alternatives they

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refused to expose themselves to the dangerous work on the mesh screens, they are protected by a DOL Regulation against subsequent discrimination by the employer for the refusal. It is only when there is a good faith decision that there is a danger of injury or death that employees can refuse assignments and be protected. [Whirlpool v. Marshall, 445 U.S. 1] 10. In May, the nurses union at Waterbury Hospital went on strike, and the hospital was shut down. In mid- June, the hospital began hiring replacements and gradually opened many units. To induce nurses to take employment during the strike, the hospital guaranteed replacement nurses their choice of positions and shifts. If a preferred position was in a unit that was not open at that time, the hospital guaranteed that the individual would be placed in that position at the end of the strike. The strike ended in October and as the striking workers returned to work, the hospital began opening units that had been closed during the strike. It staffed many of these positions with replacement nurses. The nurses who had the positions prior to the strike and were waiting to return to work believed that they should have been called to fill these positions rather than the junior replacements who had held other positions during the strike. Decide. [Waterbury Hospital v. NLRB, 950 F.2d 849 (2d Cir.)] Answer: Rights of economic strikers. The permanent replacement nurses have the right to remain in the jobs they held during the strike; senior strikers have no right to displace them. Moreover, the replacement nurses have no standing for the poststrike openings that occurred because they did not occupy these jobs during the strike. Thus, the hospital violated the act to the extent that it denied re-instatement to senior returning strikers who previously held those jobs.

The use of the terms ―junior‖ and ―senior‖ refers to the relative standing of employees on the hospital‘s seniority list. Positions at the hospital had been filled under the collective bargaining contract by the senior qualified nurse. [Waterbury Hospital v. NLRB, 950 F. 2d 849 (2d Cir.)] 11. Buffo was employed by the Baltimore & Ohio Railroad. Along with a number of other workers, he was removing old brakes from railroad cars and replacing them with new brakes. In the course of the work, rivet heads and scrap from the brakes accumulated on the tracks under the cars. This debris was removed only occasionally when the workers had time. Buffo, while holding an air hammer in both arms, was crawling under a car when his foot slipped on scrap on the ground, causing him to strike and injure his knee. He sued the railroad for damages under the Federal Employers Liability Act. Decide. [Buffo v.

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Baltimore & Ohio Railroad Co., 72 A.2d 593 (Pa.)] Answer: Negligence and assumption of risks under the Federal Employer‘s Liability Act. Judgment for Buffo. The Federal Employer‘s Liability Act allows recovery only when the employer is negligent. Here, the railroad was negligent in failing to provide a safe place to work in that it did not remove the scraps from beneath the car. The fact that the area was dangerous was not a valid defense because the doctrine of assumption of risk was abolished by an amendment to the act. [Buffo v. Baltimore & Ohio Railroad Co., 72 A. 2d 593 (Pa.)] 12. Employees frustrated by a new policy at work and unable to make headway in direct discussions with their employer aired their grievance publicly in an interview with a reporter for a local television news station. The company fired these employee for flagrant disloyalty. The NLRB found that the employees‘ actions were not malicious actions and were protecting ―concerted‖ activities allowed under the National Labor Relations Act. The employer appealed. Decide. [Direct TV Inc. v. NLRB, 837 F.3d 25] Answer: Firing employees for union activities. Substantial evidence of record supported the Board‘s conclusion that the employee statements ―for the most part were accurate representations of what the company had instructed the technicians to tell the customers (falsely) about needing to connect a phone line for the receiver to work. These employees were reinstated with pay. [Direct TV, Inc. v. NLRB, 837 F.3d 25] 13. Reno, Nevada, police officers John Bohach and Jon Catalano communicated with each other on the Alphapage computer system, typing messages on a keyboard and sending them to each other by use of a ―send‖ key. The computer dials a commercial paging company, which receives the message by modem, and the message is then sent to the person paged by radio broadcast. When the system was installed, the police chief warned that every Alphapage message was logged on the network, and he barred messages that were critical of department policy or discriminatory. The two police officers sought to block a department investigation into their messages and prevent disclosure of the messages‘ content. They claimed that the messages should be treated the same as telephone calls under federal wiretap law. The department contended that the system was essentially a form of e-mail whose messages are by definition stored in a computer, and the storage was itself not part of the communication. Was the federal wiretap law violated? [Bohach v. City of Reno, 932 F. Supp. 1232 (D. Nev.)] Answer: Employee privacy. No, the federal wiretap law was not violated because most

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 37: Equal Employment Opportunity Law

courts have held that e-mail does not belong to the employee. The e-mail system and all messages by employees belong to the employer. It is not an issue of whether there are ―wire‖ characteristics associated with e-mail. Rather, it is an issue of employer ownership and notice to employees. [Bohach v. City of Reno, 932 F. Supp. 1232 (D. Nev.)] 14. Michael Kittell was employed at Vermont Weatherboard. While operating a saw at the plant, Kittell was seriously injured when a splinter flew into his eye and penetrated his head. Kittell sued Vermont Weatherboard, seeking damages under a common law theory.

His complaint alleged that he suffered severe injuries solely because of the employer‘s wanton and willful acts and omissions. The complaint stated that he was an inexperienced worker, put to work without instructions or warning on a saw from which the employer had stripped away all safety devices. Vermont Weatherboard made a motion to dismiss the complaint on the ground that the Workers‘ Compensation Act provided the exclusive remedy for his injury. Decide. [Kittell v. Vermont Weatherboard, Inc., 417 A.2d 926 (Vt.)] Answer: Workers‘ compensation. The motion to dismiss the complaint was granted. The common law liability of the employer cannot be stretched to include accidental injuries caused by the gross, wanton, or willful acts of the employer short of genuine intentional injury. Because there was an absence of specific intent on the part of the employer to injure Kittell, the state‘s Workers‘ Compensation Act provided the exclusive remedy for Kittell‘s work-connected injury. [Kittell v. Vermont Weatherboard, Inc., 417 A. 2d 926 (Vt.)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 37: Equal Employment Opportunity Law

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 358 Questions and Case Problems .......................................................................................................... 358

Answers to the End-of-Chapter Questions Questions and Case Problems

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1.

List the major federal statutes dealing with the regulation of equal rights in employment.

Answer: Major federal statutes. The major federal statutes are the Equal Pay Act of 1963, the Civil Rights Act of 1964, as amended by the Equal Opportunity Act of 1972, the Age Discrimination in Employment Act of 1967, as amended, the Rehabilitation Act of 1973, the Pregnancy Disability Act of 1978, the Americans with Disabilities Act of 1990, and the Civil Rights Act of 1991. See also, the Family Medical and Leave Act in Chapter 36.

2.

The EEOC notified North American Stainless (NAS) in February 2003 that Miriam Regalado had filed a charge of sex discrimination against the company. Three weeks later NAS fired her coworker Eric Thompson, a person to whom Ms. Regalado was engaged. Thompson had worked for NAS for seven years as a metallurgical engineer. Thompson filed his own charge with the EEOC and a subsequent lawsuit under Title VII of the Civil Rights Act, claiming that NAS fired him to retaliate against Regalado for filing her charge with the EEOC. The employer contended that because Thompson did not ―engag[e] in any statutorily protected activity, either on his own behalf or on behalf of Miriam Regalado,‖ he is not included in the class of persons for whom Congress created a retaliation cause of action.

Thompson argued that the Supreme Court adopted a broad standard in its Burlington decision because Title VII‘s antiretaliation provision is worded broadly, and that there is no textual basis for making an exception to it for third-party reprisals. Decide. [Thompson v.

North American Stainless Steel, LP, 131 S. Ct. 863] Answer: Retaliation. Judgment for Thompson. Thompson was an employee of NAS, and the purpose of Title VII is to protect employees from their employers‘ unlawful actions.

Moreover, accepting the facts as alleged, Thompson is not an accidental victim of the retaliation—collateral damage, so to speak, of the employer‘s unlawful act. To the contrary, injuring him was the employer‘s intended means of harming Regalado. Hurting him was the unlawful act by which the employer punished her. In those circumstances, we think Thompson is well within the ―zone of interest‖ sought to be protected by Title VII. He is a person aggrieved with standing to sue. [Thompson v. North American Stainless Steel, LP, 131 S. Ct. 863)]

3.

S. Ct. 863] 3. Dial Corp. implemented a ―work tolerance test,‖ which all new employees were required to pass to obtain employment in its Armour Star brand sausage-making department. Of the applicants who passed the test, 97 percent were male and 38 percent were female. The EEOC ―demonstrated‖ that the facially neutral work tolerance test

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―caused‖ a disparate impact on women. The defending employer did not deny that the employment practice in question caused the disparate impact. Rather, the employer responded that the test was ―job related‖ and ―necessary‖ to reduce job-related injuries at the plant and submitted evidence that the number of job injuries had been reduced after implementation of the testing program. The evidence showed that the company had initiated numerous other safety initiatives that had an impact on reducing injuries at the plant. After they failed the test, 52 women were denied jobs. Decide this case. [EEOC v.

Dial Corp., 2005 WL 2839977 (S.D. Iowa)] Answer: Proof in disparate impact case. The employer did not meet its burden of persuasion that the work tolerance test led to a reduction in injuries because the company had initiated numerous other safety initiatives during the time period that likely led to the reduction in injuries at the plant. The employer was ordered to pay $3.4 million in damages to the 52 women denied a job after they failed the test. [EEOC v. Dial Corp., 2005 WL 2839977 (S.D. Iowa)] 4.

Rosanna Orellana and her boyfriend went skydiving at Altitude Express. Donald Zarda was Orellana‘s tandem instructor. He told her that he was a homosexual because he thought it would mitigate awkwardness that might arise from being strapped tightly to the woman.

Orellana and her boyfriend complained to Altitude Express about Zarda‘s behavior and Zarda was fired shortly thereafter. Altitude Express maintains that Zarda was fired because he failed to provide an enjoyable experience for a customer. Zarda maintains that he acted appropriately and was fired either because of his supervisor‘s prejudice against homosexuals or because he informed a client about his sexuality. Decide this case. [Zarda v. Altitude Express, 855 F.3d 76 (2d Cir.); affd. Bostock v. Clayton County, Georgia, 140 S.Ct. 1731] Answer: Discrimination based on sexual orientation. The Second Circuit did not overturn its precedent that Title VII does not prohibit discrimination based on sexual orientation.

The court recognized that the Supreme Court in Price Waterhouse v. Watkins held that Title VII forbids discrimination based on sex stereotypes. Nevertheless, the Second Circuit found that Zarda did not adequately establish proximity between his termination and gender nonconformity. The Supreme Court overturned the Second Circuit in its Bostock v.

Clayton County, Georgia decision determining that the language of Title VII ―because of sex‖ prohibits discrimination on the basis of homosexuality or transgender status.

Under Title VII, a plaintiff must demonstrate that sex was a substantial or motivating factor contributing to the employer‘s decision to take the adverse employment action. The

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plaintiff need show only that the motive to discriminate was one of the employer‘s motives, even if the employer had other lawful motives that were causative in the employer‘s decision. Univ. of Tx. Sw. Med. Ctr. V. Nassar, 133 S. Ct. 2523 (2013). But the court did not apply this standard because it did not find that Zarda had established the requisite proximity between his termination and his failure to conform to gender stereotypes. The Zarda case will be heard by the United States Supreme Court in the 20192020 term. [Zarda v. Altitude Express, 855 F.3d 76 (2d Cir.); affd. Bostock v. Clayton County, Georgia, 140 S. Ct. 1731] 5.

Beth Faragher worked part-time and summers as an ocean lifeguard for the Marine Safety Section of the city of Boca Raton, Florida. Bill Terry and David Silverman were her supervisors over the five-year period of her employment. During this period, Terry repeatedly touched the bodies of female employees without invitation and would put his arm around Faragher, with his hand on her buttocks. He made crudely demeaning references to women generally. Silverman once told Faragher, ―Date me or clean the toilets for a year.‖ She was not so assigned, however. The city adopted a sexual harassment policy addressed to all employees. The policy was not disseminated to the Marine Safety Section at the beach, however. Faragher resigned and later brought action against the city, claiming a violation of Title VII and seeking nominal damages, costs, and attorneys‘ fees. The city defended that Terry and Silverman were not acting within the scope of their employment when they engaged in harassing conduct and that the city should not be held liable for their actions. Are part-time employees covered by Title VII? Was Silverman‘s threat, ―Date me or clean toilets for a year,‖ a basis for quid pro quo vicarious liability against the city? Decide this case. [Faragher v. City of Boca Raton, 524 U.S. 775] Answer: Sexual harassment. Part time and summer or seasonal employees are protected against discrimination under Title VII. Silverman‘s ―date me or clean toilets for a year‖ threat is not a basis for quid pro quo automatic vicarious liability against the City because she was not the victim of any significant employment action for Silverman never carried out his threat. The case must be treated as a hostile work environment case, where the plaintiff must prove severe and pervasive conduct on the part of the supervisors, which is present in this case. The employer may then attempt to raise affirmative defenses.

However, the City would be unsuccessful because the City failed to disseminate the sexual harassment policy to beach employees. Not set forth in the facts, the City‘s policy was also defective because it did not provide a means for employees to bypass their harassing supervisors in registering their complaints. [Faragher v. City of Boca Raton, 524 U.S. 775]

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6.

Mohen is a member of the Sikh religion whose practice forbids cutting or shaving facial hair and requires wearing a turban that covers the head. In accordance with the dictates of his religion, Mohen wore a long beard. He applied for a position as breakfast cook at the Island Manor Restaurant. He was told that the restaurant‘s policy was to forbid cooks to wear facial hair for sanitary and good grooming reasons and that he would have to shave his beard or be denied a position. Mohen contended that the restaurant had an obligation to make a reasonable accommodation to his religious beliefs and let him keep his beard. Is he correct?

Answer: Reasonable accommodation of religious practices. Judgment for the restaurant.

Sanitary reasons and a consistently applied grooming policy for all employees demonstrate that the restaurant could not accommodate Mohen‘s religion without undue business hardship, including the loss of customers who don‘t like facial hair on their eggs or who are ―turned off‖ by seeing a cook with facial hair.

7.

Sylvia Hayes worked as a staff technician in the radiology department of Shelby Memorial Hospital. On October 1, Hayes was told by her physician that she was pregnant. When Hayes informed the doctor of her occupation as an X-ray technician, the doctor advised Hayes that she could continue working until the end of April so long as she followed standard safety precautions. On October 8, Hayes told Gail Nell, the director of radiology at Shelby, that she had discovered she was two months pregnant. On October 14, Hayes was discharged by the hospital. The hospital‘s reason for terminating Hayes was its concern for the safety of her fetus given the X-ray exposure that occurs during employment as an X-ray technician. Hayes brought an action under Title VII, claiming that her discharge was unlawfully based on her condition of pregnancy. She cited scientific evidence and the practice of other hospitals where pregnant women were allowed to remain in their jobs as X-ray technicians. The hospital claimed that Hayes‘s discharge was based on business necessity. Moreover, the hospital claimed that the potential for future liability existed if an employee‘s fetus was damaged by radiation encountered at the workplace. Decide. [Hayes v. Shelby Memorial Hospital, 546 F. Supp. 259 (N.D. Ala.)] Answer: Pregnancy Discrimination Act, remedies and BFOQ. Judgment for Hayes. The court found that the Pregnancy Discrimination Act (PDA) articulates a per se rule that renders any distinction among employees on the basis of pregnancy a sufficient basis for a prima facie case under Title VII. After the plaintiff establishes a prima facie case, the burden shifts to the employer to come forth with a business necessity for its action. Concern over a business necessity defense must be grounded on the delivery of services the business provides. Because the hospital was concerned with possible damage to its future financial

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condition rather than with any current interference, the defense failed. The court also rejected a hospital argument that a condition of nonpregnancy was a BFOQ for working in the x-ray lab. [Hayes v. Shelby Memorial Hospital, 546 F. Supp. 259 (N.D. Ala.)] 8.

Overton suffered from depression and was made sleepy at work by medication taken for this condition. Also, because of his medical condition, Overton needed a work area away from public access and substantial supervision to complete his tasks. His employer terminated him because of his routinely sleeping on the job, his inability to maintain contact with the public, and his need for supervision. Overton argued that he is a person with a disability under the ADA and the Rehabilitation Act, fully qualified to perform the essential functions of the job, and that the employer had an obligation to make reasonable accommodations, such as allowing some catnaps as needed and providing some extra supervision. Decide. [Overton v. Reilly, 977 F.2d 1190 (7th Cir.)] Answer: Discrimination against persons with disabilities. Judgment for Overton to the extent that Overton was entitled to a trial to prove that he could perform the essential functions of the job and may thus be viewed as qualified and entitled to reasonable accommodation without undue hardship to the employer. The court recognized that supervisors are prone to view catnaps as inappropriate and unprofessional but insisted that Overton be allowed to attempt to prove his case. [Overton v. Reilly, 977 F. 2d 1190 (7th Cir.)] Authors‘ Comment: Students may be asked to suggest a reasonable accommodation that would allow Overton to continue to work. For example, Overton could be allowed to take short naps as needed in a secluded area where such napping would not demoralize the public and fellow workers. Needless to say, employers would have difficulty accepting the propriety of this type of accommodation. However, the purpose of the ADA and the Rehabilitation Act is to seek out reasonable accommodations once it is determined that the employee in question is a qualified individual.

9.

A teenage female high school student named Salazar was employed part-time at Church‘s Fried Chicken Restaurant. Salazar was hired and supervised by Simon Garza, the assistant manager of the restaurant. Garza had complete supervisory powers when the restaurant‘s manager, Garza‘s roommate, was absent. Salazar claimed that while she worked at the restaurant, Garza would refer to her and all other females by a Spanish term that she found objectionable. According to Salazar, Garza once made an offensive comment about her body and repeatedly asked her about her personal life. On another occasion, Garza allegedly physically removed eye shadow from Salazar‘s face because he claimed it was

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unattractive. Salazar also claimed that one night she was restrained in a back room of the restaurant while Garza and another employee fondled her. Later that night, when Salazar told a customer what had happened, she was fired. Salazar brought suit under Title VII against Garza and Church‘s Fried Chicken, alleging sexual harassment. Church‘s, the corporate defendant, maintained that it should not be held liable under Title VII for Garza‘s harassment. Church‘s based its argument on the existence of a published fair treatment policy. Decide. [Salazar v. Church’s Fried Chicken, Inc., 44 Fair Empl. Prac. Cas. (B.N.A.) 472 (S.D. Tex.)] Answer: Sexual harassment. This case presents facts that overlap hostile environment and quid pro quo cases in that Salazar claimed that she was terminated as a direct result of her supervisor‘s sexual advances. In quid pro quo cases, the employer is liable for the acts of its supervisors. The court was not persuaded that Church‘s should escape liability because the company had an antidiscrimination policy and a grievance procedure. The court found that Salazar could have perceived the first step in the procedure—notification of the store manager—as pointless because the manager was Garza‘s roommate. In any event, mere maintenance of a fair treatment policy and a grievance procedure do not provide an automatic defense for an employer in a quid pro quo case. [Salazar v. Church's Fried Chicken, Inc., 44 Fair Empl. Prac. Cas. (BNA) 472 (S.D. Tex.)] 10. Manuel Fragante applied for a clerk‘s job with the city and county of Honolulu. Although he placed high enough on a civil service eligibility list to be chosen for the position, he was not selected because of a perceived deficiency in oral communication skills caused by his ―heavy Filipino accent.‖ The clerks are constantly dealing with the public and the ability to speak clearly is one of the most important skills required for the position according to the city. Fragante brought suit, alleging that the defendants had discriminated against him on the basis of his national origin in violation of Title VII of the Civil Rights Act. Decide.

[Fragante v. City and County of Honolulu, 888 F.2d 591 (9th Cir.)] Answer: National origin discrimination. Judgment for the city and county of Honolulu.

Accents and national origin are inextricably intertwined in many cases. Courts look carefully at nonselection based on foreign accents because an employer may unlawfully discriminate against someone based on national origin by falsely stating that it was the individual‘s inability to measure up to the communication skills demanded for the job.

Because the record showed that the ability to speak clearly was one of the most important skills required for the clerk‘s position and because the trial court judge confirmed that Fragante was difficult to understand, the court dismissed his complaint. [Fragante v. City and County of Honolulu, 888 F. 2d 591 (9th Cir.)].

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11. John Chadbourne was hired by Raytheon on February 4, 1980. His job performance reviews were uniformly high. In December 1983, Chadbourne was hospitalized and diagnosed with AIDS. In January 1984, his physician informed Raytheon that Chadbourne was able to return to work. On January 20, 1984, Chadbourne took a return-to-work physical examination required by Raytheon. The company‘s doctor wrote the County Communicable Disease Control director, Dr. Juels, seeking a determination of the appropriateness of Chadbourne‘s returning to work. Dr. Juels informed the company that ―contact of employees to an AIDS patient appears to pose no risk from all evidence accumulated to date.‖ Dr. Juels also visited the plant and advised the company doctor that there would be no medical risk to other employees at the plant if Chadbourne returned to work. Raytheon refused to reinstate Chadbourne to his position until July 19, 1984. Its basis for denying reinstatement was that coworkers might be at risk of contracting AIDS. Was Raytheon entitled to bar Chadbourne from work during the six-month period of January through July? [Raytheon v. Fair Employment and Housing Commission, 261 Cal. Rptr. 197 (Ct. App.)] Answer: Discrimination against the handicapped. No. The United States Supreme Court in School Board of Nassau County v. Arline, 480 U.S. 273, 107 Supreme Court 1123, issued its view on communicable diseases and held that courts must look to existing, objective medical evidence when considering a decision detrimental to those handicapped by contagious diseases. In Arline, the Supreme Court stated that a court inquiry should be ―based on reasonable medical judgments given the state of medical knowledge, . . . and that in making these findings courts normally should defer to the reasonable judgments of public health officials.‖ This is exactly what the Fair Employment and Housing Commission did. All the established evidence indicated that AIDS was not transmittable in the workplace and that Chadbourne could return to his job without risk to his fellow workers.

Any other conclusion about the transmission of the HIV virus would have been pure speculation on the part of Raytheon. Raytheon‘s failure to reinstate Chadbourne to his job was based on an irrational and unsupported belief that he posed a risk to the health and safety of other employees. [Raytheon v. Fair Employment and Housing Commission, 261 Cal. Rptr. 197 (Ct. App.)] 12. Connie Cunico, a white woman, was employed by the Pueblo, Colorado, School District as a social worker. She and other social workers were laid off in seniority order because of the district‘s poor financial situation. However, the school board thereafter decided to retain Wayne Hunter, a black social worker with less seniority than Cunico because he was the only black on the administrative staff. No racial imbalance existed in the relevant

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workforce with black persons constituting 2 percent. Cunico, who was rehired over two years later, claimed that she was the victim of reverse discrimination. She stated that she lost $110,361 in back wages plus $76,000 in attorneys‘ fees and costs. The school district replied that it was correct in protecting with special consideration the only black administrator in the district under the general principles it set forth in its AAP. Did the employer show that its affirmative action in retaining Hunter was justified as a remedial measure? Decide. [Cunico v. Pueblo School District No. 6, 917 F.2d 431 (10th Cir.)] Answer: Reverse discrimination, voluntary AAPs. The decision to retain Hunter over Cunico was facially discriminatory as the board retained him because he was the only black administrator, though he had less seniority than Cunico, who was white. Such a layoff is of dubious legality. The school district did not justify that the AAP was remedial in nature.

The court stated the following: Given the limited number of actual positions for either social workers or administrators in the District, there is no substantial significance to be gleaned from the absence of any blacks in such a small sample when the available workforce consisted of only 2 percent blacks. The District has produced no evidence of discrimination against qualified minorities in any aspect of its operations, much less with respect to minority social workers or administrators. No statistical disparity exists that would support the inference of past discrimination.

The court added that the action in this case was ―not narrowly tailored to achieve any perceived need for remedial action.‖ Judgment was for Cunico. She was awarded back pay plus attorneys‘ fees. [Cunico v. Pueblo School District No. 6, 917 F. 2d 431 (10th Cir.)] 13. Della Janich was employed as a matron at the Yellowstone County Jail in Montana. The duties of the position of matron resemble those of a parallel male position of jailer. Both employees have the responsibility of booking prisoners, showering and dressing them, and placing them in the appropriate section of the jail depending on the offender‘s sex.

Because 95 percent of the prisoners at the jail were men and 5 percent were women, the matron was assigned more bookkeeping duties than the jailer. At all times during Janich‘s employment at the jail, her male counterparts received $125 more per month as jailers.

Janich brought an action under the Equal Pay Act, alleging discrimination against her in her wages because of her sex. The county sheriff denied the charge. Decide. [Janich v.

Sheriff, 29 Fair Empl. Prac. Cas. (B.N.A.) 1195 (D. Mont.)]

Answer: Equal Pay for substantially equal work. Under the EPA, the court must consider

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whether the two jobs entail equal skill, effort, and responsibility. In this case, the duties of the two job classifications appear equal. The county argued that the discrepancy reflected the hazardous nature of the jailer‘s work with male prisoners and the state‘s interest in protecting women due to the difference in strength between males and females. The court found the working conditions substantially equal for matrons and jailers and ruled that the wage distinction was based on sex. The county‘s proffered reason was the type of anachronistic belief Congress intended to eliminate through the Equal Pay Act. [Janich v.

Sheriff, 29 Fair Empl. Prac. Cas. (BNA) 1195 (D. Mont.)]

14. Following a decline in cigarette sales, L & M, Inc., hired J. Gfeller as vice president of sales and charged him to turn around the sales decline. After receiving an analysis of the ages of sales personnel and first-line management, Gfeller and his assistant, T. McMorrow, instituted an intensive program of personnel changes that led to the termination of many older managers and sales representatives. A top manager who sought to justify keeping an older manager was informed that he was ―not getting the message.‖ Gfeller and McMorrow emphasized that they wanted young and aggressive people and that the older people were not able to conform or adapt to new procedures. R. E. Moran, who had been rated a first-rate division manager, was terminated and replaced by a 27-year-old employee. Gfeller and McMorrow made statements about employees with many years‘ experience: ―It was not 20 years‘ experience, but rather 1 year‘s experience 20 times.‖ The EEOC brought suit on behalf of the terminated managers and sales representatives. The company vigorously denied any discriminatory attitude with regard to age. Decide. [EEOC v. Liggett and Meyers, Inc., 29 F.E.P. 1611 (E.D.N.C.)] Answer: Age discrimination. In reengineering and restructuring, employers‘ conduct is evaluated as to whether age was a determining factor in the sense that ―but for the employer‘s motive to discriminate against him because of his age he would not have suffered discharge.‖ The message sent to managers here was one of requiring the discharge of older employees and the hiring of younger employees in their place. The court‘s decision was also influenced by Moran‘s record including laudatory reviews. The statement on experience was telling in that the older employees were targeted. [EEOC v.

Liggett and Meyers, Inc., 29 FEP 1611 (E.D. N.C.)] 15. Mazir Coleman had driven a school bus for the Casey County, Kentucky, Board of Education for four years. After that time, Coleman‘s left leg had to be amputated. Coleman was fitted with an artificial leg and underwent extensive rehabilitation to relearn driving skills. When his driving skills had been sufficiently relearned over the course of four years, Coleman applied to the county board of education for a job as a school bus driver. The

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board refused to accept Coleman‘s application, saying that it had no alternative but to deny Coleman a bus-driving job because of a Kentucky administrative regulation. That regulation stated in part: ―No person shall drive a school bus who does not possess both of these natural bodily parts: feet, legs, hands, arms, eyes, and ears. The driver shall have normal use of the above named body parts.‖ Coleman brought an action under the Rehabilitation act, claiming discrimination based on his physical handicap. The county board of education denied this charge, claiming that the reason they rejected Coleman was because of the requirement of the state regulation. Could Coleman have maintained an action for employment discrimination in light of the state regulation on natural body parts? Decide. [Coleman v. Casey County Board of Education, 510 F. Supp. 301 (N.D. Ky.)] Answer: Decision against the handicapped. Judgment for Coleman. The state regulation does not prevent an action from being brought under the Rehabilitation Act or the ADA, which are federal statutes. The supremacy clause of the U.S. Constitution, Article IV, Section 2, requires that the federal law displace the state law when the two conflict.

Under both the ADA and the Rehabilitation Act, Coleman must prove that he is in fact a handicapped person entitled to protection. (Coleman is handicapped because the loss of a leg is an impairment that affects a major activity—namely, walking.) Coleman must then prove that he is an otherwise qualified person and that he was denied employment solely by reasons of his handicap. He must also show that with reasonable accommodation, he can perform the essential functions of a school bus driver.

Applying these factors, the court ruled that Coleman had been discriminated against because of his disability. The only accommodation required for Coleman would be either an automatic transmission or a hand clutch, and a state agency had offered to accept the costs of these devices in this case. [Coleman v. Casey County Board of Education, 510 F. Supp. 301 (N.D. Ky.)] 16. Marcia Saxton worked for Jerry Richardson, a supervisor at AT&T‘s International Division.

Richardson made advances to Saxton on two occasions over a three-week period. Each time Saxton told him she did not appreciate his advances. No further advances were made, but thereafter Saxton felt that Richardson treated her condescendingly and had stopped speaking to her on a social basis at work. Four months later, Saxton filed a formal internal complaint, asserting sexual harassment, and went on ―paid leave.‖ AT&T found inconclusive evidence of sexual harassment but determined that the two employees should be separated. Saxton declined a transfer to another department, so AT&T transferred Richardson instead. Saxton still refused to return to work. Thereafter, AT&T

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 38: Types of Business Organizations

terminated Saxton for refusal to return to work. Saxton contended that she had been a victim of hostile working environment sexual harassment. AT&T argued that while the supervisor‘s conduct was inappropriate and unprofessional, it fell short of the type of action necessary for sexual harassment under federal law (the Harris case). Decide. [Saxton v. AT&T Co., 10 F.3d 526 (7th Cir.)] Answer: Sexual harassment. Judgment for AT&T. The Harris factors to consider are (1) frequency of the conduct, (2) its severity, (3) whether it was physically threatening or humiliating or an offensive utterance, and (4) whether it unreasonably interfered with the victim‘s work performance. Concerning the frequency and severity factors, the court found that the two incidents were relatively limited and did not rise to the level of pervasive harassment. Concerning the humiliation and work interference factors, the court determined that ―even if we assume that Richardson turned a particularly cold shoulder to Saxton after she rebuffed his advances, the evidence does not suggest that this behavior rendered her environment hostile. There is no evidence that this behavior interfered with Saxton‘s work.‖ [Saxton v. AT&T Co., 10 F. 3d 526 (7th Cir.)] Authors‘ Comment: Students may be asked if the decision would change if the case were evaluated under a reasonable-woman standard rather than a reasonable-person standard.

In a footnote, the court declined to address the appropriateness of evaluating the case from the standpoint of a reasonable woman as opposed to a reasonable person, stating that the result would be the same under either standard. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 38: Types of Business Organizations

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 369 Questions and Case Problems .......................................................................................................... 370 End of Chapter: CPA Questions and Answers ................................................................................. 377 Answers to AICPA Questions ............................................................................................................ 377

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Questions and Case Problems 1.

In July 2008 Miller Brewing Co. and Coors Brewing Co. formed a joint venture to better compete with the dominant beer manufacturer, Anheuser Busch. The venture was named ―MillerCoors LLC.‖ Under the joint venture agreement, Miller Brewing Co. and Coors Brewing Company have a 50 percent voting interest in the entity, and each appoints half of the directors. Moreover, the CEOs of Miller and Coors resolve disputes, and all revenues are distributed directly to Miller and Coors, with cash returned to meet the operating needs of the joint venture. Ohio law requires just cause for the termination of beer distributors but allows a ―successor manufacturer‖ to terminate existing distributorships without proving just cause so long as the predecessor does not exercise control over the successor. In accordance with the ―successor manufacturer‖ exception, MillerCoors LLC notified Ohio wholesale beer distributors that it was terminating their distributorships. The distributorships sought injunctive relief. MillerCoors LLC moved for summary judgment.

Decide. [Beverage Distributors, Inc. v. Miller Brewing Co., 690 F.3d 788 (6th Cir.)] Answer: Termination of franchises. Miller and Coors exercise control over the MillerCoors joint venture. From a commonsense standpoint, equal control is a form of control. Even though the formation papers indicated the joint venture was independent of the forming manufacturers, they had equal voting power, appointment of directors and control over revenues. It was thus not a ―successor‖ so as to allow termination without just cause or consent. [Beverage Distributors, Inc. v. Miller Brewing Co., 690 F. 3d 788 (6th Cir.)]

2.

Bader Farms brought suit against Monsanto and BASF Corporation, alleging that its peach trees were damaged extensively by a form of dicamba-based herbicides that drifted onto its orchards from neighboring fields. Some farms were immune from damage, but others, such as Bader, had used an older form of herbicide that put them at risk for damage.

According to Bader Farms, the defendants knew that the herbicide would drift and cause substantial plant damage. At trial, Bader Farms introduced internal documents that showed Monsanto and BASF anticipated the type of damage that would occur and ―conspired to create an ecological disaster‖ to increase profits on dicamba-tolerant seeds.

A jury returned a verdict of $265 million against the defendants, including $250 million in punitive damages. BASF stated that only Monsanto should be liable for the $250 million punitive damage portion of the verdict. The jury, however, found that BASF and Monsanto were involved in a joint venture. Are BASF and Monsanto jointly liable? [Bader Farms Inc. et al. v. Monsanto Co. et al., (E.D. Missouri)]

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Answer: Joint ventures. This case is one of several against Monsanto and BASF over the genetically modified seeds. Whether or not the companies conspired or worked together to promote the genetically modified herbicide to withstand dicamba is the key question to the joint venture issue. The plaintiffs maintain that ―There is no such thing as a nonvolatile dicamba herbicide—and defendants knew this.‖ The case has been appealed on a variety of issues. This is a good case for students to follow up on. [Bader Farms Inc. et al. v.

Monsanto Co. et al. (E.D. Missouri)] 3.

Morris Friedman was president of Tiny Doubles International, Inc. He sold business opportunities for Tiny Doubles Studios, which made small photographic statues of people for customers. Friedman was the primary negotiator with prospective buyers of these studio business opportunities. He advised buyers up front that the opportunities were not franchises, and, accordingly, he did not provide all of the information set forth in the disclosure rule on franchising, although he did provide full answers to all questions asked.

Many businesses closed, however, because of lack of success. The FTC claims that Friedman violated its disclosure rule. Friedman disagrees. Decide. [FTC v. Tiny Doubles Int’l, Inc., 1996 Bus. Franchise Guide (C.C.H.) ¶ 10,831] Answer: Franchises. Friedman need not call the business opportunities franchises for them to be labeled as such. The FTC was correct, and Friedman needed formal paperwork. [FTC v. Tiny Doubles Int'l, Inc., 1996 Bus. Franchise Guide (CCH) ¶ 10,831]

4.

in vending machines by taking out ads in newspapers throughout the country. When individuals responded, telemarketers called ―fronters‖ would tell them of false earnings estimates, and those who could afford $16,000 to $25,000 for vending machines were turned over to ―closers‖ who promised wonderful results. References were provided who were ―shills‖—they did not own vending machines but were paid to tell ―stories‖ that were monitored by Wolf, King, and other supervisors. None of the individuals was given franchise disclosure documents. King induced one investor to mortgage her house so that she could pay $70,000 for a number of vending machines. In three years Wolf, King, and others took in some $31.3 million. The FTC alleged that the defendants violated the FTC franchise disclosure rule.

Is there a franchise disclosure rule violation if Wolf and King were merely selling vending machines? What if Wolf and King promised exclusive territories for the machines? Why would a franchise disclosure rule be necessary in this case? Decide. [FTC v. Wolf, Bus. Franchise Guide ¶ 27,655 (C.C.H. D. Fla.)]

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Answer: Franchise disclosure rule. An argument could be made that the outright sale of vending machines does not amount to a franchise as defined in section 7 of the chapter.

However, Wolf and King's advertisements referred to buying a business ―opportunity." In fact, the evidence shows that "closers" were promising "very desirable territories to investors." Such is franchising; and franchise offering circulars were necessary under FTC and certain states rules. The totality of Wolf and King's misconduct is clear evidence of the need for mandatory disclosure rules. The court decided in favor of the FTC and a receiver was appointed to collect all of the defendants' assets up to $31,362,576 and provide redress to the investors. [FTC v. Wolf, Bus. Franchise Guide ¶ 27,655 (CCH D. Fla.)] 5.

Katherine Apostoleres owned the rights to Dunkin‘ Donuts franchises in Brandon and Temple Terrace, Florida. The franchisor offered all its franchisees the right to renew their existing franchise agreements if they agreed to abide by advertising decisions favored by two-thirds of the local franchise owners in a given television market. Apostoleres refused the offer because she did not want to be bound by the two-thirds clause. Soon thereafter, Dunkin‘ Donuts audited her two stores. Using a ―yield and usage‖ analysis, it concluded that gross sales were being underreported. Based on these audits and a subsequent audit, Dunkin‘ Donuts gave notice of immediate termination of Apostoleres‘s franchises, contending that the franchise agreement had been violated. Apostoleres stated that an implied obligation of good faith exists by operation of law in every contract and that the audits were in retaliation for her refusal to accept the renewal agreement. The yield and usage test used in the audit was not specified in the franchise agreement as a measure to be used to enforce the franchisor‘s rights, and certain accounting experts testified as to the unreliability of this test. Was Dunkin‘ Donuts liable for breach of its implied obligation of good faith in this case? [Dunkin’ Donuts of America v. Minerva, Inc., 956 F.2d 1566 (11th Cir.)] Answer: Termination of franchise contracts. The franchisor, Dunkin' Donuts, breached its implied obligation of good faith and fair dealing in conducting the audit of the franchisee‘s stores. Evidence suggested that the audits were substantially motivated by Apostoleres‘s refusal to subscribe to the franchise renewal agreement. Moreover, the method the franchisor used to audit the stores was not disclosed in the franchise agreements and was not an appropriate and reasonably accurate accounting tool to detect underreporting of sales, according to expert witnesses. [Dunkin' Donuts of America v. Minerva, Inc., 956 F. 2d 1566 (11th Cir.)]

6.

A woman claimed that she was sexually harassed by a male coworker at the franchisee‘s pizza store. She sued not only the harasser and the franchisee but also the franchisor,

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Domino‘s, claiming that the franchisor was the employer of those working for the franchisee and that the franchisee was the agent of the franchisor. The court recognized that the franchisor exerted control through ―comprehensive and meticulous standards for marketing its trademarked brand and operating its franchises in a uniform way.‖ Was Domino‘s vicariously liable for the conduct of the franchisee‘s employee? [Patterson v.

Domino’s Pizza, 333 P.3d 723 (S. Ct. Cal.)] Answer: Vicarious liability of franchisor. The court held that Domino‘s was not vicariously liable for the conduct of the franchisee‘s employee because it lacked the general control of an employer or principal over relevant day-to-day workplace behavior, including training, reporting, and discipline related to sexual harassment. The court cautioned, however, that it did not mean ―to imply that franchisors, including those of immense size, can never be held accountable for sexual harassment at a franchised location. A franchisor will be liable if it has retained or assumed the right of general control over the relevant day-to-day operations at its franchised locations . . . .‖ [Patterson v. Domino’s Pizza, 333 P. 3d 723 (S. Ct. Cal)] 7.

For a five-year period, Laurie Henry worked for James Doull, the owner of four Taco Bell franchises. During that time, she had an affair with Doull. He was the father of her two illegitimate children. Enraged over a domestic matter, Doull physically assaulted her at the Taco Bell Restaurant and then fired her and ordered her off the premises. Later, on Doull‘s recommendation, she was hired by a ―company store‖ in an adjoining state. Henry brought suit against Doull, his corporate entity Taco Tia, Inc., and the Taco Bell Corporation (TBC).

She did not characterize her suit as a case of sexual harassment. Rather, she contended that TBC was responsible for Doull‘s actions because he was TBC‘s agent. She sought damages for the loss of romantic and material satisfactions a person might expect from a traditional courtship and wedding. TBC denied that Doull was its employee or agent. The evidence showed that Henry knew that Doull‘s stores differed from TBC ―company‖ stores.

Henry insisted, having worked for four years for Doull at stores adorned with Taco-Bell signs, that Taco Bell was responsible for Doull‘s actions. Decide. [Henry v. Taco Tia, Inc., 606 So. 2d 1376 (La. App.)] Answer: Vicarious liability claims against franchisors. Judgment for Taco Bell Corporation.

Laurie Henry‘s employer, James Doull, was the franchise owner, not the franchisor, Taco Bell Corporation. She had actual knowledge that Doull was a franchisee, not an agent of Taco Bell Corporation. No basis exists to believe that Doull was an apparent agent of Taco Bell Corporation. [Henry v. Taco Tia, Inc., 606 So. 2d 1376 (La. App.)]

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8.

The Armory Committee was composed of officers from various National Guard units. It organized a New Year‘s Eve dance at a charge of $2 per person to defray costs. Perry, along with others, was a member of the Armory Committee. Libby was a paying guest at the dance who was injured by slipping on frozen ruts in the immediate approaches to the steps leading to the armory building where the dance was held. He sued Perry, Turner, and the other committee members. The evidence showed that every member of the committee had taken some part in planning or running the dance with the exception of Turner. Was the Armory Committee an unincorporated association or a joint venture? Decide. [Libby v.

Perry, 311 A.2d 527 (Me.)] Answer: Unincorporated associations; joint ventures. The Armory Committee was a voluntary unincorporated association with the nonprofit purpose of running this social function. It was not a joint venture for the chief reason that the committee did not seek to make a profit. Judgment was for Libby against the committee. The Armory Committee was negligent in not protecting guests from the ice. Liability rested only with those members who were shown to have actively participated in the planning and running of the dance.

Because Turner took no part in the planning or running of the dance, he was not liable.

[Libby v. Perry, 311 A. 2d 527 (Me.)]

9.

The Kawasaki Shop of Aurora, Illinois (dealer), advised Kawasaki Motors Corp. (manufacturer) that it intended to move its Kawasaki franchise from New York Street to Hill Avenue, which was in the same market area. The Hill Avenue location was also the site of a Honda franchise. The manufacturer‘s sales manager advised the dealer that he did not want the dealer to move in with Honda at the Hill Avenue site. In February, the dealer moved to the Hill Avenue location. Effective May 1, the manufacturer terminated the dealer‘s franchise. The dealer brought suit against the manufacturer under the state‘s Motor Vehicle Franchise Act, which made it unlawful to terminate franchises for site control (requiring that the dealer‘s site be used exclusively as a Kawasaki dealership). The manufacturer argued that it had a right to have its products sold by a dealer who was not affiliated with a competitor. Decide. [Kawasaki Shop v. Kawasaki Motors Corp., 544 N.E.2d 457 (Ill. App.)] Answer: Termination of franchises. Judgment for the dealer. The termination of the dealer because of the dealer‘s affiliation with a competitor, Honda, violated the site control provision of the Illinois Motor Vehicle Franchise Act. It makes good business sense for a manufacturer to have each dealer‘s site be used exclusively for its products. However, such a goal is contrary to the applicable state law. [Kawasaki Shop v. Kawasaki Motors Corp., 544 N.E. 2d 457 (Ill. App.)]

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10. Goodward, a newly hired newspaper reporter for the Cape Cod News, learned that the local cranberry growers had made an agreement under which they pooled their cranberry crops each year and sold them at what they determined to be a fair price. Goodward believes that such an agreement is in restraint of trade and a violation of the antitrust laws.

Is he correct?

Answer: Cooperatives. The local cranberry growers formed a sellers‘ cooperative; Goodward is correct in believing that such an agreement is in restraint of trade. However, such a cooperative does not violate the antitrust laws because of the Capper-Volstead Act of 1922, which expressly exempts the normal selling activities of farmers‘ cooperatives from the operation of the Sherman Antitrust Act, so long as the cooperatives do not conspire with outsiders to fix prices. Thus, Goodward is incorrect in believing that the cooperative violates the antitrust laws.

11. Food Caterers of East Hartford, Connecticut, obtained a franchise from Chicken Delight to use that name at its store. Food Caterers agreed to the product standards and controls specified by the franchisor. The franchise contract required the franchisee to maintain a free delivery service to deliver hot, freshly prepared food to customers. The franchisee used a delivery truck that bore no sign or name. Its employee, Carfiro, was driving the truck in making a food delivery when he negligently struck and killed McLaughlin. The victim‘s estate sued Chicken Delight on the theory that Carfiro was its agent because he was doing work that Chicken Delight required and that benefited Chicken Delight. Was Carfiro the agent of Chicken Delight? [McLaughlin’s Estate v. Chicken Delight, Inc., 321 A.2d 456 (Conn.)]

Answer: The franchisor and third persons. No. The fact that Carfiro was doing acts that would benefit Chicken Delight did not make him the agent of Chicken Delight. He was not the agent because there was no proof that Chicken Delight had any control over Carfiro.

[McLaughlin’s Estate v. Chicken Delight, Inc., 321 A. 2d 456 (Conn.)]

12. Donald Salisbury, William Roberts, and others purchased property from Laurel Chapman, a partner of Chapman Realty, a franchisee of Realty World. The purchasers made payments directly to Laurel Chapman at the Realty World office, and Chapman was to make payments on the property‘s mortgage. However, Chapman did not make the payments and absconded with the funds. Salisbury and Roberts sued the franchisor, Realty World, claiming that Realty World was liable for the wrongful acts of the apparent agent, Chapman. Realty World and Chapman Realty were parties to a franchise agreement stating

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that the parties were franchisor and franchisee. The agreement contained a clause that required Chapman to prominently display a certificate in the office setting forth her status as an independent franchisee. Chapman displayed such a sign, but the plaintiffs did not recall seeing it. Chapman Realty hires, supervises, and sets the compensation for all of its employees. The plaintiffs pointed out that Chapman Realty used the service mark Realty World on its signs, both outside and inside its offices. They pointed out that a Realty World manual sets forth the general standards by which franchisees must run their businesses and that this represents clear control over the franchise. They contended that, all things considered, Realty World held out Chapman Realty as having authority to bind Realty World. Realty World disagreed, stating that both were independent businesses.

Decide. [Salisbury v. Chapman and Realty World, Inc., 65 N.E.2d 127 (Ill. App.)] Answer: Franchisors and third parties. Judgment for Realty World. A declaration in a franchise agreement that a relationship is franchisor/franchisee and not principal/agent is not controlling when in fact there is a holding out to the public of the franchisee as an agent. However, in this case, the franchisee maintained its individual identity, supervised its own operations, hired its own employees, and established the terms of employment.

The facts did not support a determination that the franchisor had the requisite degree of control over the franchisee to establish an actual or apparent principal-agent relationship.

[Salisbury v. Chapman and Realty World, Inc., 65 N.E. 2d 127 (Ill. App.)] 13. Uber Technologies Inc. and Uber drivers challenged California‘s Assembly Bill 5 which makes it more difficult to classify workers as independent contractors. They claim that the law would throw gig economy businesses into chaos and that it unconstitutionally targets app-based companies. Uber claims that it faces an impossible choice between ―incurring enormous and unrecoverable costs of attempting to restructure their business models or facing enforcement actions and potential civil and criminal penalties.‖ The district court held that A.B. 5‘s classifications were legitimate and rational and that the plaintiffs would suffer no harm from its enforcement. According to the court, California‘s need to police worker misclassification outweighs any harm to the gig economy. Are Uber drivers independent contractors under California‘s ABC test? Do they have a valid argument that the law should not apply to them? [Olson et al. v. State of California, 2020 U.S. Dist. LEXIS 34710 (C.D. Cal.)] Answer: Misclassification of workers. The Dynamex decision that A.B. 5 enshrined in law adopted a stricter three-prong test, known as the ABC test, which presumes that all workers are employees unless a business can show the worker is free from its supervision, performs work that is outside the usual course or place of business, and works "in an

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independently established trade, occupation or business of the same nature" as the work they do for the entity that is hiring them.

"The legislative history makes clear that A.B. 5 seeks to remedy the widespread misclassification of workers as independent contractors, which the Legislature determined 'has been a significant factor in the erosion of the middle class and the rise in income inequality,'" the state argued. "The Legislature wanted to ensure that workers were afforded the appropriate protections under state law, including minimum wage, workers' compensation, unemployment insurance, paid sick leave, and paid family leave."

The case is on appeal to the Ninth Circuit. [Olson et al. v. State of California, 2020 U.S. Dist.

LEXIS 34710 (C.D. Cal.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

A joint venture is a(an): a.

Association limited to no more than two persons in business for profit.

b.

Enterprise of numerous co-owners in a nonprofit undertaking.

c.

Corporate enterprise for a single undertaking of limited duration.

d.

Association of persons engaged as co-owners in a single undertaking for profit.

[return to top] Answers to AICPA Questions 1.

A joint venture is a(an): a.

Association limited to no more than two persons in business for profit.

b.

Enterprise of numerous co-owners in a nonprofit undertaking.

c.

Corporate enterprise for a single undertaking of limited duration.

d.

Association of persons engaged as co-owners in a single undertaking for profit.

(d) A joint venture resembles a partnership, except that it is formed for only one transaction (or in some cases, a limited number of transactions). Answer (a) is incorrect because it is possible to have more than two persons as part of the joint

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venture. Answer (b) is incorrect because a joint venture is a for-profit undertaking, not a nonprofit undertaking. Answer (c) is incorrect because a joint venture is treated as a partnership and not as a corporate enterprise. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 39: Partnerships

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 378 Questions and Case Problems .......................................................................................................... 378 End of Chapter: CPA Questions and Answers ................................................................................. 384 Answers to AICPA Questions ............................................................................................................ 385

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Ford and Mitcham were partners engaged in construction. Ford was killed at work. His widow made a claim for workers‘ compensation against the partnership. Mitcham opposed the claim on the ground that Ford was a partner, not an employee. Is the widow entitled to workers‘ compensation? [Ford v. Mitcham, 298 So. 2d 34 (Ala. App.)] Answer: Definition of a partnership. Workers‘ compensation was denied. A partner is not an employee. The essential element of an employment relationship is the right of the employer to control the employee. A partner is not subject to the control of the partnership in the same sense as an employee is not an ―employee‖ of the partnership for the purpose of workers‘ compensation. [Ford v. Mitcham, 298 So. 2d 34 (Ala. App.)]

2.

Baxter, Bigelow, Owens, and Dailey were partners in a New York City advertising agency.

Owens, who was in poor health and wanted to retire, advised the partners that she had assigned her full and complete interest in the partnership to her son, Bartholomew, a highly qualified person with 10 years of experience in the advertising business. Baxter, Bigelow, and Dailey refused to allow Bartholomew to attend management meetings and

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refused his request to inspect the books. Bartholomew pointed out that his mother had invested as much in the firm as any other partner. He believed, as assignee of his mother‘s full and complete partnership interest, that he is entitled to (a) inspect the books as he sees fit and (b) participate fully in the management of the firm. Was Bartholomew correct?

Answer: Assignment of partner‘s interest. No. Bartholomew is an assignee and is entitled to receive only a partner‘s share of the profits during the continuance of the firm and the assignor‘s interest on dissolution. The assignee has no right to inspect the books or to participate in management. An assignee may, however, become a partner, with the consent of all the other partners. Consent was not present in this case.

3.

Amy Gargulo and Paula Frisken operated as a partnership Kiddies Korner, an infants‘ and children‘s clothing store. They operated the business very successfully for three years, with both Paula and Amy doing the buying and Paula keeping the books and paying the bills.

Amy and Paula decided to expand the business when an adjoining store became vacant.

At the same time, they incorporated the business. Children‘s Apparel, Inc., was a major supplier to the business before the expansion. After the expansion, business did not increase as anticipated, and when a nationally known manufacturer of children‘s apparel opened a factory outlet nearby, the business could no longer pay its bills. Children‘s Apparel, which had supplied most of the store‘s stock after expansion, sued Amy and Paula as partners for bills due for expansion stock. Children‘s Apparel did not know that Amy and Paula had incorporated. Amy and Paula contended that the business was incorporated and that they therefore were not liable for business debts occurring after incorporation. Were Amy and Paula correct?

Answer: Notice of dissolution of partnership to third persons. No. Amy and Paula will not be able to avoid personal liability in a suit brought by Children‘s Apparel, Inc., because they dealt with Children‘s Apparel prior to dissolution of the partnership and gave it no notice of the dissolution of the partnership and the change to the corporate form of organization. Having done business originally with Amy and Paula as a partnership, Children‘s Apparel, Inc., can hold Amy and Paula liable as partners until notice to the contrary is given.

4.

Calvin Johnson and Rudi Basecke did business as the Stockton Cheese Co., a partnership, which owned a building and equipment. The partners agreed to dissolve the partnership but never got around to completing the winding-up process. Calvin continued to use the building and to pay insurance on it but removed Rudi‘s name as an insured on the policy.

When the building was later destroyed by fire, Calvin claimed the proceeds of the fire

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insurance policy because he and his wife were the named insureds on the policy and they had paid the premiums. Rudi claimed that although the partnership was dissolved before the fire, the winding up of the partnership was not completed at the time of the fire. He therefore claimed that he was entitled to half of the net proceeds of the policy. Decide.

[State Casualty v. Johnson, 766 S.W.2d 113 (Mo. App.)] Answer: Effect of dissolution. Judgment for Rudi Basecke. The building was partnership property, even though the parties had ceased joint operation of the partnership cheese business and had dissolved the partnership five years earlier. A partnership is not terminated by a delay in the winding-up process. It was breach of Johnson‘s fiduciary duty to Basecke to eliminate him as a named insured without giving him notice. The partners had an equal interest in the partnership property and were entitled to an equal share of the insurance proceeds. [State Casualty v. Johnson, 766 S.W. 2d 113 (Mo. App.)] 5.

Samuel Shaw purchased a ticket through Delta Airlines to fly a ―Delta Connection‖ flight on SkyWest Airlines to Elko, Nevada. He was seriously injured when the SkyWest plane crashed near Elko. SkyWest‘s relationship with Delta was a contractual business referral arrangement, whereby Delta benefits through its charges for issuing tickets to connecting passengers to and from smaller communities, and SkyWest benefits from revenue generated by passengers sent to it by Delta. Both firms make a profit from this arrangement. SkyWest and Delta are often mentioned together by Delta in national print advertisements. Shaw believed that regardless of how the airlines characterize themselves, these airlines are in fact partners because they share profits from their combined efforts.

Delta contended that it had no control over SkyWest‘s airplane operations and that sharing profits as compensation for services does not create a partnership. Decide. [Shaw v. Delta Airlines, Inc., 798 F. Supp. 1453 (D. Nev.)] Answer: Determining the existence of a partnership. Delta and SkyWest are not partners.

The agreement between Delta and SkyWest indicates no desire to engage in a business as risk-sharing partners with joint control over the enterprise. It is true that both parties expected to make a profit from the enterprise; however, a person ―who has no proprietary interest in a business except to share profits as compensation for services is not a partner.‖ In this case, SkyWest certainly did not have joint control over the operations of Delta. Nor did SkyWest directly participate in the profits or losses of the Delta Corporation. However, the court held that a jury must consider the issue of apparent authority and a partnership by estoppel or implication. [Shaw v. Delta Airlines, Inc., 798 F. Supp. 1453 (D. Nev.)]

6.

Two brothers, Eugene and Marlowe Mehl, formed a partnership to operate the family

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farm. One year, Eugene Mehl withdrew $7,200 from the partnership account and bought the Dagmar Bar. The warranty deed and the liquor license to the bar were obtained in the names of Eugene Mehl and his wife, Bonnie. In a subsequent lawsuit, Marlowe claimed that the bar was a partnership asset. Decide. [Mehl v. Mehl, 786 P.2d 1173 (Mont.)]

Answer: Partnership property. Judgment for Marlowe. The bar had been purchased with partnership funds and therefore belonged to the partnership. There was no agreement of the partnership that Eugene and his wife could acquire title. [Mehl v. Mehl, 786 P. 2d 1173 (Mont.)]

7.

Summers and Dooley formed a partnership to collect trash. Summers became unable to work and he hired a third man to do his work and paid him out of his personal funds.

Summers suggested to Dooley that the third man be paid from the partnership funds, but Dooley refused to do so. Summers sued Dooley for reimbursement of the money he spent to pay the third man. Decide.

Answer: Authority of partners. Judgment for Dooley. Summers had no authority to employ the third man at the expense of the firm. Because the partners were evenly divided on the question of such employment, Summers had no authority to act. [Summers v. Dooley, 481 P. 2d 318 (Idaho)]

8.

Friedman, the ―O‖ Street Carpet Shop, Inc., and Langness formed a partnership known as NFL Associates. ―O‖ Street Carpet‘s net contribution to capital was $5,004; Langness contributed $14,000 in cash; and Friedman contributed his legal services, on which no value was placed by the articles of partnership. The articles stated that Friedman was entitled to 10 percent of the profits and that Langness was to receive payments of $116.66 per month. The partnership‘s accountant treated the payments to Langness as a return of her capital. Years later, the partnership sold the rental property owned by the partnership, and the partnership was wound up. Friedman claimed that he was entitled to 10 percent of the partnership capital upon dissolution. Langness claimed that Friedman was not entitled to a capital distribution and that the monthly payments to her should not have been treated as a return of capital. Decide. [Langness v. ―O‖ Street Carpet, Inc., 353 N.W.2d 709 (Neb.)] Answer: Distribution of assets. Judgment for Langness. A partner who contributes only services to the partnership is not deemed to have made a capital contribution. Thus, Friedman was not entitled to be credited with 10 percent of the partnership capital on dissolution. The monthly checks to Langness of $116.66 were considered capital

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withdrawals, reducing Langness‘s capital contribution. [Langness v. "O" Street Carpet, Inc., 353 N.W. 2d 709 (Neb.)] 9.

Ross, Marcos, and Albert are partners. Ross and Marcos each contributed $60,000 to the partnership; Albert contributed $30,000. At the end of the fiscal year, distributable profits total $150,000. Ross claims $60,000 as his share of the profits. Is he entitled to this sum?

Answer: Division of profits. No. In the absence of any contrary provision in the partnership agreement, partners share profits equally; so, each partner in the described situation is entitled to $50,000. Ross‘s claim is that profits are to be distributed in the same ratio as contributions. Contributions were made in the ratio of 2:2:1, so on that basis, Ross would be entitled to two-fifths, or $60,000. This could be expressly authorized by the partnership agreement, but if the partnership agreement contains no such proration provision, an equal division of profits is to be made.

10. Leland McElmurry was one of three partners of MHS Enterprises, a Michigan partnership.

Commonwealth Capital Investment Corp. sued the partnership and obtained a judgment of $1,137,285 against it, but the partnership could not pay the judgment. Commonwealth then sued McElmurry for the entire debt on the theory that, as a partner of MHS, he was liable for its debts. What, if any, is McElmurry‘s liability? [Commonwealth Capital Investment Corp. v. McElmurry, 302 N.W.2d 222 (Mich. App.)] Answer: Extent of partner‘s liability. Partners are jointly liable for debts and obligations of the partnership (UPA § 15). Where no partnership assets remain to satisfy the judgment, as in this case, the judgment creditor may enforce the claim against any of the individual partners. McElmurry has the right to contribution from the other partners. Or McElmurry could have insisted that the other partners be added to the lawsuit as codefendants and that they all be sued together, with the court setting forth the individual amounts due from each partner to satisfy each partner‘s joint partnership obligation. [Commonwealth Capital Investment Corp. v. McElmurry, 302 N.W. 2d 222 (Mich. App.)] 11. Thomas Smith and Jackie Lea were partners in the logging business. In January 1981, they joined Gordon Redd and went into business running a sawmill, calling the business Industrial Hardwood Products (IHP). Smith and Lea used their logging equipment at the mill site. Smith hauled 400 loads of gravel, worth some $26,000, from his father‘s land for the mill yard in the process of getting the mill operational. Smith and Lea received $300 a week compensation for their work, which was reported on federal W-2 forms. They worked up to 65 hours per week and were not paid overtime. All three discussed business

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decisions. Smith and Lea had the authority to write checks and to hire and fire employees.

Lea left the business in 1983 and was paid $20,000 by Redd. The testimony indicated that the three individuals agreed in January 1981 that as soon as the bank was paid off and Redd was paid his investment, Lea and Smith would be given an interest in the mill. No written agreement existed. Redd invested $410,452 in the business and withdrew $500,475 from it. As of December 31, 1986, IHP had sufficient retained earnings to retire the bank debt. In April 1987, Smith petitioned the Chancery Court for dissolution of the ―partnership‖ and an accounting. Redd denied that any partnership agreement was formed and asserted that Smith was an employee because he was paid wages. He offered to pay Smith $50,000 for the gravel and use of his equipment. Decide. [Smith v. Redd, 593 So. 2d 989 (Miss.)]

Answer: Determining the existence of a partnership. Judgment for Smith. The fact that Smith received wages does not per se defeat the existence of a partnership and the position that Smith was a partner. Smith worked long hours, sometimes 25 overtime hours in a week without pay, to establish the business and to pay off debts. Other facts, such as the control exercised by Smith, the admission of Redd that an ownership interest was intended, the contribution of $26,000 worth of gravel to the firm, and the prior payment of $20,000 to buy out Lea‘s interest, indicated that Smith was a partner. [Smith v. Redd, 593 So. 2d 989 (Miss.)]

12. Mason and Phyllis Ledbetter operated a business in Northbrook, Illinois, as a partnership called Ledbetters‘ Nurseries that specialized in the sale of garden lilies. The grounds of the nurseries were planted with numerous species of garden lilies, and hundreds of people toured the Ledbetters‘ gardens every day. After a tour, Sheila Clark offered to buy the facilities at a ―top-notch price.‖ Mason felt he could not refuse the high offer, and he signed a contract to sell all the facilities, including all flowers and the business name.

When Phyllis refused to go along with the contract, Clark sued the Ledbetters‘ Nurseries partnership, seeking to obtain specific performance of the sales contract. Decide.

Answer: Prohibited transactions for partners. Judgment for the partnership. The act of one partner in making a contract in carrying on the business of the partnership may be binding on the partnership under UPA § 9(1). However, the transaction in the instant case did not carry on the business of the partnership but was the sale of the business itself. Under UPA § 9(2), such a transaction is not binding on the partnership unless it is authorized by all partners. Because Phyllis did not authorize Mason to sell the business, the transaction was not binding.

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13. St. John Transportation Co., a corporation, made a contract with the partnership of Bilyeu and Herstel, contractors, by which the latter was to construct a ferryboat. Herstel, a member of the firm of contractors, executed a contract in the firm name with Benbow for certain materials and labor in connection with the construction of the ferryboat. In an action brought by Benbow to enforce a lien against the ferryboat, the James Johns, it was contended that all members of the firm were bound by the contract made by Herstel. Do you agree? [Benbow v. The Ferryboat James Johns, 108 P. 634 (Or.)] Answer: Nature and extent of partner‘s liability. Yes. All members of the firm are liable on contracts made by a partner for the partnership in the firm name if such contracts are made within the scope of the partner‘s actual or apparent power. [Benbow v. The Ferryboat James Johns, 108 P. 634 (Or.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Acorn and Bean were general partners in a farm machinery business. Acorn contracted, on behalf of the partnership, to purchase 10 tractors from Cobb Corp. Unknown to Cobb, Acorn was not authorized by the partnership to make such contracts. Bean refused to allow the partnership to accept delivery of the tractors, and Cobb sought to enforce the contract. Cobb will: a.

Lose, because Acorn‘s action was beyond the scope of Acorn‘s implied authority.

b.

Prevail, because Acorn had implied authority to bind the partnership.

c.

Prevail, because Acorn had apparent authority to bind the partnership.

d.

Lose, because Acorn‘s express authority was restricted, in writing, by the partnership agreement.

2.

Upon dissolution of a general partnership, distributions will be made on account of: I.

Partners‘ capital accounts.

II.

Amounts owed partners with respect to profits.

III. Amounts owed partners for loans to the partnership in the following order: a.

III, I, II

b.

I, II, III

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3.

c.

II, III, I

d.

III, II, I

Which of the following statements is correct with respect to a limited partnership? a. A limited partner may not be an unsecured creditor of the limited partnership.

4.

b.

A general partner may not also be a limited partner at the same time.

c.

A general partner may be a secured creditor of the limited partnership.

d.

A limited partnership can be formed with limited liability for all partners.

When a partner in a general partnership lacks actual or apparent authority to contract on behalf of the partnership, and the party contracted with is aware of this fact, the partnership will be bound by the contract if the other partners: Ratify the Contract

Amend the Partnership Agreement

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

[return to top] Answers to AICPA Questions 1.

Acorn and Bean were general partners in a farm machinery business. Acorn contracted, on behalf of the partnership, to purchase 10 tractors from Cobb Corp. Unknown to Cobb, Acorn was not authorized by the partnership to make such contracts. Bean refused to allow the partnership to accept delivery of the tractors, and Cobb sought to enforce the contract. Cobb will: a.

Lose, because Acorn‘s action was beyond the scope of Acorn‘s implied authority.

b.

Prevail, because Acorn had implied authority to bind the partnership.

c.

Prevail, because Acorn had apparent authority to bind the partnership.

d.

Lose, because Acorn‘s express authority was restricted, in writing, by the partnership agreement.

(c) In a general partnership, any partner may bind the partnership and other partners to all transactions within the apparent scope of the partnership business. Each partner

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Solution and Answer Guide:

is an agent for the other partners and for the partnership and may bind the partnership based upon apparent authority, such as what is customary in the business or by previous dealings. Note how there is no apparent authority if the third party is aware of the partner‘s limitation, and there is no apparent authority to transact business outside the normal scope of the business. Answer (c) is correct because a partner would have apparent authority to do normal partnership business, such as order tractors for a farm machinery business. Answers (a) and (b) are incorrect because there can be no implied authority if there is no actual authority.

Answer (d) is incorrect because express limitations in a partnership agreement have no bearing on apparent authority unless the third party was aware of the limitation.

2.

Upon dissolution of a general partnership, distributions will be made on account of: I.

Partners‘ capital accounts.

II.

Amounts owed partners with respect to profits.

III. Amounts owed partners for loans to the partnership in the following order: a.

III, I, II

b.

I, II, III

c.

II, III, I

d.

III, II, I

(a) Under the UPA, the order of distribution is: outside creditors; partners‘ advances; capital contributions and then profits.

3.

Which of the following statements is correct with respect to a limited partnership? a.

A limited partner may not be an unsecured creditor of the limited partnership.

b.

A general partner may not also be a limited partner at the same time.

c.

A general partner may be a secured creditor of the limited partnership.

d.

A limited partnership can be formed with limited liability for all partners.

(b) It is permissible for a general partner to be a secured creditor of the limited partnership. Answer (a) is incorrect because a limited partner may loan money to and transact other business with a partnership. Answer (b) is correct because a general partner may be a limited partner at the same time. Answer (c) is incorrect because security would eliminate the general partners personal liability. Answer (d) in incorrect because only limited partners have limited liability; the general partners are personally liable for the partnership debts.

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386

Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 40: LPs, LLCs, and LLPs

4.

When a partner in a general partnership lacks actual or apparent authority to contract on behalf of the partnership, and the party contracted with is aware of this fact, the partnership will be bound by the contract if the other partners: Ratify the Contract

Amend the Partnership Agreement

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

(a) If the third party knows of the limitation, the third party does not have the right to enforce it. Changing the partnership agreement retroactively will not solve the issue.

The answer is ratification and ratification only. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 40: LPs, LLCs, and LLPs

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 387 Questions and Case Problems .......................................................................................................... 387 End of Chapter: CPA Questions and Answers ................................................................................. 395 Answers to AICPA Questions ............................................................................................................ 395

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

What is the principal advantage of an LLP over an LLC? Answer: LLC v. LLP. The principal advantage of an LLP over an LLC is that existing

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Solution and Answer Guide:

traditional general partnerships can be converted into LLPs with limited liability features without redrafting and renegotiating the underlying agreement.

2.

The Gardners sued on behalf of their young child who was injured at Henderson Water Park. The Gardners sued both Henderson Water Park, LLC and seven members of the LLC as individuals. The Gardners alleged the members were negligent and contributed to the child‘s injuries because of inadequate lifeguard staffing. The LLC members claimed that they were not individually liable for the negligence and that the alter ego theory did not apply to LLCs. [Gardner v. Eighth Judicial Dist. Court of State, 405 P.3d 651 (Nev.)] Answer: Liability of members and of an LLC. The Supreme Court of Nevada held that the members could be liable. States have consistently applied the alter ego doctrine to LLCs. The court noted that no member or manager is vicariously liable for the obligations of the LLC solely by reason of being a member or manager. And the statute protects members and managers only from individual liability resulting from the debt and liabilities of the LLC not liabilities incurred as a result of an individual act In this case there was evidence that the managers had authority and control over the Water Park and therefore owed personal duties to their patrons that they intentionally and willfully breached. [Gardner v.

Eighth Judicial Dist. Court of State, 405 P.3d 651 (Nev.)]

3.

Alan Waung, a Hong Kong businessperson, purchased a golf course in Saginaw, Michigan, as an investment. As an avid golfer, Alan anticipates spending several weeks during the year at his ―Northern Pines‖ course. He has been informed that a Subchapter S corporation would allow him and his family-member shareholders to be treated as partners for U.S. tax purposes while retaining the limited liability of the corporate form. Advise Mr. Waung on this matter. What form of business organization would you recommend?

Answer: Application of Subchapter S Corporations to aliens; alternative forms of business organizations. Alan has received inaccurate information about the use of the subchapter S form to his situation. One must be a U.S. citizen or a resident alien to use this form. Alan is neither a U.S. citizen nor a resident alien. The LLC form of business organization will give Alan the limited liability he seeks and the tax treatment as a partnership. This is the form to be recommended.

4.

Kate Haley, an experienced builder, formed a limited partnership in August 2011, along with two limited partners, Drs. Growbioski and Gailen, who each provided $100,000 to the partnership for initial capital for the construction of a medical office building near Stowe, Vermont. With the bustle of getting building and environmental permits and placating

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Solution and Answer Guide:

abutters to the property, as well as lining up suppliers and subcontractors and getting the job started, Kate simply did not find an opportunity to take the long drive to file the certificate of limited partnership with the Secretary of State‘s office in Montpelier. A confluence of bad weather, an accident causing serious personal injury, financing disappointments, labor difficulties, design problems, and some personal problems resulted in the project being stopped before completion with some $550,000 in overdue bills. Dr. Growbioski has been approached by several suppliers and craftsmen seeking payment for supplies and work performed. As a limited partner, he believes that he is not liable for firm debts beyond his investment, which was $100,000. Explain to Dr. Growbioski his obligations at this point.

Answer: Filing a certificate of limited partnership. Since the certificate of limited partnership was not filed with the secretary of state's office as required by the state limited partnership act, a limited partnership was not formed. Kate's failure was not a mere technical defect in the certificate. She simply failed to file. As a result, all participants have status and liability of general partners in a general partnership. Dr. Growbioski's liability is thus not limited to his $100,000 investment. As such all partners are jointly liable on all firm debts and Dr. Growbioski's personal assets are at risk. There is obviously some equity in the partially completed building that may be sold to reduce the amount owed by the partnership.

5.

Sabastian Hafner joined a start-up business with a business plan focused on making breads without common food allergens, such as wheat, yeast, dairy, and gluten, to be marketed in a major metropolitan area. The five founders of the business, including Sabastian, selected the limited liability company (LLC) as their form of business organization. The Articles of Organization for the limited liability company were duly filed with the Secretary of State. The Operating Agreement simply provided that founding member Jillian Lopez would be the sole manager of the firm, and it set a salary for her at $40,000 per year. She hired employees to perform production, delivery, and sales work.

Sabastian and the other three members spent nights and early mornings ―pitching in‖ at the bakery. After two months of diligent work, Sabastian, a second-year MBA student, sought back pay for the 40 hours each week he spent at the bakery during the previous eight weeks. He pointed out to the other members of the LLC that state law authorizes employees to sue for their wages. What are Sabastian‘s rights regarding pay for the service he performed for the LLC? Answer: Pay for members of LLC for services rendered the company. A member of an LLC is not entitled to compensation for services performed by an LLC unless it is stipulated in the

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Solution and Answer Guide:

Operating Agreement. Jillian Lopez is the only member entitled to a salary under the Operating Agreement. Members like Sabastian receive profits and losses according to the terms of the Operating Agreement. He is not an employee and does not have rights under state "improperly withheld wages" laws.

6.

Hurwitz and Padden practiced law as equal partners for a short period of time before converting to an LLC. Some three years later, Padden informed Hurwitz that he intended to leave the firm. When they could not agree on how to divide $200,000 in fees relating to work acquired before the dissolution of the LLC, Hurwitz filed suit seeking an equal division of the fees under partnership principles. Padden contended that partnership principles should not apply to the dissolution of an LLC even though the state‘s LLC law incorporated the definition and use of the term dissolution from the UPA. Decide. [Hurwitz v. Padden, 581 N.W.2d 359 (Minn. App.)] Answer: Application of partnership principles to an LLC. The fact that the LLC did not have a written operating agreement dealing with the division of contingency fees upon dissolution, nor was there an oral agreement on this matter, required the court to apply the term "dissolution" according to partnership principles. The state's LLC statute incorporated the term "dissolution" from the UPA. The court divided the fees equally under partnership principles since the work was acquired before dissolution. [Hurwitz v.

Padden, 581 N.W. 2d 359 (Minn. App.)]

7.

Don Mason and Beth Daley were managers and members of Pacific Beach Developers, LLC (PBD), a start-up real estate development company focusing on rehabilitating older properties for increased rental values and possible resale. Daley made a contract with San Diego Architects Associates (SDAA) to provide plans for the rehabilitation of a 60-unit building on Ingraham Street for $97,000, signing the contract ―Beth Daley, manager P.B.D. LLC.‖ Financing for the Ingraham Street property fell through, and PBD‘s option on the property expired. Although Daley notified SDAA that the ―Ingraham Street deal was off,‖ SDAA had nearly completed its work, and SDAA brought suit for the contract price against both the LLC and Beth Daley. At the point the lawsuit was initiated, PBD had no working capital remaining, and Don and Beth had ―moved on,‖ having taken jobs as mutual fund salespersons. Advise Beth of her legal obligations to SDAA. Answer: Liability of members and of an LLC. Beth made the contract with SDAA as an agent for the limited liability company, PBD LLC. She signed the contract with SDAA ―Beth Daley, manager PBD, LLC‖, fully disclosing that she was acting as an agent for the LLC. An agent is not liable for the contracts made on behalf of a disclosed principal. Beth is not

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Solution and Answer Guide:

personally liable beyond her investment in the LLC simply because she was a member (owner) of the LLC. The limited liability company form of business entity provides for no liability for members beyond their investment in the firm. Beth cannot be held personally liable for the contract with SDAA. 8.

John and Amelia have general commitments from a number of individuals to invest in their Sproondrift Cove Club golf course and distinctive residential community in Duval County. John wants to form a limited partnership. He realizes that every limited partnership must have a general partner who manages the business and is subject to unlimited liability for all debts and liabilities of the limited partnership. But he says that is no problem because the general partner can be a corporation and can limit its liability exposure by simply creating a ―shell‖ corporation. John stated to Amelia, ―As officers of the corporate general partner, you and I can operate the business without the limited partners interfering . . . we run the show!‖ Amelia responded, ―John, what you propose seems so very complicated, risky, and expensive. A number of our investors are relatives who may want to be listened to, and some of our investors are professionals who could give us some valuable advice. Maybe a limited liability company would be a better entity for us.‖ Compare the advantages and disadvantages of an LLC with a limited partnership and recommend the most appropriate form of business organization for this venture.

Answer: LLC distinguished from a limited partnership. Generally, none of the owners of an LLC are personally liable for the entity‘s debts while general partners in a limited partnership have personal liability for partnership debts and liabilities.

Limited partners cannot participate in the management of the partnership except certain ―safe harbor‖ activities under the RULPA, such as being an employee of the general partnership. All owners of an LLC may participate in the entity‘s management. John is correct in his statement that the general partner of a limited partnership may be a corporation, but there is potential liability exposure if partnership creditors pierce the corporate veil of the corporate general partnership because the corporation was a ―shell‖ with grossly inadequate capitalization. Moreover, if a limited partner becomes actively involved in management, the limited partner could be found liable as a general partner.

The legal cost in organizing a limited partnership should be greater than the legal costs in organizing an LLC because of the need to file documents not only establishing the limited partnerships but also the documents establishing the corporation to serve as corporate general partner. It is less complicated and expensive regarding professional fees and organizational and annual maintenance fees for an LLC rather than a limited partnership

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Solution and Answer Guide:

with a corporate general partner. The limited partnership with a corporate general partner must file additional tax returns, maintain additional books and records, and comply with corporate formalities.

A ―Duval County‖ exists in Florida, a state which imposes an annual intangible asset tax on the value of intangible assets held by a Florida resident as of January 1 of each year (Fla. Stat §§ 199.032 and 199.103). The tax rate is $1.50 per $1000 of value. An LLC is subject to this state tax while a limited partnership that is not publicly traded is not subject to this tax. If John and Amelia‘s entity will own significant equity this tax may compel that the limited partnership form of entity be selected over an LLC. The decision on whether to use an LLC or a limited partnership form is a complex one, sometimes turning on taxation matters.

If taxation is not an issue, the LLC form appears to be the most advantageous form of entity for John and Amelia‘s business.

9.

Hacienda Farms, Ltd., was organized as a limited partnership with Ricardo de Escamilla as the general partner and James L. Russell and H. W. Andrews as limited partners. The partnership raised vegetables and truck crops that were marketed principally through a produce concern controlled by Andrews. All three individuals decided which crops were to be planted. The general partner had no power to withdraw money from the partnership‘s two bank accounts without the signature of one of the limited partners. After operating for some seven and one-half months under these procedures, the limited partners demanded that the general partner resign as farm manager, which he did. Six weeks later, the partnership went into bankruptcy. Laurance Holzman, as trustee in bankruptcy, brought an action against Russell and Andrews, claiming that they had become liable to the creditors of the partnership as general partners because they had taken part in the control of the partnership business. How would you decide the case under the ULPA? Would the outcome be different under the RULPA? [Holzman v. de Escamilla, 195 P.2d 833 (Cal. App.)] Answer: Management and control of the firm. Judgment against Russell and Andrews under both the ULPA and the RULPA. The limited partners, Russell and Andrews, took part in the control of the business of the partnership and thus became liable as general partners under the ULPA. Russell and Andrews were active in dictating the crops to be planted. The banking procedures of the partnership were such that the general partner had no power to withdraw money from firm accounts without the signature of either Russell or Andrews. Furthermore, Russell and Andrews required the general partner to

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Solution and Answer Guide:

resign as manager, and they selected his successor.

Even under the RULPA, the activities of Russell and Andrews were not such as to bring them within the safe harbors provisions of the RULPA. In exercising control over the business, they did not act as contractors, agents, or employees of the limited partnership or the general partner; nor did they consult with and advise the general partner. [Holzman v. de Escamilla, 195 P. 2d 833 (Cal. App.)] 10. Jerome Micco was a major shareholder and corporate officer of Micco and Co., Inc., which was a limited partner in Harbor Creek, Ltd., a limited partnership formed to build a condominium complex. Hommel, an electrical contractor, was the successful bidder on certain electrical work for the project. For several months, Hommel worked under the direction of the construction supervisor and was paid by the limited partnership for his work. Because of financial difficulties, the supervisor was released. Thereafter, Jerome Micco played a major role in the building of the project, directing the work to be performed. Hommel submitted payment invoices directly to Micco. When Hommel was not paid, he sued Micco, contending that Micco was a limited partner who ran the operation personally and was personally responsible for the debt. Micco argued that he was an employee or agent of a corporation (Micco and Co., Inc.) and thus could not be held liable for the debt. The evidence reveals that Micco had no occasion to tell Hommel that he was acting as a corporate officer. Is it ethical for a corporate officer and shareholder to seek to avoid individual liability in this case? How would you decide the case? [Hommel v. Micco, 602 N.E.2d 1259 (Ohio App.)] Answer: Business ethics [Preface]; limited partnership, control of firm. It is true that under the RULPA, a number of safe harbors exist for limited partners to engage in certain activities without losing their protection from liability. Micco‘s role changed drastically with the progression of events, and after the construction supervisor was fired, he took over the control of the project. It does not appear to be within the ethical principles of integrity and fairness for a corporate officer and shareholder to fail to indicate to a subcontractor that he is acting on behalf of a corporation. After the changed circumstances that occurred with the dismissal of the superintendent, Hommel did work for Micco, who was now in control of the project, and he submitted invoices directly to him. Hommel was entitled under limited partnership law to presume that Micco would now be liable for the debts of the limited partnership. The failure of Micco to tell Hommel that he was acting as a corporate employee or agent exposed Micco to individual liability, just like an agent who fails to tell a third person that the agent is acting for a principal is liable to the third person on a contract. [Hommel v. Micco, 602 N.E. 2d 1259 (Ohio App.)]

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11. Peter Kertesz formed an LLC and operated it in South Florida under the business name ―Mourning Flowers.‖ The LLC specialized in the sale of flowers to funeral homes. Although Kertesz was initially the only member and manager, he ultimately granted ownership interests totaling 55 percent of the LLC to six individuals. In mid-2007, the members had a falling out that culminated in the majority removing Kertesz as managing member. Kertesz alleged that shortly after this, the LLC‘s distributors and clients ―threatened to terminate their relationship with the LLC if Kertesz was not brought back into the operations of the LLC.‖ These actions, Kertesz claimed, caused the LLC to suffer irreparable harm. Kertesz sought the judicial dissolution of the LLC on the basis of these circumstances and an alleged deadlock in management of the LLC. He sought the appointment of a receiver to protect the assets and goodwill of the LLC. What relief, if any, is Kertesz entitled to?

[Kertesz v. The Spa Floral, LLC, 994 So. 2d 473 (Fla. App.)] Answer: Governance and operation of an LLC in the absence of other written terms.

Judgment against Kertesz. He had no majority. The majority members had the absolute right to replace this managing member. A ―deadlock,‖ like its cousin ―gridlock,‖ is a standstill caused by the opposition of persons or of factions. Here there was no impasse; the majority interest holders voted, and Kertesz lost. That the LLC lost business and opportunities because of his removal, calls into question the wisdom or business judgment of the majority. But it is not actionable. [Kertesz v. The Spa Floral, LLC, 994 So. 2d 473 (Fla. App.)] 12. Thomas Banner assigned his voting rights and his right to receive distributions in the Hut at Avon, LLC, to Elizabeth Condo as part of a divorce settlement. When the other members of the Hut Group, Thomas Connors and George Roberts, learned of the unapproved assignment, they contacted Banner and expressed the view that the assignment violated the anti-assignment clause of the operating agreement, which required the primary consent of all the members. After some negotiations, Banner agreed to sell his entire rights to Connors and Roberts for $125,000. Condo sued these members in court for the destruction of the value of the assignment. The LLC defended that the assignment was in violation of the operating agreement and thus was void. Decide. [Condo v. Connors, 266 P.3d 1110 (Colo. 2011)] Answer: Assignment of interest in an LLC. Banner‘s assignment of membership rights to Elizabeth Condo in violation of the operating agreement made the assignment void.

Judgment was thus rendered for Connors and Roberts. The plain meaning of the antiassignment clause of the operating statement rendered member Thomas Banner

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 41: Corporation Formation

powerless to make an unapproved assignment. The court determined that public policy favored allowing members to tightly control who could receive membership rights and duties. [Condo v. Connors, 266 P. 3d 1110 (Colo.)] [return to top] End of Chapter: CPA Questions and Answers Correct answer in boldface.

1.

Which of the following statements is correct with respect to a limited partnership? a.

A limited partner may not be an unsecured creditor of the limited partnership.

b.

A general partner may not also be a limited partner at the same time.

c.

A general partner may be a secured creditor of the limited partnership.

d.

A limited partnership can be formed with limited liability for all partners.

[return to top] Answers to AICPA Questions 1.

Which of the following statements is correct with respect to a limited partnership? a.

A limited partner may not be an unsecured creditor of the limited partnership.

b.

A general partner may not also be a limited partner at the same time.

c.

A general partner may be a secured creditor of the limited partnership.

d.

A limited partnership can be formed with limited liability for all partners.

(c) A general partner can also hold a limited partnership interest. There must always be at least one general partner with unlimited personal liability to create a limited partnership. Limited partners can also be creditors. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 41: Corporation Formation

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Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 396 Questions and Case Problems .......................................................................................................... 396 End of Chapter: CPA Questions and Answers ................................................................................. 403 Answers to AICPA Questions ............................................................................................................ 404

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Edwin Edwards and Karen Davis owned EEE, Inc., which owned three convenience stores, all of which sold gasoline. Reid Ellis delivered to the three convenience stores $26,675.02 worth of gasoline for which he was not paid. Ellis proved that Edwards and Davis owned the business, ran it, and in fact personally ordered the gasoline. He claimed that they were personally liable for the debt owed him by EEE, Inc. Decide. [Ellis v. Edwards, 348 S.E.2d 764 (Ga. App.)] Answer: Ignoring the corporate entity. Mere ownership and operation of a corporation does not render one personally liable for the corporation‘s debts. Ellis would have to show fraud, illegality, or the need to prevent injustice to have the court pierce the corporate veil.

Businesspersons dealing with a corporation must be on the alert to assess the credit rating of the corporation and, when in doubt, to make sure that purchases are paid for in cash.

[Ellis v. Edwards, 348 S.E. 2d 764 (Ga. App.)]

2.

Clinton Investors Company, as landlord, entered into a three-year lease with the Clifton Park Learning Center as tenant. The lease was executed by Bernie Watkins who represented himself as the treasurer of the Learning Center. On May 31, 1984, the day before the lease term began, Watkins signed a rider to the lease. He again signed as treasurer of the tenant, identifying the tenant as ―the Clifton Park Learning Center, Inc.‖ Watkins had not consulted an attorney regarding the formation of the corporation. He mistook the reservation of the business name with the Secretary of State for the filing of a certificate of incorporation. On February 11, 1985, a certificate of incorporation was filed.

By March 1986, the Learning Center had become delinquent in rental payments and other fees in the amount of $18,103. Clinton sued Watkins and the Learning Center for the amounts due. Watkins claimed that only the corporation was liable. Decide. [Clinton Investors Co. v. Watkins, 536 N.Y.S. 2d 270 (A.D. 1989)]

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Solution and Answer Guide:

Answer: Personal liability of promoter. Judgment against Watkins. No corporation existed when Watkins signed the lease with Clinton. Consequently, Watkins was a promoter. The subsequent formation of a corporation and adoption of the lease did not relieve Watkins from liability in addition to his individual liability as a promoter. [Clinton Investors Co. v.

Watkins, 536 N.Y.S. 2d 270 (A.D.)] 3.

Compare and contrast consolidations, mergers, and conglomerates.

Answer: Nature of consolidations, mergers, and conglomerates. ―Consolidation‖ and ―merger‖ refer to a process of fusion by which two existing corporations become one.

Usually, such a procedure is expressly authorized by statute. When a merger occurs, one corporation takes over the other; then, only that corporation remains. In the case of a consolidation, both corporations legally disappear, and the combined mass is a new corporation rather than either of the two original corporations.

In the case of a conglomerate, each corporation in the conglomerate remains in existence and preserves its separate identity. One corporation will own the stock of the other corporations in the conglomerate and will thus exercise control by voting the shares. It is not essential that the other businesses in the conglomerate be incorporated, although as a practical matter this will ordinarily be the case in order to secure the advantage of limited liability.

As a matter of custom, the conglomerate will be an aggregate of dissimilar businesses. If all the businesses were the same, the term ―holding company system‖ would be applied instead of ―conglomerate.‖ In the case of a consolidation, the new corporation, and in the case of a merger, the surviving corporation, will generally be liable for the debts of any corporation that disappears in the fusion process. In the case of the conglomerate, the controlling corporation will not be liable for the debts of the controlled corporations unless the court should ignore the separate entities or unless the controlling corporation expressly guarantees the payment of the debt of a controlled corporation.

4.

On January 27, 1982, Joe Walker purchased a wheel-loader machine from Thompson & Green Machinery Co. (T&G). Walker signed a promissory note for $37,886.30 on behalf of ―Music City Sawmill, Inc., by Joe Walker, President.‖ When Sawmill was unable to make payments on the loader, the machine was returned to T&G. T&G brought suit against Sawmill and subsequently discovered that Sawmill had not been incorporated on January

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397

Solution and Answer Guide:

27, 1982, when the machine was purchased but had been incorporated the next day. T&G then sued Walker individually. The lawsuit was Walker‘s first notice that Sawmill was not incorporated on the date of the sale. Walker‘s defense was that T&G dealt with Sawmill as a corporation and did not intend to bind him personally on the note and therefore was estopped to deny Sawmill‘s corporate existence. Decide. [Thompson & Green Machinery Co. v. Music City Lumber Co., Inc., Music City Sawmill Co., Inc., 683 S.W.2d 340 (Tenn. App.)] Answer: Corporate liability on promoter‘s contract. No. When a corporation ratifies or adopts a contract made by a promoter and a third person, the contract is binding on both the corporation and the third person. The fact that the contract could not have been made with the corporation at the time that it was made by the promoter is ignored. The defenses therefore are not valid. [Thompson & Green Machinery Co. v. Music City Lumber Co., Inc., Music City Sawmill Co., Inc., 683 S.W. 2d 340 (Tenn. App.)] 5.

Richard Ramlall was hired by CloseCall (MD) Inc. to negotiate a billing dispute with Verizon involving some $2 million in asserted overcharges. CloseCall (MD) agreed to a contingent fee ―bonus‖ for its negotiators of 10 percent of the refund. The negotiations were successful. However, before he could collect his fee CloseCall (MD) merged with MVCC Acquisition Corp., a wholly owned subsidiary of MobilePro Corp., which was created for the express purpose of merging with CloseCall (MD). MVCC survived and CloseCall (MD) dissolved. MVCC then changed its name to CloseCall (DE). The merger agreement between CloseCall and MVCC referenced the 10 percent bonus due on the Verizon billing dispute.

The surviving Delaware corporation created by the merger of CloseCall (MD) into MVCC is CloseCall (DE). Ramlall sued CloseCall (DE) for the bonus as the successor corporation of CloseCall (MD). CloseCall (DE) contends that after the merger CloseCall (DE) did not owe any money to Ramlall. Is CloseCall (DE) a successor corporation? Is it liable to Ramlall for the ―bonus fee‖? [Ramlall v. Mobile Pro Corp., 30 A.2d 1003 (Md. App.)] Answer: Liability of Successor Corporations. ―Successor‖ means a corporation surviving a merger. CloseCall (DE) is liable to Ramlall for the bonus fee. The court pointed out that corporations are largely the molders of their own destinies in acquisition transactions, they may buy assets without assuming liabilities, and they may buy stock and preserve the acquired company as a subsidiary (insulating the parent from subsidiary liabilities). But if an acquiring corporation—for its own business (and perhaps tax) purposes—chooses a formal de jure merger, with its familiar consequences of the total assumption of predecessor liabilities, the corporation will not be heard to extract itself from its wholly voluntary and deliberately undertaken actions.

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Solution and Answer Guide:

The court stated that Maryland‘s legislative policy is sound. To allow successor corporations to contract around obligations of predecessor corporations would permit corporations to use the merger statute to evade their legal obligations. The Maryland statute, like its counterpart in Delaware, reflects ―a strong public policy, designed primarily for the protection of creditors and third parties who dealt in good faith with the predecessor corporation.‖ [Ramlall v. Mobile Pro Corp., 30 A. 2d 1003 (Md. App.)] 6.

The Community Youth Center (CYC) Corporation failed to pay its annual registration fee in 2000 and was automatically dissolved by the state corporation commission. CYC continued to operate and held itself out as a corporation well into 2005 when it obtained a loan from the First Community Bank to finance a swimming pool at its facility. The loan was secured by the CYC property. After the corporation defaulted on its loan payments, the bank foreclosed and subsequently purchased the property at a foreclosure sale. CYC contended that the president, vice president, and treasurer of CYC had no standing to make the 2005 loan transaction because CYC‘s corporate status had been terminated. The bank contended that under the doctrine of corporation by estoppel, CYC continued to exist in 2005, and, consequently, the officer-directors had authority to borrow money and grant a deed of trust, thereby giving the bank a valid lien on the property. Decide. [First Community Bank, N.A. v. Community Youth Center, 2010 WL 8696179 (Ca. Cir. Ct.)] Answer: Corporation by estoppel. Judgment for the bank. A corporation acting and carrying on its corporate business under its corporate name for more than five years after termination of its corporate existence should be deemed a corporation by estoppel. CYC may not have been a de jure corporation, but the court cannot reasonably ignore the actual existence of such a corporation. CYC obtained a loan from First Community Bank and made numerous payments before defaulting on the loan. In order to relieve CYC of its loan obligations, the corporation must have ceased to exist in 2000 in both law and in fact.

CYC ceased to exist only in law, not in fact. CYC‘s directors failed to wind up the corporate business as was their duty. The corporation cannot be relieved from liability for acts done in its name and during its actual existence as a corporation by estoppel. [First Community Bank, N.A. v. Community Youth Center, 2010 WL 8696179 (Ca. Cir. Ct.)]

7.

Emmick was a director and shareholder of Colonial Manors, Inc. (CM). He organized another corporation named Oahe Enterprises, Inc. To obtain shares of the Oahe stock, Emmick transferred CM shares arbitrarily valued by him at $19 per share to Oahe. The CM shares had a book value of $.47 per share, but Emmick believed that the stock would increase to a value of $19. The directors of Oahe approved Emmick‘s payment with the valuation of $19 per share. Golden sued Emmick on the ground that he had fraudulently

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399

Solution and Answer Guide:

deceived Oahe Corp. about the value of the CM shares and thus had made a secret profit when he received the Oahe shares that had a much greater value than the CM shares he gave in exchange. Emmick contended that his firm opinion was that the future potential value of CM shares would surely reach $19 per share. Decide. [Golden v. Oahe Enterprises, Inc., 295 N.W.2d 160 (S.D.)] Answer: Promoter‘s liability. As a promoter of Oahe, Emmick owed a fiduciary duty to both the corporation and its shareholders to deal with them in good faith. Obtaining a secret profit by a promoter is a fraud on the corporation, and the promoter may be required to account for the profit. The value of Colonial Manors, Inc., stock was based on Emmick‘s self-serving estimates. It is the market value of the stock exchanged, not some future value, that must be taken as the basis for the exchange. The difference between the value of the Colonial Manors, Inc., stock and the value of the Oahe stock must therefore be equalized by canceling the number of Oahe shares held by Emmick that was proportional to the overvaluation. [Golden v. Oahe Enterprises, Inc., 295 N.W. 2d 160 (S.D.)] 8.

Madison Associates purchased control of the majority of shares of 79 Realty Corp. from the Kimmelmans and the Zauders, who then resigned as directors. The Alpert group, which owned the remaining 26 percent of 79 Realty refused to sell their shares. Partners of Madison Associates replaced the Kimmelmans and Zauders as directors of 79 Realty Corp., and as controlling directors, they approved a plan to merge 79 Realty Corp. with the Williams Street Corp., which was owned by Madison Associates. A shareholders‘ meeting was called, and the merger was approved by two-thirds of the shareholders. The Alpert group‘s shares were then forcibly canceled, with the price paid for these shares determined at their fair market value. The Alpert group brought suit contending that the merger was unlawful because the sole purpose was to benefit the Madison Associates.

Decide. [Alpert v. 28 Williams Street Corp., 473 N.E.2d 19 (N.Y.)] Answer: Corporate mergers. Judgment for Madison Associates. State law allows for the merger of two corporations into a single corporation as long as certain procedures are followed, such as obtaining approval of the merger by a two-thirds vote of shareholders.

Madison met all required procedures. Even a freeze-out merger which involves the removal of minority shareholders by a forced cancellation of their shares by a cash purchase, is allowed provided it advances a general corporate interest. The merger in this case was valid since it advanced the bona fide business purpose of obtaining increased capital. [Alpert v. 28 Williams Street Corp., 473 N.E. 2d 19 (N.Y.)]

9.

The Seabrook Island Property Owners Association, Inc., is a nonprofit corporation

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Solution and Answer Guide:

organized under state law to maintain streets and open spaces owned by property owners of Seabrook Island. Seabrook Island Co. is the developer of Seabrook Island and has majority control of the board of directors of the association. The association‘s bylaws empower the board of directors to levy an annual maintenance charge. Neither the association‘s charter nor its bylaws authorize the board to assess any other charges. When the board levied, in addition to the annual maintenance charge, an emergency budget assessment on all members to rebuild certain bridges and to revitalize the beach, the Loverings and other property owners challenged in court the association‘s power to impose the assessment. Decide. [Lovering v. Seabrook Island Property Owners Ass’n, 344 S.E.2d 862 (S.C. App.)] Answer: Ultra vires acts. Judgment for the Loverings. Acts beyond the scope of a corporation‘s powers as defined by law or its charter are ultra vires. Neither the corporation‘s charter nor its bylaws authorized the special emergency assessment. The corporation had no power to impose a special assessment. [Lovering v. Seabrook Island Property Owners Ass'n, 344 S.E. 2d 862 (S.C. App.)] 10. Adams and two other persons were promoters for a new corporation, Aldrehn Theaters Co. The promoters retained Kridelbaugh to perform legal services in connection with the incorporation of the new business and promised to pay him $1,500. Aldrehn was incorporated through Kridelbaugh‘s services, and the promoters became its only directors.

Kridelbaugh attended a meeting of the board of directors at which he was told that he should obtain a permit for the corporation to sell stock because the directors wished to pay him for his previous services. The promoters failed to pay Kridelbaugh, and he sued the corporation. Was the corporation liable? [Kridelbaugh v. Aldrehn Theaters Co., 191 N.W. 803 (Iowa)] Answer: Liability of corporation for promoter‘s contracts. Yes. A corporation is not liable for the contracts made by its promoters merely because it benefited either through such contracts having been performed or by using a charter or bylaws prepared by the promoters. The corporation is not bound by the promoter‘s contract unless it ratifies or adopts the contract. However, a formal ratification is not required, and the statement by the directors at the directors‘ meeting that the plaintiff should obtain a stock permit because the directors wanted to pay him was a sufficient ratification. [Kridelbaugh v.

Aldrehn Theaters Co., 191 N.W. 803 (Iowa)] 11. On August 19, 1980, Joan Ioviero injured her hand when she slipped and fell while leaving the dining room at the Hotel Excelsior in Venice, Italy. This hotel was owned by an Italian

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Solution and Answer Guide:

corporation, Cigahotels, S.p.A. (The designation S.p.A. stands for Societa per Azionean, the Italian term for corporation.) In 1973, a firm called Ciga Hotels, Inc., was incorporated in New York. Its certificate of incorporation was amended in 1979, changing the name of the firm to Landia International Services, Inc. This New York corporation was employed by the Italian corporation Cigahotels, S.p.A., to provide sales and promotional services in the United States and Canada. Ioviero sought to hold the New York corporation liable for her hand injury at the Venice hotel. She pointed to the similarity of the first corporate name used by the New York firm to the name Cigahotels, S.p.A., and the fact that the New York firm represented the interests of the Italian firm in the United States as clear evidence that the two firms were the same single legal entity. She asked that the court disregard the separate corporate entities. The New York corporation moved that the case be dismissed because it was duly incorporated in New York and did not own the Excelsior Hotel in which Ioviero was injured. Decide. [Ioviero v. CigaHotel, Inc., aka Landia I.S., Inc., 475 N.Y.S.2d 880 (A.D.)] Answer: Ignoring the corporate entity. Judgment for the New York corporation. The designation ―S.p.A.‖ refers to the term ―Societa per Azionean.‖ It is defined as a stock corporation (see Genco, Dictionary of Italian Legal Terms & Relevant Definitions, p. 262).

Despite the similarity between the appellant‘s first corporate name (Ciga Hotels, Inc.) and the name Cigahotels, S.p.A., the evidence established the existence of two separate and distinct corporate entities. No basis was established to pierce the corporate veil in this case. [Ioviero v. CigaHotel, Inc., aka Landia I.S., Inc., 475 N.Y. S. 2d 880 (App. Div.)] 12. William Sullivan was ousted from the presidency of the New England Patriots Football Club, Inc. Later, he borrowed $5,348,000 to buy 100 percent control of the voting shares of the corporation. A condition of the loan was that he reorganize the Patriots so that the income from the corporation could be devoted to repayment of the personal loan and the team‘s assets could be used as collateral. Sullivan, therefore, arranged for a cash freezeout merger of the holders of the 120,000 shares of nonvoting stock. David Coggins, who owned 10 shares of nonvoting stock and took special pride in the fact that he was an owner of the team, refused the $15-a-share buyout and challenged the merger in court.

He contended that the merger was not for a legitimate corporate purpose but to enable Sullivan to satisfy his personal loan. Sullivan contended that legitimate business purposes were given in the merger proxy statement, such as the National Football League‘s policy of discouraging public ownership of teams. Coggins responded that before the merger, Sullivan had 100 percent control of the voting stock and thus control of the franchise and that no legal basis existed to eliminate public ownership. Decide. [Coggins v. New England Patriots Football Club, 492 N.E.2d 1112 (Mass.)]

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Solution and Answer Guide:

Answer: Freeze-out mergers. Judgment for Coggins. The merger served no valid corporate purpose unrelated to the personal interests of Sullivan. While a number of corporate purposes were listed in the proxy statement, the true reason for the merger was to enable Sullivan to satisfy his $5,348,000 debt. [Coggins v. New England Patriots Football Club, 492 N.E. 2d 1112 (Mass.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

Which of the following statements is correct concerning the similarities between a limited partnership and a corporation? a.

Each is created under a statute and must file a copy of its certificate with the proper state authorities.

b.

All corporate stockholders and all partners in a limited partnership have limited liability.

2.

c.

Both are recognized for federal income tax purposes as taxable entities.

d.

Both are allowed statutorily to have perpetual existence.

Rice is a promoter of a corporation to be known as Dex Corp. On January 1, 1985, Rice signed a nine- month contract with Roe, a CPA, which provided that Roe would perform certain accounting services for Dex. Rice did not disclose to Roe that Dex had not been formed. Prior to the incorporation of Dex on February 1, 1985, Roe rendered accounting services pursuant to the contract. After rendering accounting services for an additional period of six months pursuant to the contract, Roe was discharged without cause by the board of directors of Dex. In the absence of any agreements to the contrary, who will be liable to Roe for breach of contract?

3.

a.

Both Rice and Dex

b.

Rice only

c.

Dex only

d.

Neither Rice nor Dex

In general, which of the following must be contained in articles of incorporation? a.

The names of the states in which the corporation will be doing business

b.

The name of the state in which the corporation will maintain its principal place of

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Solution and Answer Guide:

business c.

The names of the initial officers and their terms of office

d.

The classes of stock authorized for issuance

[return to top] Answers to AICPA Questions 1.

Which of the following statements is correct concerning the similarities between a limited partnership and a corporation? a.

Each is created under a statute and must file a copy of its certificate with the proper state authorities.

b.

All corporate stockholders and all partners in a limited partnership have limited liability.

c.

Both are recognized for federal income tax purposes as taxable entities.

d.

Both are allowed statutorily to have perpetual existence.

(a) Answer (a) is correct as both corporations and limited partnerships file certificates with the state. Answer (b) is incorrect because only the limited partners in the LP have limited liability; the general partners, those who manage the business, are personally liable for firm debts, but may avoid personal liability by incorporating.

Answer (c) is not correct. A corporation is a taxable entity, but an LP has pass through tax treatment, where the profits and losses flow through to the partners.

Answer (d) is not correct. A corporation may have perpetual existence by statute; a LP, like a general partnership is dissolved by the death, retirement, or insanity of a partner.

2.

Rice is a promoter of a corporation to be known as Dex Corp. On January 1, 1985, Rice signed a nine- month contract with Roe, a CPA, which provided that Roe would perform certain accounting services for Dex. Rice did not disclose to Roe that Dex had not been formed. Prior to the incorporation of Dex on February 1, 1985, Roe rendered accounting services pursuant to the contract. After rendering accounting services for an additional period of six months pursuant to the contract, Roe was discharged without cause by the board of directors of Dex. In the absence of any agreements to the contrary, who will be liable to Roe for breach of contract? a.

Both Rice and Dex

b.

Rice only

c.

Dex only

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 42: Shareholder Rights in Corporations

d.

Neither Rice nor Dex

(b) The correct answer is (b). Rice, as the promoter is personally liable for all contracts made on behalf of the corporation before its existence unless the promoter is exempted by the terms of the agreement. The corporation, Dex, is not liable on a contract made by its promoter for its benefit unless the corporation takes some affirmative action to adopt the contract, such as express words of adoption or acceptance. There is an argument that Dex could also be liable because it ―accepted‖ the accounting services for six months after the incorporation. But Rice, as the promoter, would still be jointly and severally liable.

3.

In general, which of the following must be contained in articles of incorporation? a.

The names of the states in which the corporation will be doing business

b.

The name of the state in which the corporation will maintain its principal place of business

c.

The names of the initial officers and their terms of office

d.

The classes of stock authorized for issuance

(d) Answer (d) is the correct answer. Articles of incorporation must contain (1) the name of the corporation; (2) the number of shares of stock the corporation is authorized to issue; (3) the street address of the corporation‘s initial registered office and the name of its initial registered agent; and (4) the name and address of each incorporator. It should also state the type of corporate structure (profit, non-profit, professional corporation, etc.); and the name and addresses of the initial board of directors. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 42: Shareholder Rights in Corporations

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 406 Questions and Case Problems .......................................................................................................... 406 End of Chapter: CPA Questions and Answers ................................................................................. 416 Answers to AICPA Questions ............................................................................................................ 417

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Solution and Answer Guide:

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Monica Beam, a shareholder of Martha Stewart Living Omnimedia, Inc. (MSO), filed a derivative action against Martha Stewart and the other MSO board of directors, alleging that Stewart breached her duties to MSO by illegally selling ImClone stock and mishandling media attention, thereby jeopardizing the financial future of MSO. Ms. Beam asserted that it would be a futile act to make a demand on the corporation because a majority of the outside directors were not independent of Stewart. Ms. Beam pleaded the particularized facts that director Darla Moore attended a wedding reception hosted by Stewart‘s personal lawyer for his daughter and was a longtime friend of Stewart; and that director Naomi Seligman made a phone call to publisher John Wiley, Inc., to express concern over a planned book critical of Stewart. Should Ms. Beam be excused from making a demand on the board of directors to pursue the derivative action because the outside directors were not independent of Stewart? [Beam v. Stewart, 845 A.2d 1040 (Del)] Answer: Demand futility in shareholder derivative lawsuits. The case was dismissed because Beam failed to particularize facts demonstrating presuit demand futility raising reasonable doubt that a majority of the outside directors were not independent of Stewart. Allegations about Director Darla Moore, a longtime friend of Stewart, did not create a reasonable doubt about her independence, nor did the allegation about Director Naomi Seligman. The Supreme Court of Delaware noted that had Beam brought an action to inspect MSO‘s books and records, she might have uncovered facts that would have created a reasonable doubt, enabling the case to go to trial, but allegations of a social relationship are not enough to negate a director‘s independence. [Beam v. Stewart, 845 A. 2d 1040 (Del.)]

2.

Six members of the Weston family, who owned 6.8 percent of the stock of Weston Paper and Manufacturing Company, brought suit against three corporate directors and CFIS, a firm hired by the company to make the annual evaluation of the company‘s stock for allocating stock options to its employees. The Westons stated that their claims against the defendants were personal claims, alleging that they were injured by CFIS and the three directors who kept the price of the stock low to obtain more shares of stock through the stock option plan. From an adverse ruling on their right to maintain a direct action against the directors, the Westons appealed. How would you decide this case? [Weston v. Weston Paper and Manufacturing Co., 74 Ohio 377]

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Answer: Stockholder derivative actions. Judgment for the corporation. If any injuries occurred, they occurred to all the shareholders alike. And such is precisely the situation in which a derivative action is required. However, the Westons meet none of the criteria for bringing a derivative action: (1) they made no effort to have the directors take the action they demanded; (2) they did not explain why they failed to make this effort; and (3) they did not show that they ―fairly and adequately‖ represented the interests of the shareholders ―similarly situated.‖ A plaintiff-shareholder does not have an independent cause of action where there is no showing that he has been injured in any capacity other than in common with all other shareholders as a consequence of the wrongful actions of a third party directed towards the corporation. Every one of the other 100 shareholders was similarly situated as the plaintiffs and could have brought the same action themselves, thus no separate or distinct injury occurred to plaintiffs that is unique to them. Because of this, plaintiffs did not have a direct cause of action, the proper cause of action is a derivative suit. For a shareholder to bring a derivative action, the complaining shareholders must show to the court: (1) efforts they made to have the directors or other shareholders take the action demanded; or (2) why they failed in this effort or did not make it; and (3) show that they ―fairly and adequately‖ represent the interests of other shareholders ―similarly situated.‖ In filing their suit, plaintiffs made none of these required showings, thus coloring their claim.

The Westons could have plead a derivative action if what they sought was to hold the directors and CFIS responsible for some alleged wrong. Instead they sought a direct cause of action. The Westons may have sought personal claims against the defendants, so that any judgment in their favor would be awarded directly to them and would not have to be shared among the other shareholders. The Westons could have easily complied with the first requirement for a derivative action and demanded the directors reform the allocation scheme, but they didn‘t. If the Westons had thought that such a demand on the directors was futile because of the board‘s own conflicting interests, the second requirement for a derivative action could had been fulfilled by explaining to the court the reasons why they did not make a demand on the directors. It is this omission that the court is particularly upset about and explains why the court thought it important to observe the requirements for a derivative suit.

In essence, the Westons could have filed a derivative suit but didn‘t and the court is aware of the selfish motives for this failure to assert this claim. The court notes that the Westons did not have a direct cause of action because their claim was of the type that met the third

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required of a derivative action. The court is subtle in its contempt for the Westons‘ claim and dismisses it with an iteration of the requirement for a derivative action (which was unpleaded by the Westons) if only to rub in what the Westons should have done had they not been motivated by personal gain at the expense of other shareholders. [Weston v.

Weston Paper and Manufacturing Co., 74 Ohio 377)] 3.

Tomlinson and Hubbard were two of five shareholders in Multimedia Software Distributors, a corporation. The corporation was formed in 1992 and filed for bankruptcy in 1994. In 1996, Tomlinson filed a claim in his own name, alleging that Hubbard had breached his fiduciary duties to Tomlinson by diverting proceeds owned by Multimedia to another business owned by Hubbard. Hubbard contends that Tomlinson is an improper plaintiff. Decide. [Hubbard v. Tomlinson, 747 N.E.2d 69 (Ind. App.)] Answer: Shareholders actions. Judgment for Hubbard. Shareholders of a corporation may not maintain actions in their own names to redress an injury to the corporation even if the value of their stock is impaired as a result of the injury. They must bring action derivatively because direct action would ignore the corporate entity, fail to protect the corporation from multiple lawsuits, and be unfair to the corporation‘s creditors. Tomlinson, who is one of five shareholders, in his direct lawsuit would not protect other innocent shareholders.

[Hubbard v. Tomlinson, 747 N.E. 2d 69 (Ind. App.)]

4.

Shareholders of Clovis Oncology Inc. brought a shareholder derivative suit alleging that the board of directors ignored red flags in the testing of a lung cancer treatment called Rocilentinib. The clinical trials for Rocilentinib failed to follow standard protocol, which would prevent the drug from gaining FDA approval. The company allegedly made public statements about the success of trials that were inconsistent with the information the board received. When Clovis withdrew the drug from FDA consideration in 2016, the stock price plummeted. Will a court allow the shareholder derivative suit to go forward? [In re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS (Del. Ch.)] Answer: Shareholder derivative suit. The Delaware Court of Chancery allowed the Caremark suit to go forward. The court applied the ―duty to monitor‖ doctrine that the Delaware Supreme Court used in Marchand v. Hill. The court interpreted Marchand as requiring a higher level of board oversight in industries where ―externally imposed regulations govern its ‗mission critical operations.‘‖ The Clovis decision highlights the importance of board level efforts to oversee compliance with governing law and regulatory mandates, particularly in situations where compliance issues are critical to a ―monoline‖ company, and how stockholders are using books and records demands under

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8 Del. C. § 220 to pursue fiduciary claims focused on those same compliance issues.

Caremark cases may be on the rise. [In re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS (Del. Ch. 2019)] 5.

The stock of West End Development Co. was subject to a transfer restriction. This restriction required that any shareholder selling shares first offer every other shareholder the right to purchase a proportion of the shares being sold. The proportions were to be the same as the percentages of the outstanding shares that the other shareholders already owned. This restriction was stated in the articles of incorporation but was not stated on the stock certificate of the corporation. The Taylors owned stock in the company and sold their stock to Vroom, an officer of the corporation, without first offering any stock to the other shareholders, as required by the restriction. The other shareholders brought an action against Vroom to recover from him the percentages of the shares they would have been entitled to if the Taylors had followed the transfer restriction. Decide. [Irwin v. West End Development Co., 481 F.2d 34 (10th Cir.)] Answer: Restrictions on transfer of shares. Judgment for the shareholders. A transfer restriction is not binding unless it is conspicuously noted on the share certificate or it is known by the transferee. In this case, the restriction was not noted on the certificates, but was stated in the articles. However, Vroom, as an officer of the corporation, was charged with knowledge of what was stated in the articles. Consequently, he knew of the existence of the restriction and was subject to it. [Irwin v. West End Development Co., 481 F. 2d 34 (10th Cir.)]

6.

Siebrecht organized Siebrecht Realty Co., a corporation, and then transferred his building to the corporation in exchange for its stock. The corporation rented different parts of the building to different tenants. Elenkrieg, an employee of one of the tenants, fell and was injured because of the defective condition of a stairway. She sued Siebrecht individually on the ground that the corporation had been formed by him for the purpose of securing limited liability. Decide. [Elenkrieg v. Siebrecht, 144 N.E. 519 (N.Y.)] Answer: Limited liability of corporate shareholders; incorporation for the express purpose of obtaining limited liability. Judgment for Siebrecht, the defendant. Shareholders ordinarily have limited liability, even though the corporation was formed for the purpose of securing that limited liability. [Elenkrieg v. Siebrecht, 144 N.E. 519 (N.Y.)]

7.

U.S. Die Casting, Inc., is a closely held Ohio corporation that owns 5 percent of Security First Corporation, a Delaware corporation. David Slyman is the president of U.S. Die and its

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sole shareholder. The defendant, Security First, entered into a merger agreement with Mid Am, Inc., a large regional bank holding company. After the announcement of the merger, Security First‘s stock increased significantly. The merger agreement required Security First to pay a termination fee of $2 million plus third-party expenses not to exceed $250,000 contingent on the occurrence of certain events within one year after termination should Security First pull out of the merger. The merger did not go through, and the market price for Security First dropped significantly. According to Secuirty First, it did not go through with the merger because it realized that Mid Am‘s ―management philosophy and direction were fundamentally different from its own.‖ Security First paid Mid Am $275,000 in expenses and agreed to pay an additional $2 million if a certain event occurred within one and one-half years after termination. U.S. Die submitted a written demand to Security First pursuant to Section 220 of the Delaware Code to inspect all of its books and records related to the Mid Am merger and its termination. Security First refused to comply. The Court of Chancery granted U.S. Die‘s demand and Security First appealed. Should U.S. Die be allowed to inspect Security First‘s books? [Security First Corp. v. U.S. Die Casting, Inc., 687 A.2d 563 (Del.)] Answer: Inspection of corporate books. Judgment for U.S. Die. Section 220 proceedings are an important part of the corporate governance landscape in Delaware. Stockholders have a right to at least a limited inquiry into books and records when they have established some credible basis to believe there has been wrongdoing. Slyman testified that he wanted to inspect the books because: I would like to make my own decision as to why the merger was not completed. Telling me that it was a difference of philosophies didn’t get me to understand why it was not completed. The philosophy was there prior to it . . . .

The Court of Chancery found the defendant‘s reason suspect because management philosophies could have been researched before entering into the agreement. Expense payments made to Mid Am in excess of the stipulation in the merger agreement and payment of a termination fee for a period beyond the time period set forth in the agreement are a basis for U.S. Die to inspect books and records. [Security First Corp. v. U.S. Die Casting, Inc., 687 A. 2d 563 (Del.)] 8.

Ken and Charlotte Maschmeier were the majority shareholders of Southside Press; each owned 1,300 shares. Marty and Larry Maschmeier, who each owned 1,200 shares of the corporation, had a falling out with Ken and Charlotte and were terminated as employees of the business. Ken and Charlotte started a new corporation, which employed most of the

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employees of the old corporation and which took most of its former customers. Gross receipts of Southside Press went from $613,258 down to $18,172 two years later. The $18,172 figure was from the lease of equipment. Ken and Charlotte continued to draw from Southside annual salaries of $20,000, which were in excess of the gross receipts of the business. Marty and Larry brought suit against Ken and Charlotte, alleging ―oppressive‖ conduct. Ken and Charlotte stated that they had paid Marty and Larry excellent salaries when they were employed by the corporation. Ken and Charlotte contended that they had a right to start a new corporation as they saw fit. Decide.

[Maschmeier v. Southside Press, Inc., 435 N.W.2d 377 (Iowa App.)] Answer: Majority shareholder conduct oppressive toward minority. Judgment for Marty and Larry. It was wasteful to the corporation and oppressive to the minority shareholders for Ken and Charlotte to take salaries in excess of $20,000 from the business when its gross receipts were $18,172 from the lease of equipment. It is no defense that Larry and Marty were paid well when they were employed by the corporation. [Maschmeier v. Southside Press, Inc., 435 N.W. 2d 377 (Iowa App.)] 9.

Gladys Boles and 28 other owners of property at Hidden Valley Lakes Development sued the corporate developer, National Development Co. Inc. (NDC); NDC‘s parent, Sunstates Corporation; and the individual behind both corporations, Clyde Engle, for breach of contract and fraud. The centerpiece of this development, Crystal Lake, a 30-acre recreational lake, failed to hold water; and it was determined that it could never do so.

Instead of having a 30-acre lake as the centerpiece, the plaintiffs had a 30-acre hole in the ground. While the controversy over NDC‘s breach of contract was pending, Engle made a ―proposal‖ to the CEO of NDC to transfer $2.4 million in receivables to Sunstates in exchange for an unsecured promissory note. Evidence showed that all of Sunstates‘ assets thereafter were transferred to Engle, making the note NDC held from Sunstates worthless.

Sunstates purchased approximately $1.9 million of oriental art, antique jewelry, rare books, and other collectibles, which were maintained in Engle‘s home in Illinois. Likewise, Sunstates purchased a Rolls Royce from Libco, a corporation in which Engle was the majority shareholder. This automobile also appeared to be in Engle‘s possession or control. Engles regrets that the lake did not work out, a risk that the developer and the homeowners have to live with, and points out that NDC is a separate legal entity with limited liability for its shareholders. Engle asserts that he is not personally liable for damages in this case. Decide. [Boles v. National Development Co., Inc., 175 N.W.3d 226 (Tenn. App.)] Answer: Limited liability of corporate shareholders. The evidence supports the conclusion

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that NDC and Sunstates were instrumentalities of Engle and that their remaining assets were diverted by him. All of the corporations under Engle‘s control were insolvent, and it would be an injustice to allow him to use the corporate entity as a shield to thwart the satisfaction of the judgment in this case. The corporate entity was disregarded in order to accomplish justice in this case. [Boles v. National Development Co., Inc., 175 N.W. 3d 226 (Tenn. App.)] 10. Ed Klein was the sole shareholder, director, and chief executive officer of The Gun Exchange, Inc., a retail firearms dealership. The inventory of The Gun Exchange had been pledged as security for a $622,500 debt owed to InterFirst Bank. It also owed $231,484.60 to Sporting Goods, Inc.; this debt was unsecured. On May 20, InterFirst Bank notified Klein of its intention to foreclose on the inventory and sell it at public auction. InterFirst Bank further advised Klein that, pursuant to his personal guarantee, he would be responsible for any deficiency following the sale. Klein immediately incorporated The Gun Store, Inc., for the purpose of purchasing the assets of The Gun Exchange at the foreclosure sale. Before the foreclosure sale, Klein obtained a $650,000 line of credit from CharterBank on behalf of The Gun Store. At the sale, Klein purchased the assets of The Gun Exchange for $650,000 even though the highest prior bid was $175,000. (Had the $175,000 bid been accepted, Klein would have been personally liable for the deficiency to InterFirst Bank.)

After the foreclosure sale, no funds existed to pay the unsecured creditors of The Gun Exchange. Following the sale, The Gun Store began operating as a retail firearms dealer with the inventory purchased from the foreclosure sale. It operated in the same location and with the same personnel as The Gun Exchange. Sporting Goods, Inc., sued Klein individually for the $231,484.60. Klein contended that the corporate form under which he did business insulated him as a shareholder from liability for corporate obligations. Decide.

Is it ethical to seek limited liability under the corporate form, as Klein did in this case?

[Klein v. Sporting Goods, Inc., 772 S.W.2d 173 (Tex. Civ. App.)] Answer: Piercing the corporate veil. The court disregarded the corporate entity in this case.

The corporate veil will be pierced, even though corporate formalities had been observed and individual property had been kept separate. Shareholder liability will exist when the corporate form has been used as part of an unfair device to achieve an inequitable result.

Neither fraud nor an intent to defraud need be shown as a prerequisite to disregard the corporate entity. It is sufficient if recognizing the separate corporate existence would bring about an inequitable result.

Applying the ethical principles set forth in the Preface leads to the same conclusion as the

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one breached by the court in this case. While it is ordinarily not unethical to seek limited liability by using the corporate form of business organization, in this case, the ethical principles of fairness and doing no harm appear to have been violated. Klein, through the corporate maneuvers set forth in the facts, sought to avoid personal liability for a deficiency owed to the bank as a secured creditor. The scheme was unfair and did harm to Sporting Goods, Inc. [Klein v. Sporting Goods, Inc., 772 S.W. 2d 173 (Tex. Civ. App.)] Authors' Comment: Ask your class why Sporting Goods, Inc., should have won this case. As a result of the court's judgment, Klein must personally pay $231,484.60 to Sporting Goods, Inc. However, Klein had no personal guarantee to Sporting Goods, Inc. Therefore, if Klein had not formed the second corporation and the inventory was sold for its highest bid of $175,000, Klein would have owed the deficiency to the bank, and Sporting Goods, Inc., would have received nothing. Your students will enjoy putting a pencil to this case and determining whether Sporting Goods, Inc., got lucky.

11. The plaintiff, Smith, is a United States Marine Corps veteran. He suffers from schizophrenia, posttraumatic stress disorder, and depression, and he is functionally illiterate. Smith was living out of his car and working as a trash collector when he was the victim of a fraud scheme. Smith was approached by a participant in the scheme about a ―special investment program‖ that would not require him to invest any money. He agreed and two real estate purchases were orchestrated in Smith‘s name using a false financial profile of his income, assets, and work and renting history. Smith began receiving phone calls about missed mortgage payments and the properties subsequently went into foreclosure. Smith‘s mental health deteriorated further and his ruined credit history prevented him from renting an apartment. Smith brought suit against the associate who handled the real estate closing and the firm he worked for, RKelley Law, PC, and Robert Kelley, personally. Judgment entered against the PC, but the court dismissed the case against Kelley for personal liability. At all times, Kelley was the sole shareholder of the PC. The day after the judgment was entered against the PC, Kelley voted to wind up the corporation. He immediately opened a sole proprietorship called Law Office of R. Emmett Kelly. He used the same office and had the same clients as under the PC. Smith brought suit to hold the sole proprietorship liable as a successor corporation to the PC. In deposition testimony, Kelley was asked whether he dissolved the PC because of the judgment. Kelley testified, ―That is exactly why I dissolved it.‖ Is the sole proprietorship liable for the judgment against the PC? [Smith v. Kelley, 139 N.E.3d 314 (Mass.)]

Answer: Liability of shareholders. The Supreme Judicial Court of Massachusetts held that in the narrow factual circumstances of this case, Kelley‘s sole proprietorship may be held

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liable for the final judgment entered against the PC as a successor in interest. As a general rule of corporate law, the liabilities of a corporation, including a professional corporation, are not imposed upon its successor. Under principles of equity, a court will consider a transaction according to its real nature, looking through its form to its substance and intent. If the entity remains essentially the same, despite a formalistic change of name or of corporate form, successor liability may be imposed. There was substantial evidence that Kelley‘s sole proprietorship served as a mere continuation of the PC. Kelley openly admitted in deposition testimony that he dissolved the PC precisely because of the judgment entered against it. It is not unfair to convert the debt of the PC into personal debt because Kelley is responsible for the conversion himself. Had Kelley continued the law practice as a PC, he would not have been personally liable for the PC‘s debt. As an attorney held to the high ethical standards of the bar, his actions are especially concerning. [Smith v. Kelley, 139 N.E.3d 314 (Mass. 2020)] 12. On March 3, 2002, pursuant to a public offering, First All State Trucking Corp. (FAST) issued securities to investors in denominations of $1,000. The interest rate was 7 percent per year payable semiannually, and the maturity date was March 3, 2010. The rights and obligations of the issuer, FAST, and the holders of the securities were set forth in an indenture agreement. Because the securities were not secured by a mortgage or lien on corporate property, Alec believes that they are shares of preferred stock. Is Alec correct?

Fully explain the type of security involved, and discuss the extent of the holders‘ voting rights.

Answer: Bonds. Alec is incorrect. The security is a form of bond called a debenture. The rights and obligations of the issuer and the holders were set forth in an indenture agreement. Such an agreement contains the contractual terms of a particular bond issue.

And because the bond is unsecured, it is called a debenture. The interest rate of 11 percent per year should have indicated to Alec that the security was a debt security.

Preferred stock would pay a dividend. Note also the maturity date of 2003 that indicated the date on which the loan of the corporation is due. Stock does not have a maturity date.

Holders of this security, called bondholders, do not have voting rights as do owners of common stock. The bondholders‘ rights are set forth in the indenture agreement, and the indenture trustee represents the bondholders‘ interests.

13. Linhart owned shares of stock in First National Bank. She borrowed money from the bank and pledged the stock as security. She later decided to transfer 70 head of cattle and the shares of stock to her son, but she could not deliver the share certificate to him because it was held by the bank. She therefore executed a bill of sale reciting the transfer of the

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cattle and the stock to the son. She gave him the bill of sale, and he had the bill recorded.

After her death, the son brought an action to determine the ownership of the stock. Was the son the owner of the shares?

Answer: Mechanics of transfer of shares. No. In order to effect a transfer of shares of stock, there must be either a delivery of the share certificate properly indorsed or a delivery of the share certificate accompanied by an executed assignment. No provision is made for the transfer of ownership by the delivery of a bill of sale. Because there was nothing that satisfied the requirements of the code, no transfer of the ownership of the shares to the son occurred.

Authors‘ Comment: For an advanced section, the point can be made that here the social force of enforcing the intent of the parties has been defeated. There is no question that a transfer of the shares was in fact intended. Why does the law not give effect to that intent and overlook the fact that the bill of sale was given as being a ―mere irregularity‖? The answer is that the desire to enforce the intent of the parties is outweighed by the desire to prevent fraud and to further practical expediency. If the courts were to open the door to substitute methods of transfer that were claimed to be just as good as the delivery of an indorsed certificate or a certificate accompanied by an assignment, a great administrative burden would be imposed on corporations and on transfer agents. They would be called on to make decisions as to whether substitute methods of transfer were good enough.

This in turn would give rise to much litigation that would be a waste of time, money, and the time of the courts, and to that extent could be regarded as defeating the social force in favor of protecting the general welfare.

By reducing the formality standards, which the court refuses to do, it would become possible for a fraudulent claimant to seize on various letters, memoranda, or statements of intent and claim that they constituted transfers of the shares on the ground that they showed an intent to transfer. Actually, they might fall short of an intent to transfer. That is, they might merely be a ―thinking over‖ of whether to make a transfer, as opposed to a definitive and final intent to transfer.

By refusing to make any exceptions to the statutory requirements, the court avoids all the above dangers.

14. Birt was a hospital patient. The doctor who treated him was a shareholder of a professional corporation organized under the Indiana Medical Professional Corporation Act. Birt claimed that the doctor who treated him was guilty of malpractice, and he sued

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the doctor. He also sued the professional corporation and all of its officers, directors, and shareholders. These other defendants asserted that they were not liable because the corporate entity shielded them. The plaintiff claimed that the corporation was not a shield because in fact all of the persons were rendering medical services and should be held liable as in a partnership. The statute did not expressly regulate the matter of limited liability beyond declaring that it did not change the law between a person supplying medical services and the patient. Decide. [Birt v. St. Mary Mercy Hospital, 370 N.E.2d 379 (Ind. App.)] Answer: Malpractice liability in a professional corporation. Judgment against Birt as to the other defendants. These other defendants had not rendered services to the plaintiff. The fact that they were part of a corporation did not impose vicarious liability on them for the conduct of anyone else. Nothing in the statute required imposing such liability. The corporate entity therefore protected all persons connected with the corporation from malpractice liability rendered by an employee of the corporation. [Birt v. St. Mary Mercy Hospital, 370 N.E. 2d 379 (Ind. App.)] 15. Ronald Naquin, an employee of Air Engineered Systems & Services, Inc., owned one-third of its outstanding shares. After six years, he was fired and an offer was made to buy out his interest in Air Engineered at a price that Naquin thought inadequate. He then formed a competing business and made a written request to examine the corporate records of Air Engineered. This request was denied. Naquin filed suit to require Air Engineered to allow him to examine the books. Air Engineered raised the defense that he was a competitor seeking to gain unfair competitive advantage. Decide. [Naquin v. Air Engineered Systems & Services, Inc., 463 So. 2d 992 (La. App.)] Answer: Inspection of books. Judgment for Naquin. Because Air Engineered attempted to buy him out at a price he thought inadequate, Naquin had the right to examine the corporation‘s financial records so that he could determine the true value of his shares.

Naquin, as a six-year employee, already knew who Air Engineered‘s customers were and could gain no unfair advantage, as asserted by Air Engineered. [Naquin v. Air Engineered Systems & Services, Inc., 463 So. 2d 992 (La. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

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1.

A stockholder‘s right to inspect books and records of a corporation will be properly denied if the stockholder: a.

Wants to use corporate stockholder records for a personal business.

b.

Employs an agent to inspect the books and records.

c.

Intends to commence a stockholder‘s derivative suit.

d. Is investigating management misconduct.

2.

The limited liability of a stockholder in a closely held corporation may be challenged successfully if the stockholder:

3.

a.

Undercapitalized the corporation when it was formed.

b.

Formed the corporation solely to have limited personal liability.

c.

Sold property to the corporation.

d.

Was a corporate officer, a director, or an employee.

Price owns 2,000 shares of Universal Corp.‘s $10 cumulative preferred stock. During its first year of operations, cash dividends of $5 per share were declared on the preferred stock but were never paid. In the second year, dividends on the preferred stock were neither declared nor paid. If Universal is dissolved, which of the following statements is correct?

4.

a.

Universal will be liable to Price as an unsecured creditor for $10,000.

b.

Universal will be liable to Price as a secured creditor for $20,000.

c.

Price will have priority over the claims of Universal‘s bond owners.

d.

Price will have priority over the claims of Universal‘s unsecured judgment creditors.

Under the Revised Model Business Corporation Act, a dissenting stockholder‘s appraisal right generally applies to which of the following corporate actions?

Consolidations

Shares from mergers

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

[return to top] Answers to AICPA Questions

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1.

A stockholder‘s right to inspect books and records of a corporation will be properly denied if the stockholder: a.

Wants to use corporate stockholder records for a personal business.

b.

Employs an agent to inspect the books and records.

c.

Intends to commence a stockholder‘s derivative suit.

d. Is investigating management misconduct. (a) No explanation given.

2.

The limited liability of a stockholder in a closely held corporation may be challenged successfully if the stockholder: a.

Undercapitalized the corporation when it was formed.

b.

Formed the corporation solely to have limited personal liability.

c.

Sold property to the corporation.

d.

Was a corporate officer, a director, or an employee.

(a) No explanation given.

3.

Price owns 2,000 shares of Universal Corp.‘s $10 cumulative preferred stock. During its first year of operations, cash dividends of $5 per share were declared on the preferred stock but were never paid. In the second year, dividends on the preferred stock were neither declared nor paid. If Universal is dissolved, which of the following statements is correct? a.

Universal will be liable to Price as an unsecured creditor for $10,000.

b.

Universal will be liable to Price as a secured creditor for $20,000.

c.

Price will have priority over the claims of Universal‘s bond owners.

d.

Price will have priority over the claims of Universal‘s unsecured judgment creditors.

(a) No explanation given.

4.

Under the Revised Model Business Corporation Act, a dissenting stockholder‘s appraisal right generally applies to which of the following corporate actions?

Consolidations

Shares from mergers

a.

Yes

Yes

b.

Yes

No

c.

No

Yes

d.

No

No

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 43: Securities Regulation

(a) No explanation given. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 43: Securities Regulation

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 419 Questions and Case Problems .......................................................................................................... 419 End of Chapter: CPA Questions and Answers ................................................................................. 434 Answers to AICPA Questions ............................................................................................................ 436

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Lawrence D. Polizzotto, a former vice president at First Solar Inc., spoke in one-on-one phone calls with some analysts and investors. He stated that the company was unlikely to receive a much-anticipated loan guarantee from the U.S. Department of Energy. The next morning, this information was disclosed in a press release. The stock price dropped 6 percent. Has Polizzotto violated any SEC rules or regulations? [In the Matter of Lawrence D. Polizzotto, Adm. Proc. File No. 3-15458 (September 6, 2013)] Answer: Regulation FD. The SEC maintained that Polizzotto violated Regulation FD by disclosing material nonpublic information to private parties. According to the SEC, all investors, regardless of their size or relationship with the company, are entitled to the same information at the same time. In this case, Polizzotto agreed to pay $50,000 to settle the SEC‘s charges. [In the Matter of Lawrence D. Polizzotto, Adm. Proc. File No. 3-15458 (September 6, 2013)]

2.

Business Week magazine is sent to a national distributor of magazines, Curtis Circulations Co., which sells the magazines to various wholesalers, including Hudson News. Business Week publishes a column entitled ―Inside Wall Street,‖ and the evidence shows that stocks

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discussed favorably in the column tend to increase in value after release to the public.

Business Week has a strict confidentiality policy prior to release of the magazine to the public applicable to all employees involved in production and distribution. This policy also applies to Hudson News. Gregory Savage, an employee of Hudson News, and the ―top person‖ in the delivery room area, arranged to have the ―Inside Wall Street‖ column faxed to his neighbor, a stockbroker named Larry Strath, prior to the close of the market on Thursday and prior to release to the public that evening. Strath traded on the information and passed it on to Joseph Falcone, who likewise traded on the basis of this information.

While Falcone paid Strath $200 for a copy of the column each week, he contends that the information he received was too remote from the Business Week confidentiality policy to be actionable by the SEC. What theory do you believe the SEC pursued against Falcone?

What are the elements of the theory? How would you decide this case? [United States v.

Falcone, 257 F.3d 226 (2d Cir.)] Answer: The misappropriation theory of insider trading. To support a conviction of Falcone, the government had to prove (1) a breach of duty owed to the owner of the misappropriated information; and (2) Falcone's knowledge that the tipper had breached the duty. The tipper in this case is Gregory Savage who owed a duty to Business Week through his employer Hudson News not to release the confidential column in question.

Savage, as the "top person" in the area obviously knew of the policy. Thus, Savage breached his duty to Hudson News and Business Week. While Falcone denied knowledge that the tipper breached his duty, the fact that he paid $200 per column was substantial evidence that he was aware that he was obtaining stolen information and that a tipper had breach his duty. Decision against Falcone. [United States v. Falcone, 257 F. 3d 226 (2d Cir.)] 3.

Gogo provides in-flight internet connectivity services to customers traveling by airplane.

Gogo‘s service works by integrating hardware and software installed on airplanes with satellite and ground-based networks. To provide internet access, Gogo relies for each flight on one of two systems—the ―air to ground‖ (―ATG‖) system or its new 2Ku antennaand- satellite-based system, first deployed in 2016.

Each 2Ku system is installed in a ventilated compartment known as the ―radar dome‖ or ―radome.‖ When airport personnel spray the aircraft with de-icing fluid, the fluid may permeate the radomes via the ventilation valves. When de-icing fluid infiltrates the radomes, the antennas become ―sticky‖ and unable to function due to the glycol in the fluid.

In November or December 2017, Delta Airlines, a major partner that accounted for 25% of

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Gogo‘s revenue in 2014, 2015, and 2016, placed calls to Gogo complaining that its 2Ku systems were not working and threatening to shut them down if they were not fixed. Gogo reacted promptly, and its employees worked overtime to address the problem. Gogo could not solve the deicing problems, and Delta was not satisfied with the attempted repairs.

Despite these issues Gogo issued statements to investors and analysts that summarized the advantages of the 2Ku system as ―characterized by three numbers: 15, 98, 98. This means 15plus megabits per second speed to connect the passengers; 98% coverage of global flight hours and 98% service availability.‖ In reality, the de-icing fluid infiltration problem was negatively affecting the systems‘ performance and requiring costly repairs.

With the problems not being addressed, Gogo brought in a new CEO. On May 4, 2018, the new CEO, Oakleigh Thorne, disclosed the full truth about the 2Ku defect and the associated installation and repair issues. In a conference call, Thorne revealed that Gogo‘s 2018 first-quarter earnings were poor because of the ―de-icing fluid impact on 2Ku,‖ which caused the airlines to ―h[o]ld back on marketing the product‖ and Gogo to ―ramp[ ] up spending to fix reliability‖ as soon as possible. Thorne acknowledged that Gogo had previously set forth its ―goal‖ of ―98% system availability, 98% flight route coverage and 15 megabits per second speeds,‖ but the company had ―slipped on the 98% system availability with [its] de-icing problems.‖ The winter weather and the accompanying deicing stops had caused availability to ―plunge[ ] down to the mid 80s.‖ Gogo‘s shares fell $1.73 per share to close at $7.86 on May 7, 2018 (a drop of over 18%).

The same day, after the market closed, Moody‘s downgraded Gogo‘s credit rating, and the share price fell an additional $2.80 per share to close at $5.06.

A group of shareholders brought a class-action suit against the company under 10b-5 alleging that the company was not forthcoming with the extent of the de-icing problem and the effects on performance of the system and the company. Discuss whether the dissemination of information was a violation of 10b-5 and be sure to discuss what the shareholders had to establish. [ Pierrelouis v. Gogo, Inc., 414 F. Supp. 3d 1164 (N.D. Ill.)] Answer: 10(b) and corporate dissemination of information. In this case, without more ―specific facts,‖ to demonstrate when the 2Ku problems showed themselves to be of ―a sufficient magnitude,‖ plaintiffs' allegations do not support a reasonable belief that defendants' statements were false, misleading, or without a reasonable basis at the time they were made. Merely alleging that (a) Gogo could and did track service outages, (b)

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defendants had access to outage reports, and (c) at some time prior to May 4, 2018, during or after the ―winter,‖ the 2Ku system‘s ―availability plunged down to the mid-80s‖ (Am. Compl. ¶ 62), without other details, does not provide sufficiently specific and particularized information about when the data revealed that the de-icing problem had caused a precipitous drop in availability, or when it became clear that costly remediation efforts were necessary. See Yourish, 191 F.3d at 995-96; Arazie, 2 F.3d at 1467; see also Zerger v. Midway Games, Inc., No. 07 C 3797, 2009 WL 3380653, at *9 (N.D. Ill. Oct. 19, 2009) (―Plaintiffs' bald allegation . . . does [not] show that the financial consequences of that decision were known, or could have been known, at the time those guidances were issued. Plaintiffs thus fail to plead the ―when‖ of Defendants' alleged fraud with enough particularity.‖), In re Harley-Davidson, Inc. Sec. Litig., 660 F. Supp. 2d 969, 987 (E.D. Wis. 2009) (―[A]llegations regarding the preparation and dissemination of daily reports do not actually mention any reports that contained statistics materially inconsistent with the defendants' public statements.‖).

True, while the Court must ensure that ―the grounds for the plaintiff‘s suspicions . . . make the allegations plausible,‖ it must do so while ―remain[ing] sensitive to information asymmetries that may prevent [plaintiff] from offering more detail‖ based only on its precomplaint inquiry, which it conducts without the benefit of discovery. But even bearing in mind that plaintiffs cannot yet obtain documents or data that only defendants possess, plaintiffs must still plead sufficient factual matter to make the alleged fraud plausible.

Plaintiffs do not carry this burden by pleading that defendants merely had access to data that may have shown that their statements to investors were misleading when made, without describing specific documents containing that data or otherwise alleging that the data was available to the defendants in *some specific form. See Yourish, 191 F.3d at 99596; cf. Pension Tr. Fund for Operating Engineers v. DeVry Educ. Grp., Inc., No. 16 C 5198, 2017 WL 6039926, at *8-9 (N.D. Ill. Dec. 6, 2017) (plaintiffs sufficiently alleged falsity by identifying documents that they could not obtain but that were compiled by a government agency during an exhaustive investigation and described in some detail in a Joint Rule 26(f) report that the agency filed in separate litigation); Jones v. Corus Bankshares, Inc., 701 F. Supp. 2d 1014, 1020-21 (N.D. Ill. 2010) (―These allegations set forth in very clear and specific terms [by way of specific figures] the information available to Corus and why, given its possession of this information, Corus‘s statements about the adequacy of its reserves were misleading.‖). Plaintiffs have not made sufficiently particularized allegations to make plausible, rather than merely possible, that defendants' statements were misleading when made.

II. SCIENTER

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The Court has already explained that plaintiffs do not make sufficiently particularized allegations of falsity because they do not allege when the 2Ku de-icing problem manifested itself as such a severe problem as to make defendants' statements to investors misleading. Similarly, plaintiffs do not make sufficiently particularized allegations of scienter because they do not allege when defendants knew or should have known of the magnitude of the de-icing problem. Again, plaintiffs allege, in pertinent part, that (a) Gogo could and did track service outages, (b) defendants had access to outage reports, and (c) at some time prior to May 4, 2018, during or after the ―winter,‖ the 2Ku system‘s ―availability plunged down to the mid-80s‖ due to de-icing fluid infiltration (Am. Compl. ¶ 62). (See id. ¶¶ 132-39.) But these allegations do not answer the critical question of when defendants had sufficient knowledge to put them on notice that there was at least a substantial risk that Gogo would have to incur considerable remediation costs to prevent service outages due to de-icing fluid infiltration. [Pierrelouis v. Gogo, Inc., 414 F.Supp.3d 1164 (N.D. Ill. 2019)] 4.

The following transactions in Heritage Cosmetics Co., Inc., stock took place: On January 21, Jones, the corporation‘s vice president of marketing, purchased 1,000 shares of stock at $25 per share. On January 24, Sylvan, a local banker and director of Heritage, purchased 500 shares of stock at $26 per share. On January 30, McCarthy, a secretary at Heritage, purchased 300 shares of stock at $26.50. On February 12, Winfried, a rich investor from New England, purchased 25,000 shares at an average price of $26 per share. At that time, Heritage had a total of 200,000 shares of stock outstanding. On June 14, Winfried sold his entire holding in Heritage at an average price of $35 per share. In a local newspaper interview, Winfried was quoted regarding his reasons for selling the stock: ―I have not had the pleasure of meeting any person from Heritage, but I have the highest regard for the Heritage Company, . . . I sold my stock simply because the market has gone too high and in my view is due for a correction.‖ After independently reading Winfried‘s prediction on the stock market, Jones, Sylvan, and McCarthy sold their shares on June 15 for $33 per share. On June 20, Heritage Co. demanded that Jones, Sylvan, McCarthy, and Winfried pay the corporation the profits made on the sale of the stock. Was the corporation correct in making such a demand on each of these people?

Answer: Short-swing profits. Jones, an officer, and Sylvan, a director, are prohibited from making short-swing profits under § 16(b) of the 1934 act and must turn over the profits to the corporation. Winfried, who owned more than 10 percent of the equity shares outstanding, also is governed by § 16(b) and must turn over the profits to the corporation, even though it is apparent that he was not in fact an insider and acted in good faith.

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McCarthy may keep her profit because she is not an officer, a director, or a 10 percent owner and thus is not subject to § 16(b).

5.

Dorozhko hacked into the corporate network of Thomson Financial on October 17, 2007, at 2:15 p.m. and gained access to IMS Health‘s soon-to-bereleased negative earnings announcement due out at 5:00 p.m. He purchased $41,670 worth of put options. IMS shares were trading at $29.56 at the close on October 17. On October 18, 2007, IMS Health‘s stock price plunged at the opening of trading to $21.20 per share on the negative news issued at 5:00 p.m. on October 17. Within six minutes, Dorozhko sold the put options for a net profit of $286,456. Did Dorozhko‘s ―hacking and trading‖ violate either the traditional or misappropriation theories of ―insider trading‖?

Answer: Insider trading. When corporate insiders trade on the basis of material nonpublic information, or when a corporate insider gives a tip to a friend or family member for the purpose of having the outsider trade, and the outsider so trades, the tippees assume the ―disclose or abstain‖ duty to the other market participants from their tippers.

Dorozhko was neither a corporate insider nor a tippee, and the traditional insider theory of insider trading does not apply to him. Nor does the misappropriater theory apply based on a fiduciary duty to their employer. Dorozhko was a true ―outsider,‖ and the SEC theories did not apply to him.

Note: The Court believed Dorozhko should have been prosecuted criminally under the Computer Fraud and Abuse Act rather than this SEC action.

6.

Mary Dale worked in the law office of Emory Stone, an attorney practicing securities law.

While proofreading Mary‘s keying of a document relating to the merger of two computer software companies, Emory joked to her, ―If I weren‘t so ethical, I could make a few bucks on this info. Nomac Software stock prices are going to take off when this news hits ‗The Street.‘― That evening, Mary told her friend Rick Needleworth, a stockbroker, what her boss had said. Needleworth bought 500 shares of Nomac Software stock the next day and sold it three days later when the news of the merger was made public. He made a profit of $3,500. Did Dale, Stone, or Needleworth violate any securities law(s) or ethical principles with respect to the profit made by Needleworth?

Answer: Insider trading. Needleworth, a tippee, possessed material, inside information when he purchased Nomac stock, and he is subject to a civil penalty of up to three times the profit gained by the unlawful purchase, or $10,500, under the Insider Trading

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Sanctions Act of 1984. Dale, who worked under the control of Stone and aided or abetted in the unlawful purchase, may also be held liable under the 1984 law. Stone was a controlling person under the 1988 Insider Trading Act. He had an obligation under the 1988 act to control client confidences and make sure that controlled persons did not misuse confidential information. Instead of cautioning Dale about the confidential information he was to type, he made a joke about making a few bucks on the information.

Such appears to be reckless behavior, which could make him liable for penalties and damages under the 1988 act.

7.

International Advertising, Inc. (IA), would like to raise $10 million in new capital to open new offices in Eastern Europe. It believes it could raise the capital by selling shares of stock to its directors and executive officers as well as to its bank and a large insurance company whose home office is located near IA‘s headquarters. Opposition to the financing plan exists because of the trouble, time, and cost involved with registering with the SEC. Advise IA how best to proceed with the registration of the new issue of stock.

Answer: Registration exemptions. Banks and insurance companies, as well as directors and executive officers of the issuing corporation, are considered accredited investors. IA could issue a private placement to be sold to these accredited investors under Rule 506 of SEC Regulation D and not have to be concerned about the trouble, time, and cost of registering securities with the SEC. These securities would be restricted securities, however, and their resale might require registration.

8.

Dubois sold Hocking a condominium that included an option to participate in a rental pool arrangement. Hocking elected to participate in the arrangement. Under the arrangement, the rental pool‘s agent rented condominiums, pooled the income, and after deducting a management fee, distributed the income to the owners on a pro rata basis.

Hocking brought a Rule 10b-5 fraud action against Dubois. Dubois contended that the sale of the condominium was not a security under the securities acts so Hocking could not bring a securities suit against her. Was Dubois correct? [Hocking v. Dubois, 885 F.2d 1449 (9th Cir.)] Answer: Definition of a security. We must therefore determine whether Hocking's purchase of a condominium and rental pool was (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits produced by the efforts of others.

Before applying the Howey test to the facts of this case, we must determine what

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exactly Dubois offered to Hocking. Most of the cases finding a real estate transaction to involve a security have been direct offerings from a developer that include collateral agreements. This fact has led defendants to attempt to distinguish Hocking's purchase based on the lack of supposedly necessary links between the developer, the Libermans, HCP and Dubois. Hocking, however, has not claimed that the developer, the Libermans, or HCP sold him a security. He claims that by promoting the Libermans' condominium ―with an emphasis on the economic benefits to be derived from the managerial efforts of third parties designated or arranged for by Dubois,‖ and by including with the condominium an offer for a rental arrangement or rental pool arrangement, Dubois offered him a security.

There is no question that Dubois offered Hocking the condominium. The Libermans had listed their unit with Vitousek & Dick, and Dubois acted as the Libermans' real estate agent in selling the condominium to Hocking. Defendants argue, however, that Dubois could not ―offer‖ the RPA or other rental agreements to Hocking.

Nothing in the record indicates, and Hocking has not argued, that Dubois could legally bind HCP to enter into the RPA or other agreements with Hocking. There is no evidence that the Libermans transferred to Hocking a legally enforceable option to join the RPA, or that Dubois had legal authority to act on behalf of HCP. Dubois could not ―offer‖ the RPA in the sense of common law contract offer and acceptance.

The inability of Dubois to make a binding contractual ―offer‖ of the RPA to Hocking, however, does not mean that the RPA cannot be considered part of the package she offered him for purposes of determining whether that package was a security under Howey. In attempting to determine whether a scheme involves a security, the inquiry is not limited to the contract or other written instrument Hocking states in his deposition and affidavit that Dubois assured him rental of his investment would be taken care of for him, that it would be handled by ―the company‖ for him, that she informed him of the average daily rental, that she presented the rental agreements to him for his signature, and that without the rental agreements, he would not have entered into the transaction. It is undisputed that Dubois did go out and find someone to enter into a rental agreement with Hocking.

Hocking has put forward numerous facts concerning whether the condominium sale and rental agreements were presented to him as parts of one transaction. These facts distinguish this case from the everyday situation where a real estate agent or broker merely provides information to the purchaser regarding the availability of a rental pool or

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shared amenities such as a swimming pool or tennis courts. They also distinguish this case from the situation where, after a purchase and separate from any inducement to purchase, a real estate agent or broker arranges for a rental pool.

THE HOWEY TEST A. Investment of Money Defendants attempt to pull apart the package into two separate transactions. They argue that even if Hocking did invest money in the condominium, he did not invest money in the RPA, and it is the RPA which provides the elements necessary to satisfy the Howey test's other requirements. Therefore, they claim, Hocking did not satisfy this first requirement.

Since Hocking has created an issue of fact over whether the condominium and RPA were sold as a package, he has met this first requirement of Howey for purposes of summary judgment.

B. Common Enterprise We agree with Judge Reinhardt's discussion for the panel of the Ninth Circuit law on Howey 's common enterprise requirement. The Ninth Circuit accepts either traditional horizontal commonality or, when no pooling among investors is present, a strict version of vertical commonality.

The simple purchase of real estate lacks any horizontal commonality, as no pooling of interests or profits is involved. The purchase of real estate combined with an RPA, however, does evidence horizontal commonality. The participants pool their assets; they give up any claim to profits or losses attributable to their particular investments in return for a pro rata share of the profits of the enterprise; and they make their collective fortunes dependent on the success of a single common enterprise. Because in this case Hocking has raised facts supporting horizontal commonality, we need not consider vertical commonality.

Of course, whether Hocking can prove horizontal commonality at trial will depend on whether he can show that Dubois offered a package which included the RPA. As discussed above, Hocking has raised a genuine issue of fact as to that question.

C. Expectation of Profits Produced by the Efforts of Others This third prong of Howey forms the greatest hurdle for Hocking, assuming he can prove at trial that the condominium and rental agreements were part of one package. He must show an expectation of profits produced by the efforts of others, that the efforts of others

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are ―those essential managerial efforts which affect the failure or success of the enterprise.‖ The crux of defendants' argument on this point is that the rental agreements allowed Hocking to maintain a high degree of control over his condominium, thus making any managerial efforts of Dubois or HCP non-essential to the success of Hocking's investment.

Hocking was not required to enter into any of the rental agreements as a prerequisite of purchasing the condominium. He elected to delegate control of the condominium to HCP. Further, the rental agreements gave Hocking various termination rights described above, allowing him to regain control over the use and management of his investment.

Defendants point out it was the purchaser's election to delegate control and ability to regain control that led to the conclusion that the third requirement of Howey had not been satisfied.

In the absence of any legal obligation to delegate control of his investment, Hocking must establish that his exercise of control was precluded for all practical purposes.

The record presents a material question of fact: was Hocking dependent on Dubois or HCP, and unable to exercise control over his investment? Hocking claims to be an unsophisticated, inexperienced investor, lacking any special training or education. He resides thousands of miles away from the location of the investment. He is not in the business of managing condominiums or other real estate. He has raised a genuine issue of fact whether he requested and received an offer of management services.

Further, Hocking observed that the condominium complex was ―operated like a hotel from the lobby,‖ and that HCP distributed brochures and advertisements on the mainland.

Hocking's affidavit and deposition raise a genuine issue of fact whether he intended his investment to be entirely passive, and whether, as alleged, he ―relied solely on Dubois to select, manage, and protect‖ his investment. This is, however, a different inquiry than whether he lacked the ability to manage his investment.

Defendants also protest that Hocking's deposition statements prove his intent was to resell the condominium quickly for a profit, and that he therefore could not have depended on rental income from the RPA for his profits, or expected profits from the

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efforts of the rental pool operator. Even in this regard, Hocking indicated he merely planned to sell ―when [Dubois] instructed [him] it was the best time to sell.‖ Further, in his affidavit Hocking testifies that the rental arrangement was a necessary element of the transaction, that he had expected the rental income to cover his monthly payment, and that the failure to receive the rental income resulted in the loss of his investment. Placed in this light, Hocking's deposition statements concerning a possible quick resale do not eliminate the question of fact concerning the third prong of Howey— whether Hocking expected profits from the efforts of others to carry the investment until he could sell it. The deposition statements that Hocking intended to resell quickly merely provide the type of conflicting evidence that a trial is designed to resolve.

CONCLUSION We agree with defendants and amici that the three-judge panel may have written too broadly its conclusion that so long as a rental pool ‗option‘ exists, all secondary market sales necessarily involve a security. Such a per se rule would be ill-suited to the examination of the economic reality of each transaction required by Howey. In the context of isolated resales, each case requires an analysis of how the condominium was promoted to the investor, including any representations made to the investor, and the nature of the investment and the collateral agreements. The investor's intentions and expectations as communicated to the broker would be relevant in determining what investment package was actually offered.

If the Howey analysis is undertaken, the securities laws are found to apply, and the application of the securities laws places undue burdens on developers, real estate brokers, or condominium owners, changes in the law should be sought from Congress or the Securities and Exchange Commission. Howey, on this record, requires this case to proceed beyond summary judgment. REVERSED AND REMANDED. [Hocking v. Dubois, 885 F.2d 1449 (9th Cir.)] 9.

William Rubin, president of Tri-State Mining Co., sought a loan from Bankers Trust Co. To secure the loan, he pledged worthless stock in six companies and represented that the stock was worth $1.7 million. He also arranged for fictitious quotations to appear in an investment reporting service used by the bank to value the pledged securities. The bank loaned Rubin $475,000 and took the securities as pledged collateral. In a criminal action against Rubin under section 17(a) of the 1933 act, Rubin‘s defense was that the pledging of securities did not constitute an offer or sale of securities under the act. Was Rubin correct? [Rubin v. United States, 449 U.S. 424]

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Answer: Liability of sellers of securities. No. It is not essential under the terms of the act that full title pass to a transferee for the transaction to be an offer or a sale under the securities laws. Bankers Trust parted with $475,000 and obtained a valuable interest under the pledges. Treating pledges as included with offers or sales comports with the purpose of the act, which is to protect against fraud and promote the free flow of information.

[Rubin v. United States, 449 U.S. 424] 10. J. C. Cowdin, a director of Curtis-Wright Co., phoned Robert Gintel, a partner of Cady, Roberts & Co., a stock brokerage house, and advised him that Curtis-Wright‘s quarterly dividend had been cut. Gintel immediately entered orders selling Curtis- Wright shares for his customers‘ accounts. The stock was selling at over $40 a share when the orders were executed but fell to $30 soon after the dividend cut was announced to the public. The SEC contended that the firm, Cady, Roberts & Co., and Gintel violated section 10(b) of the 1934 act, Rule 10b-5, and section 17(a) of the 1933 act. Gintel and Cady, Roberts & Co. disagreed. Decide. [In re Cady, Roberts & Co., 40 SEC 907] Answer: Insider trading. Judgment against Gintel and Cady, Roberts & Co. Cowdin, as a director of Curtis-Wright, breached his fiduciary duty to the corporation by improperly disclosing the information to Gintel. The tippee is subject to the same fiduciary duty as the insider where the tippee knows or should know there has been a breach of fiduciary duty.

Gintel‘s options were to disclose to the public the information he had prior to making any sales, or if it were unrealistic to do so, his only alternative was to forego the transactions.

Gintel violated § 10(b), Rule 10b-5, and §17(a). Because Gintel was a partner of the brokerage firm and because his actions were in the course of his employment, they are regarded as the actions of the firm, making Cady, Roberts & Co. liable as well. [In re Cady, Roberts & Co., 40 SEC 907] 11. In a January 2000 prospectus for its initial public offering of shares, Apex Oil Discovery Co. (AODC) estimated a sizable volume of oil production based on the studies of two geologists and a test well at one of its Oklahoma properties. A cautionary statement advised that the projections were only estimates based on the opinion of the two experts and a test well, and that actual production could vary significantly. Lutz bought 10,000 shares of Apex in May 2000 for $20 per share. By October 2000, 12 of its 15 drilling operations under way that year turned out to be dry holes. On October 18, 2000, AODC stock fell to $6 per share. Lutz brought a private securities civil action under SEC Rule 10b5 against AODC, alleging that the AODC oil production estimates that induced him to buy the stock were fraudulent as evidenced by the 80 percent failure rate of its drilling operations. What defense, if any, does AODC have in this case? Decide.

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Answer: Litigation Reform Act, Safe Harbor Rules. Lutz cannot successfully bring a Rule 10b-5 securities fraud action against AODC when AODC‘s forward-looking statement about oil production volume turned out to be erroneous and the price of the stock fell to $6 per share on October 18, 2000. The safe harbor provisions of the Litigation Reform Act will shelter AODC in any such litigation, provided that the underlying factual assertions were true—that two geologists did studies and a test well was successful.

12. Douglas Hansen, Leo Borrell, and Bobby Lawrence were three psychiatrists who recognized the need for an inpatient treatment facility for adolescents and children in their community. They became limited partners in building a for-profit psychiatric facility. Each had a 6.25 percent interest in the partnership. Healthcare International, Inc., the general partner with a 75 percent interest, had expertise in hospital construction, management, and operation. Hansen, Borrell, and Lawrence asserted that the managerial control of the partnership was undertaken and operated by the general partner to the exclusion of the limited partners. The doctors claimed that their interest was a security—―an investment contract‖— that gave them status to file a securities suit against the general partner under the 1934 act. The general partner disagreed. Decide. [L & B Hospital Ventures, Inc. v.

Health-care International, Inc., 894 F.2d 150 (5th Cir.)] Answer: Definition of security. On the facts set forth, it is clear that the doctors made an investment of money, in the common enterprise of building and operating a health care facility with the expectation of future profits. The fourth test of making profits from the efforts of others is the big element in this dispute. It could be argued that the doctors made profits from their own efforts by sending patients to the facility. But the facts do not support this position. Moreover, the general partner was to provide and did provide all management of the construction and operation of the hospital to the exclusion of the doctors. On this basis, the doctors‘ interests were investment contracts that could give them status to file a securities suit against the general partner. [L & B Hospital Ventures, Inc. v. Health-care International, Inc., 894 F. 2d 150 (5th Cir.)] 13. Texas International Speedway, Inc. (TIS), filed a registration statement and prospectus with the Securities and Exchange Commission offering a total of $4,398,900 in securities to the public. The proceeds of the sale were to be used to finance the construction of an automobile speedway. The entire issue was sold on the offering date. TIS did not meet with success, and the corporation filed a petition for bankruptcy. Huddleston and Bradley instituted a class-action suit in U.S. district court on behalf of themselves and other purchasers of TIS securities. Their complaint alleged violations of section 10(b) of the 1934

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Solution and Answer Guide:

act. The plaintiffs sued most of the participants in the offering, including the accounting firm of Herman & MacLean. Herman & MacLean had issued an opinion concerning certain financial statements and a pro forma balance sheet that were contained in the registration statement and prospectus. The plaintiffs claimed that the defendants had engaged in a fraudulent scheme to misrepresent or conceal material facts regarding the financial condition of TIS, including the costs incurred in building the speedway. Herman & MacLean contended that the case should be dismissed because section 11 of the 1933 act provides an express remedy for a misrepresentation in a registration statement, so an action under section 10(b) of the 1934 act is precluded. Decide. [Herman & MacLean v.

Huddleston, 459 U.S. 375] Answer: Antifraud provisions. Judgment for Huddleston. Section 10(b) of the 1934 act and § 11 of the 1933 act involve distinct causes of action and were intended to address different types of wrongdoing. Section 11 imposes a stringent standard of liability on parties who play a direct role in a registered offering. Section 10(b) is a catchall antifraud provision relating to deceptive devices of any person involved in the sale of any security.

Exempting § 11 conduct from liability under § 10(b) would conflict with the basic purpose of the 1933 act, which was to provide greater protection to purchasers of registered securities. [Herman & MacLean v. Huddleston, 459 U.S. 375] 14. Melvin J. Ford, president of International Loan Network, Inc. (ILN), promoted ILN‘s financial enrichment programs to ILN members and prospective members with evangelical fervor at revival-style ―President‘s Night‖ gatherings. His basic philosophy was this: The movement of money creates wealth. What we believe is that if you organize people and get money moving, it can actually create wealth.

One ILN program was the Maximum Consideration Program, which, somewhat like a chain letter, provided $5,000 awards to members who sold $3,000 worth of new memberships called PRAs and made a deposit on the purchases of nonresidential real estate. According to Ford, an individual purchasing $16,000 worth of PRAs could receive an award of up to $80,000 because ―all of a sudden the velocity of money increases to such a point, the ability to create wealth expands to such a degree, that we could come back and give somebody an award for up to $80,000.‖ The SEC contended that ILN was selling unregistered investment contracts in violation of the 1933 act. ILN disagreed, contending that the program never guaranteed a return and was thus not an investment contract.

Decide. Could ILN have provided full disclosure to investors concerning the program in a prospectus if required by the 1933 act? [SEC v. ILN, Inc., 968 F.2d 1304 (D.C. Cir.)]

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Answer: Definition of security. Applying the Supreme Court‘s test for an investment contract to the Maximum Consideration Program, a participant must (1) invest $3,000 (2) in the common enterprise of the ILN program (3) with the expectation of future profits, and (4) from the efforts of others. The third prong of the four-prong Supreme Court test for investment contracts requires only the expectation of future profits, not the guarantee of future profits. Ford‘s statements created such an expectation. And from Ford‘s description, the big awards would come from the ―velocity of money‖ that is the future selling of additional programs by others in the chain-letter-type scheme. Such is clearly an investment contract that must be registered with the SEC in order to be sold. In Piambino v Bailey, (CA #5) 610 F. 2d 1306, n.9 (1980), the fifth circuit demonstrated the reality that the disclosure that would be required in a registration statement and prospectus could not be accomplished under such a scheme. The court stated: The essential vice of chain or pyramid distribution schemes has been well documented.

For example, if the founder recruited five distributors in the first month and if those five each recruited five more distributors in month two, and if each of these subsequent recruits enticed five people to join in the month following his own recruitment, over 244 million new distributors would be recruited in the twelfth month. Obviously, this would be impossible in a nation of only 220 million people. Equally as obvious is the fact that those who have the greatest risk of loss are those who enter the pyramid when the market is closest to saturation. . . The disclosure which would be necessary to inform a new investor of his prospects for success or failure would have to change almost daily in order to reflect the acquisition of new distributors. Needless to say, there would be substantial administrative obstacles connected with any such regime of disclosure. [SEC v. ILN, Inc., 968 F. 2d 1304 (D.C. Cir.)] 15. Closet Exchange, Inc., an online clothing exchange, was going public. Wyndam Brothers, Inc., was its underwriter for the offering. Alex Quinteros was the Wyndam partner who was handling the IPO for Closet Exchange. Alex was fairly certain that the stock would do well once it went up for sale. Two days before sales began, Alex called his aunt and told her that he felt that the stock was going to do well, much better than anyone else who had worked on it felt and that she should buy some. He told his aunt that he felt the others in his firm had underpriced the stock, explaining that, ―They don‘t get the used clothing market. It is huge.‖ Alex even offered, ―Look, we have a broker division. Let me get them to do the purchase as soon as the offering begins. If you wait to go through your broker, the price will be higher.‖ His aunt agreed, and the Wyndham broker secured a purchase of 100 Closet Exchange shares at a price of $30.00. Two hours later, the shares were selling for

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$64.00. Could Alex and his aunt be successfully charged with insider trading?

Answer: Insider trading. While the whole thing looks and feels like insider trading, it is not.

First, it is a primary offering, not a secondary sale. Second, the misappropriation theory of insider trading does not apply because Alex is not telling his aunt about information on Closet Exchange that no one else has—he just has a feeling that the sale is going to go really well. A hunch that does not come from different information than what is public is not a violation of 10b. However, Alex is just asking for trouble running the transaction through his firm and calling relatives about a stock he is working on. The aunt‘s purchase was a matter of efficiency—it was not because of the desire to withhold information from the market. Sometimes the market just gets things wrong.

16. Charu Beaumont worked in the internal audit department of Matrix, Inc. Charu has uncovered what Matrix called an early shipment program. The company ships its computer accessories products to distributors and retailers based on their past orders, but not in response to any current orders. When Charu asks her boss about the shipments, he responds, ― It‘s just predictive. We know from their order history what they will order.

These are not false earnings. They are early earnings.‖ Charu keeps thinking about the GAAP rules on revenue being tied to shipment, but worries about shipments with no orders or customer knowledge. Charu has discovered that the early shipments account for almost 25 percent of Matrix revenue for this quarter. Matrix is a 1934 act company and the 10-Q is due soon. Charu prepares the numbers for that report. Offer your advice to Charu about her rights and professional responsibilities.

Answer: Whistleblowing. Charu has a material accounting error. As an accountant she has a duty to report up the line—her supervisor is a no-go but she can go higher. She also probably has a hotline or ethics officer option (See Chapter 3). Beyond that there is the audit committee of the board as an avenue for reporting. She also has the SEC as an option, and she is protected by statute and professional rules in terms of possible client confidentiality. She can report without violating her duties to Matrix. If she reports to the SEC, she gets the Dodd-Frank protections, which include monetary awards and damages for termination if the company retaliates against her. If she reports to another government agency and she is fired she has 180 days to file with the Department of Labor for retaliation. [return to top] End of Chapter: CPA Questions and Answers

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Correct answers in boldface.

1.

Which of the following is least likely to be considered a security under the Securities Act of 1933?

2.

a.

Stock options

b.

Warrants

c.

General partnership interests

d.

Limited partnership interests

Which of the following statements is correct regarding a common stock offering that requires registration under the Securities Act of 1933? a.

The registration statement is automatically effective when filed with the SEC.

b.

The issuer would act unlawfully if it were to sell the common stock without providing the investor with a prospectus.

c.

The SEC will determine the investment value of the common stock before approving the offering.

d.

3.

The issuer may make sales 10 days after filing the registration statement.

Hamilton Corp. is making a $4,500,000 securities offering under Rule 505 of Regulation D of the Securities Act of 1933. Under this regulation, Hamilton is: a.

Required to provide full financial information to accredited investors only.

b.

Allowed to make the offering through a general solicitation.

c.

Limited to selling to no more than 35 nonaccredited investors.

d.

Allowed to sell to an unlimited number of investors both accredited and nonaccredited.

4.

Under the liability provisions of Section 11 of the Securities Act of 1933, an auditor may help to establish the defense of due diligence if: I.

The auditor performed an additional review of the audited statements to ensure that the statements were accurate as of the effective date of a registration statement.

II.

The auditor complied with GAAS.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

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Solution and Answer Guide:

[return to top] Answers to AICPA Questions 1.

Which of the following is least likely to be considered a security under the Securities Act of 1933? a.

Stock options

b.

Warrants

c.

General partnership interests

d.

Limited partnership interests

(c) Under the Securities Act of 1933, securities are defined broadly as any security that allows an investor to make a profit on an investment through the efforts of others rather than through his or her own efforts. Therefore, a general partnership interest would not likely be considered a security under the 1933 Act since partners in a general partnership have a right to manage and are considered active in the management of the business. Answers (a), (b), and (d) are incorrect because under the 1933 Act, securities are broadly defined to include stock options, warrants, and limited partnership interests.

2.

Which of the following statements is correct regarding a common stock offering that requires registration under the Securities Act of 1933? a.

The registration statement is automatically effective when filed with the SEC.

b.

The issuer would act unlawfully if it were to sell the common stock without providing the investor with a prospectus.

c.

The SEC will determine the investment value of the common stock before approving the offering.

d.

The issuer may make sales 10 days after filing the registration statement.

(b) The 1933 Act makes it unlawful for any person, directly or indirectly, to make use of any means or instruments of interstate commerce to carry or transmit for the purpose of sale, any security, including common stock, unless such security is accompanied or preceded by a prospectus that meets the requirements of the Act. 3.

Hamilton Corp. is making a $4,500,000 securities offering under Rule 505 of Regulation D of the Securities Act of 1933. Under this regulation, Hamilton is: a.

Required to provide full financial information to accredited investors only.

b.

Allowed to make the offering through a general solicitation.

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 44: Accountants‘ Liability and Malpractice

c.

Limited to selling to no more than 35 nonaccredited investors.

d.

Allowed to sell to an unlimited number of investors both accredited and nonaccredited.

(c) Under Rule 505, sales can be made to no more than 35 nonaccredited investors and to an unlimited number of accredited investors. Answer (a) is incorrect since an audited balance sheet and other financial statements must be supplied to the nonaccredited investors. Answer (b) is incorrect since no general solicitation is ever allowed under Regulation D. Answer (d) is incorrect since sales to nonaccredited investors cannot exceed 35 in number.

4.

Under the liability provisions of Section 11 of the Securities Act of 1933, an auditor may help to establish the defense of due diligence if: I.

The auditor performed an additional review of the audited statements to ensure that the statements were accurate as of the effective date of a registration statement.

II.

The auditor complied with GAAS.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

(c) Due diligence as a defense is difficult to establish but showing both of these (checking again on the number and GAAS) offers some proof of due diligence. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 44: Accountants’ Liability and Malpractice

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 438 Questions and Case Problems .......................................................................................................... 438 End of Chapter: CPA Questions and Answers ................................................................................. 444 Answers to AICPA Questions ............................................................................................................ 446

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Solution and Answer Guide:

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

The auditing firm of Timm, Schmidt & Co. prepared annual financial statements for Clintonville Fire Apparatus, Inc. (CFA). CFA showed these statements to Citizens State Bank and asked for loans. On the basis of the financial statements, Citizens loaned CFA approximately $380,000. Timm later discovered that the financial statements overvalued CFA by more than $400,000. Citizens demanded repayment of the loans. CFA could not pay the balance, and Citizens sued Timm and its malpractice liability insurer. They raised the defense that the suit was barred by lack of privity and the fact that no one in the Timm firm knew that CFA intended to use the financial statements to obtain loans from anyone.

Is the lack of privity a defense? [Citizens State Bank v. Timm, Schmidt & Co., 335 N.W.2d 361 (Wis.)] Answer: Accountants‘ liability to third parties. The absence of privity or the lack of knowledge of the intended use did not bar liability of an accountant for negligence to third persons sustaining loss by relying on the statements prepared by the accountant.

The liability of an accountant should be determined under accepted principles of negligence law. ―The fundamental principle [of that law] is that a tortfeasor is. . .liable for all the foreseeable consequences of his act.‖ The client‘s use of the statements to obtain loans and the harm to the lender were all foreseeable. [Citizens State Bank v. Timm, Schmidt & Co., 335 N.W. 2d 361 (Wis.)]

2.

Parente, Randolph, Orlando & Associates (Parente) is an accounting firm that had done auditing work for Sparkomatic for nearly 20 years. On June 14, 1993, Sparkomatic entered into a Memorandum of Intent with Williams Controls to sell Williams assets from Sparkomatic‘s Kenco division. The sale price was to be the ―audited book value‖ of the assets, and the book value would be based on the June 30, 1993, balance sheet (which Parente did not prepare). Sparkomatic then engaged Parente to audit the financial statements for December 31, 1990, 1991, and 1992 and to prepare an interim balance sheet for 1993.

On August 1, 1993, Sparkomatic and Williams Controls entered into an asset purchase agreement, which required that Williams be furnished financials through June 1993 as prepared by ―Sparkomatic‘s independent public accountant.‖ Parente was not identified by name in the agreement. Parente did review the asset purchase agreement with Williams

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Solution and Answer Guide:

prior to commencing its work and knew that Williams would be using the information Parente prepared.

Following the closing, additional information came to light indicating that Williams had overpaid for the assets of Kenco, and Williams filed suit against Parente for negligence, negligent misrepresentation, and breach of contract. Parente moved for summary judgment. What should the decision be and why? Discuss several possible theories.

[Williams Controls v. Parente, Randolph, Orlando, & Associates, 39 F. Supp. 2d 517 (M.D. Pa.)] Answer: Accountant liability; extent of recovery. Parente‘s motion for summary judgment on the third-party beneficiary claim was denied. Sparkomatic retained Parente for the express purpose of auditing and preparing financial statements in connection with the sale of the Kenco division. Parente was aware that its work was to be presented to Williams in connection with determining the final purchase price of the Kenco division. If Parente was negligent in its preparation of the financial statements that were given to Williams in September 1993, Parente may be liable for negligent misrepresentation. Parente knew that it was performing its work solely for the sale of the Kenco division. Parente knew that its work would be relied on in this transaction. Parente was not performing services generically for its client; rather, its work was specifically requested for a sales transaction.

There is no privity between Parente and Williams, but privity is not required for a negligent misrepresentation claim. Williams was an intended beneficiary of the contract between Parente and Sparkomatic. [Williams Controls v. Parente, Randolph, Orlando, & Associates, 39 F. Supp. 2d 517 (M.D. Pa.)] 3.

David S. Talesnick served as the accountant for Kenneth Ronson and his wife as well as for Ronson‘s company, performing accounting and tax services for all. From 1980 to 1983, Ronson, his wife, and his company invested in the White Rim Oil & Gas, Pine Coal, and Winchester Coal limited partnerships. During those years, the Ronsons and his company were able to report losses on their income tax returns because of these investments.

However, the IRS determined that the limited partnerships were not qualified investments under the tax code and disallowed the loss deductions. The Ronsons and his company all owed back taxes, interest, and penalties as a result. The Ronsons disputed the finding and asked Talesnick how they might appeal the ruling and not have the interest clock ticking on what they owed. Talesnick wrote a letter and advised them to post a bond of $91,300, the amount then due. Talesnick was incorrect in his advice on payment and accrual of interest, and by the time the final determination was made against the Ronsons and Ronson‘s company, they owed $235,063 with interest. The Ronsons sued Talesnick for

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Solution and Answer Guide:

malpractice. Could they recover? How much? [Ronson v. David S. Talesnick, CPA, 33 F. Supp. 2d 347 (D.N.J.)] Answer: Accountant liability for malpractice. Judgment for the Ronsons. The failure of the accountant to inform his clients of the problems with interest accruing amounted to malpractice, and the accountant could be held liable for the accrued interest not disclosed to the clients before they undertook their appeal. [Ronson v. Talesnick, 33 F. Supp. 2d 347 (D. N.J.)] 4.

The certified public accounting partnership of James, Guinn, and Head prepared a certified audit report of four corporations, known as the Paschal Enterprises, with knowledge that their report would be used to induce Shatterproof Glass Corp. to lend money to those corporations. The report showed the corporations to be solvent when in fact they were insolvent. Shatterproof relied on the audit report, loaned approximately $500,000 to the four corporations, and lost almost all of it because the liabilities of the companies were in excess of their assets. Shatterproof claimed that James and other accountants had been negligent in preparing the report and sued them to recover the loss on the loan. The accountants raised the defense that they had been retained not by Shatterproof but by Paschal. Was this defense valid? [Shatterproof Glass Corp. v. James, 466 S.W.2d 873 (Tex. App.)] Answer: Accountants‘ negligence malpractice liability to foreseeable user. No. The fact that Shatterproof was not the client of the accountants did not bar Shatterproof from suing the accountants for malpractice. To the contrary, the rule followed in some jurisdictions is that when an accountant fails to exercise ordinary care in the preparation of statements on which third persons rely, such third persons may recover their loss from the accountant when the reliance of such third persons was foreseeable or expected. [Shatterproof Glass Corp. v. James, 466 S.W. 2d 873 (Tex. App.)]

5.

AUSA Life Insurance Company and others were institutional investors in the securities of JWP, Inc., a company that went belly up, resulting in nearly a 100 percent loss of their investments. Ernst & Young served as auditor for JWP from 1985 to 1992. During most of that period, JWP was in a period of rapid expansion that was financed by private placements of debt securities, and it became increasingly leveraged. By 1991, it was losing an average of $10 million per month. Ernst & Young knew of ―accounting irregularities‖ from at least 1988 through 1991 but did not insist on their correction. Ernst & Young issued unqualified financial opinions for all of those years. One of the irregularities was recording anticipated future tax benefits of net operating loss in violation of GAAP. AUSA

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Solution and Answer Guide:

and its fellow investors sued Ernst & Young for their losses. The federal district court dismissed the case and AUSA appealed. Should AUSA be able to recover? Explain your answer. [AUSA Life Insurance Co. v. Ernst & Young, 206 F.3d 202 (2d Cir.), 119 F. Supp. 2d 394 (S.D.N.Y.), aff‘d in unpublished opinion] Answer: Accountants' negligence malpractice liability to foreseeable user. Judgment for the investors. The court held that there was privity of contract between Ernst & Young and the investors because their purchase was a private placement, Ernst & Young knew who the investors were at the time it certified the financial statements for the sale of their interests, and it continued to provide certified financial information to them from 1985 to 1992.

Because Ernst & Young had violated GAAP, there was negligence, and the investors were in a position to recover for breach of contract. However, upon retrial, while the court found the accounting firm could be held liable, it found that the firm could not have foreseen the disastrous acquisition that was the true cause of AUSA‘s note default and bankruptcy, precluding a finding of loss causation. [AUSA Life Insurance Co. v. Ernst & Young, 206 F. 3d 202 (2d Cir.), 119 F. Supp. 2d 394 (S.D. N.Y.), aff'd in unpublished opinion] 6.

For almost 13 years, Touche Ross had prepared the annual audit of Buttes Gas and Oil Co. Buttes wanted to obtain a loan from Dimensional Credit Corp. (DCC) and showed DCC its most recent annual audit. DCC made the loan on the basis of what it learned from the audit. The loan was not repaid, and DCC then realized that it had been misled by negligent statements about Buttes‘s financial condition that appeared in the annual statement prepared by Touche Ross. Would DCC be able to recover against Touche Ross for its negligence in preparing this report?

Answer: Accountant‘s liability to nonprivity plaintiff; intended beneficiary rule. No. From the fact that the accountant prepared the annual audit every year as a matter of routine, it was clear that the report shown to DDC was prepared by Touche Ross without any reason to know that it was to be used for the purpose of obtaining a loan or that it would be submitted to any lender. The nonprivity plaintiff therefore did not qualify as an intended beneficiary who could sue the accountant for negligence.

7.

Henry Hatfield, CPA, was hired to prepare audited financial statements for Happy Campers, a nonprofit organization providing summer camp scholarships for inner-city, low-income children. The executive director of Happy Campers was embezzling but falsified records that Hatfield used in his audit. First Bank gave Happy Campers a $100,000 loan based on Hatfield‘s certified financials. The embezzlement was discovered, and Happy Campers defaulted on the loan. Can First Bank recover its loss from Hatfield?

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Solution and Answer Guide:

Answer: Accountants‘ liability for fraud. First Bank is an intended user, but Henry Hatfield may have the traditional auditor defense of fraud by the client. When a client engages in fraud, the auditor is not negligent when he does not uncover it because of the deliberate acts of the client.

8.

Allen Weinstein sold his Solas Plumbing Corporation to Lawrence and David Levine.

CohnReznick, LLP, served as the accountants for the Levines and assisted in the transaction. The Levines, in effect, accomplished what Weinstein said was a conversion of his plumbing company because he was not paid what had been promised. Weinstein filed suit against CohnReznick for ―aiding and abetting‖ conversion. Discuss whether Weinstein, as a third-party, could recover against the Levines‘ accounting firm. [Weinstein v.

CohnReznick, LLP, 43 N.Y.S.3d 387 (2016)] Answer: Accountants' liability to third parties. The court held that the lower court properly granted that branch of Cohn's motion which was to dismiss the cause of action alleging aiding and abetting conversion. The complaint failed to adequately allege Cohn's actual knowledge of, and substantial assistance in, the alleged conversion of the plaintiffs' plumbing business.

However, the court held that the lower court was not correct in dismissing the claim against Cohn alleging aiding and abetting breach of fiduciary duty. ―A claim for aiding and abetting a breach of fiduciary duty requires: (1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) that [the] plaintiff suffered damage as a result of the breach‖ The decision, in this part, presents an interesting approach to recovery by third parties, not on the basis of accountant liability, but, in essence a duty to speak up or do something about the perpetration of a scheme against a third party. [Weinstein v. CohnReznick, LLP, 43 N.Y.S.3d 387 (2016)]

9.

Hicks, the president and manager of Intermountain Merchandising, wanted to sell the business to Montana Merchandising, Inc. He retained Bloomgren, an accountant, to conduct an audit of Intermountain. Bloomgren knew that Montana would use the audit report in making the purchase of the business from Intermountain. Bloomgren‘s audit report showed the Intermountain business as profitable. Thayer, Montana‘s president, relied on this report in agreeing to purchase Intermountain and in agreeing to the terms of the purchase. Sometime later, Thayer and Montana discovered that there had been a number of mistakes in the audit and that the business that was sold was actually insolvent.

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Thayer and Montana Merchandising sued Hicks and Bloomgren for damages. The suit claimed that Bloomgren had negligently misrepresented the facts. Bloomgren moved to dismiss the claim because Thayer was not in privity of contract with him. and had no right of recovery. Evaluate Bloomgren‘s liability under all of the third-party theories of recovery.

[Thayer v. Hicks, 793 P.2d 784 (Mont.)]

Answer: Privity and accountant‘s liability. Lack of privity of contract between the plaintiff and the defendant‘s accountant is not a bar to suit. While there is a conflict of what will be required in place of privity, there is no reason to deny recovery by a nonprivity plaintiff against a negligent accountant when the accountant made the audit with knowledge that an identified third person would rely on the audit report in connection with a particular transaction. Bloomgren had this knowledge as to Thayer and Montana Merchandising, so the lack of privity of the plaintiff was not a bar to recovering damages for the negligent preparation of the audit report by Bloomgren. [Thayer v. Hicks, 793 P. 2d 784 (Mont.)]

10. McGladrey conducted a financial audit of Subspecialty Centers of America, LLC (SCA). SCA is owned by Dr. Mark S. Weinberger, an ear, nose, and throat surgeon. The audit was for the year ending December 31, 2003. McGladrey issued its audit report in March 2004. The audit report indicated that SCA‘s ―balance sheet presents fairly in all material respects to the financial position of SCA in conformity with generally accepted auditing standards.‖ Citibank received the audit report and in June 2004 made a $1.4 million term loan to SCA. Dr. Weinberger took the $1.4 million and left for Europe. Dr. Weinberger was subsequently located residing in a tent in the Italian Alps and was brought back to the United States in 2010. Hundreds of malpractice suits were filed against him, and federal prosecutors charged him with multiple counts of health care fraud.

Citibank brought suit to recover the $1.4 million it loaned SCA from McGladrey on the grounds that it negligently audited Dr. Weinberger‘s surgical practice. Citibank claims that it relied on McGladrey‘s audit in making the $1.4 million term loan to SCA. Discuss whether Citibank would be able to recover and under what theories of third-party liability.

[Citibank, N.A. v. McGladrey and Pullen, LLP, 953 N.E.2d 38 (Ill. App.)] Answer: Accountants' liability; lack of privity; issue of forseeability. The court also held that Citibank had made many loans to SCA and that the $1.4 million loan was part of an entire package of lending agreements and that the jury was permitted to consider the relationship as part of its determination of whether McGladrey was responsible for the information that led to the loan, i.e., the clean audit opinion. The court held that the

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Solution and Answer Guide:

decision to lend was based on other factors and not simply the audit and financial report of McGladrey. [Citibank, N.A. v. McGladrey and Pullen, LLP, 953 N.E. 2d 38 (Ill. App.)] 11. Equisure, Inc., was required to file audited financial statements when it applied for a listing on the American Stock Exchange (AMEX). Stirtz, Equisure‘s auditor, issued a favorable audit opinion used for the AMEX application. Stirtz also issued ―clean‖ opinions on Equisure‘s required SEC filings, such as its 10k.

Noram, a securities broker, loaned $900,000 in margin credit to purchasers of Equisure‘s stock based on the firm‘s audited financials. AMEX stopped trading on Equisure‘s stock because of allegations of insider trading and stock manipulation, and Noram was left without collateral for $2.5 million in loans. Stirtz resigned as Equisure‘s auditor, and Noram filed suit against Stirtz. The trial court granted Stirtz summary judgment. Noram appealed.

Who is liable here? Was the court‘s decision correct? Evaluate on the basis of all the theories for third-party liability. [Noram Investment Services, Inc. v. Stirtz Bernards Boyden, 611 N.W.2d 372 (Minn. App.)] Answer: Accountant liability to third parties. Judgment for Stirtz. The accountant did not have a duty of care to the stockbroker who was loaning margin credit. The accountant could not be held liable for misrepresentation to a party without privity and who was unknown to the auditor. [Noram Investment Services, Inc. v. Stirtz Bernards Boyden, 611 N.W.2d 372 (Minn. App.)] [return to top] End of Chapter: CPA Questions and Answers Correct answers in boldface.

1.

In general, the third-party (primary) beneficiary rule as applied to a CPA‘s legal liability in conducting an audit is relevant to which of the following causes of action against a CPA? Fraud

Constructive Fraud

Negligence

a.

Yes

Yes

No

b.

Yes

No

No

c.

No

Yes

Yes

d.

No

No

Yes

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Solution and Answer Guide:

2.

Beckler & Associates, CPAs, audited and gave an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen‘s net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan.

Mac sued Beckler to recover for its losses associated with Queen‘s default. Which of the following must Mac prove in order to recover?

I.

Beckler was negligent in conducting the audit.

II.

Mac relied on the financial statements.

a. I only b. II only c. Both I and II d. Neither I nor II 3.

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff: a.

Is the client’s creditor who sues the accountant for negligence.

b.

Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.

4.

c.

Is the accountant‘s client.

d.

Bases the action upon fraud.

Cable Corp. orally engaged Drake & Co., CPAs, to audit its financial statements. Cable‘s management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake‘s best defense would be that Drake did not:

5.

a.

Have privity of contract with Cable.

b.

Sign an engagement letter.

c.

Perform the audit recklessly or with an intent to deceive.

d.

Violate generally accepted auditing standards in performing the audit.

Which of the following services is a CPA generally required to perform when conducting a personal financial planning engagement? a.

Assisting the client to identify tasks that are essential in order to take action on

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Solution and Answer Guide:

planning decisions.

6.

b.

Assisting the client to take action on planning decisions.

c.

Monitoring progress in achieving goals.

d.

Updating recommendations and revising planning decisions.

Which of the following statements is (are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA misrepresentation?

I.

The plaintiff has justifiably relied on the CPA‘s misrepresentation.

II.

The CPA has acted in a grossly negligent manner.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

[return to top] Answers to AICPA Questions 1.

In general, the third-party (primary) beneficiary rule as applied to a CPA‘s legal liability in conducting an audit is relevant to which of the following causes of action against a CPA? Fraud

Constructive Fraud

Negligence

a.

Yes

Yes

No

b.

Yes

No

No

c.

No

Yes

Yes

d.

No

No

Yes

(d) A third-party (primary) beneficiary of audited financial statements is one specifically intended by the CPA and the client to be the primary user of the financial statements. The CPA will be liable for negligence to a third party only if it can be established that the party was intended to be the primary beneficiary. Since a CPA is generally liable to all third parties, including foreseen and foreseeable third parties, for fraud and constructive fraud, the third-party (primary) beneficiary rule is relevant only in those cases based on negligence. Answers (a), (b), and (c) are therefore incorrect.

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Solution and Answer Guide:

2.

Beckler & Associates, CPAs, audited and gave an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen‘s net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan.

Mac sued Beckler to recover for its losses associated with Queen‘s default. Which of the following must Mac prove in order to recover?

I.

Beckler was negligent in conducting the audit.

II.

Mac relied on the financial statements.

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

(c) In order to prove negligence under common law, Mac must prove the following: 1.

A duty of care existed.

2.

That duty of care was breached.

3.

The injury was proximately caused by the defendant‘s breach of the duty of care.

4.

The plaintiff suffered an injury.

Item I corresponds to the second element—―duty of care‖. Item II corresponds to the third element—―proximate cause‖. Thus, both items I and II are necessary in order for Mac to recover.

3.

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff: a.

Is the client’s creditor who sues the accountant for negligence.

b.

Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.

c.

Is the accountant‘s client.

d.

Bases the action upon fraud.

(a) Historically, privity of contract was a requirement for a cause of action based upon negligence. This approach was established in the landmark Ultramares case. Under common law, accountants owe a duty to all third parties to make their reports without actual or constructive fraud. Gross negligence amounting to a reckless

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Solution and Answer Guide:

disregard for the truth constituted fraud. Accountants have a contractual relationship with their clients thus privity would not be a defense.

4.

Cable Corp. orally engaged Drake & Co., CPAs, to audit its financial statements. Cable‘s management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake‘s best defense would be that Drake did not: a.

Have privity of contract with Cable.

b.

Sign an engagement letter.

c.

Perform the audit recklessly or with an intent to deceive.

d.

Violate generally accepted auditing standards in performing the audit.

(d) An auditor‘s best defense when sued for negligence is proof that the auditor did not violate generally accepted auditing standards in performing the audit. Lack of privity is not a valid defense with the client who engaged the auditor. A signed engagement letter is not a required part of the audit and the lack of such a letter would not be a valid defense for the auditor. Even if the auditor did not perform the audit recklessly or with an intent to deceive, it is still possible that the auditor failed to exercise reasonable care, under the circumstances in conducting the audit.

5.

Which of the following services is a CPA generally required to perform when conducting a personal financial planning engagement? a.

Assisting the client to identify tasks that are essential in order to take action on planning decisions.

b.

Assisting the client to take action on planning decisions.

c.

Monitoring progress in achieving goals.

d.

Updating recommendations and revising planning decisions.

(a) No official explanation released.

6.

Which of the following statements is (are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA misrepresentation?

I.

The plaintiff has justifiably relied on the CPA‘s misrepresentation.

II.

The CPA has acted in a grossly negligent manner.

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448

Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 45: Management of Corporations

a.

I only

b.

II only

c.

Both I and II

d.

Neither I nor II

(c) No official explanation released. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 45: Management of Corporations

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 449 Questions and Case Problems .......................................................................................................... 449 End of Chapter: CPA Questions and Answers ................................................................................. 459 Answers to AICPA Questions ............................................................................................................ 460

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Shareholders of Bear Stearns sued the directors of the corporation for damages for violation of the directors‘ fiduciary duties in effecting a stock-forstock merger with J.P. Morgan Chase for an implied value of $10 per share while the company‘s stock had previously reached a 15-month high of $160. On March 10, 2008, information began leaking into the market that Bear Stearns had a liquidity problem. On March 13, 2008, the company was forced to seek emergency financing from the Federal Reserve and J.P. Morgan Chase. By the weekend of March 14–16, the company could no longer operate without major financing. In an effort to preserve some shareholder value while averting the uncertainty of bankruptcy (where stockholders would likely receive nothing), and represented by teams of legal and financial experts and relying on their financial advisor Lazard Freres & Co.‘s opinion that the ―exchange ratio is fair, from a financial point of view, to the shareholders,‖ the board of directors approved the initial merger agreement. The

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Solution and Answer Guide:

shareholder plaintiffs contended that the ultimate $10 share price paid was inadequate and they presented their experts who vigorously dissected the board‘s decisions. What defense, if any, would you raise on behalf of the Bear Stearns board of directors? [In re Bear Stearns Litigation, 870 N.Y.S.2d 709] Answer: Business Judgment Rule. The board of directors‘ approval of the merger did not subject them to liability because their decisions were protected by the Business Judgment Rule. Relying on teams of legal and financial advisors, no options were available other than the merger. The dissecting of the board's decision by the plaintiffs' experts was offset by counter-experts supporting the board's action. The board acted in an informed manner, in good faith, and the Business Judgment Rule protects the board members from "Monday morning quarterbacking". [In re Bear Stearns Litigation, 870 N.Y. S. 2d 709] 2.

Jerome Van Gorkom was chairman and chief executive officer of Trans Union Inc. On September 13, Van Gorkom arranged a meeting with Jay Pritzker, a well-known takeover specialist and a social acquaintance, to determine his interest in acquiring Trans Union. On Thursday, September 18, Pritzker made an offer of $55 per share (a price suggested by Van Gorkom). Pritzker wanted a decision to be made by the board no later than Sunday, September 21. On Friday, Van Gorkom called a special meeting of the board of directors for noon the following day; no agenda was announced. At the directors‘ meeting, Van Gorkom made a 20-minute oral analysis of the merger transaction. He showed that the company was having difficulty generating sufficient income to offset its increasingly large investment tax credits. Van Gorkom discussed his meeting with Pritzker and the reasons for the meeting. Copies of the proposed merger agreement were delivered too late to be studied before or during the meeting. No consultants or investment advisors were called on to support the merger price of $55 per share. The merger was approved at the end of the two-hour meeting. Certain shareholders brought a class-action suit against the directors, contending that the board‘s decision was not the product of informed business judgment. The directors responded that their goodfaith decision was shielded by the business judgment rule. Decide.[Smith v. Van Gorkom, 488 A.2d 858 (Del.)] Answer: Business judgment rule. Judgment for the shareholders. Directors cannot claim the protection of the business judgment rule if they have been grossly negligent in exercising their judgment. The directors approved the merger based on a 20-minute oral analysis by the president, Van Gorkom, at a hastily called board meeting with no prior notice of its purpose. No investment consultants or other experts were employed to assess the intrinsic value of the company, nor were the merger documents containing the terms of the merger available for study by the directors. Deciding to sell the company without

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450

Solution and Answer Guide:

any information and deliberation was gross negligence. The directors therefore could not claim the protection of the business judgment rule when they voted to ―sell‖ the company for $55 per share. The directors are personally liable for damages. [Smith v. Van Gorkom, 488 A.2d 858 (Del.)] 3.

The majority shareholder and president of Dunaway Drug Stores, Inc., William B. Dunaway, was structuring and executing the sale of virtually all of the corporation‘s assets to Eckerd Drug Co. While doing this, he negotiated a side noncompete agreement with Eckerd, giving Dunaway $300,000 plus a company car in exchange for a covenant not to compete for three years. He simultaneously amended two corporate leases with Eckerd, thereby decreasing the value of the corporation‘s leasehold estates. The board of directors approved the asset sale. Minority shareholders brought a derivative action against William Dunaway, claiming breach of his fiduciary duty in negotiating the undisclosed noncompete agreement, which did not require him to perform any service for buyer Eckerd Drug. Did William Dunaway make sufficient disclosure about all of the negotiations of the asset sale to Eckerd Drug? Did William Dunaway violate any fiduciary duty to the corporation? Decide. [Dunaway v. Parker, 453 S.E.2d 43 (Ga. App.)] Answer: Directors‘ conflicts; responsibilities; disclosure requirements. Dunaway‘s duty was to the Dunaway stores, not to himself or Eckerd. All matters relating to Eckerd should have been disclosed. Dunaway had a conflict and may have breached a corporate opportunity.

[Dunaway v. Parker, 453 S.E. 2d 43 (Ga. App.)]

4.

Larry Phillips was hired for a two-year period as executive secretary of the Montana Education Association (MEA). Six months later, he was fired. He then sued MEA for breach of contract and sued the directors and some of the other employees of MEA on the theory that they had caused MEA to break the contract with him and were therefore guilty of the tort of maliciously interfering with his contract with MEA. The evidence showed that the individual defendants, without malice, had induced the corporation to break the contract with Phillips but that this had been done to further the welfare of the corporation. Was MEA liable for breach of contract? Were the individual defendants shielded from personal liability? [Phillips v. Montana Education Ass’n, 610 P.2d 154 (Mont.)]

Answer: Privilege of officers and directors to interfere with contracts. Judgment for Phillips as to the corporation. Judgment against Phillips as to the individual defendants. When a corporation breaks a contract, it is liable for breach of the contract, regardless of why it broke the contract. The fact that officers or employees induced the corporation to break its contract with a third person does not give the third person the right to sue them. Such

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451

Solution and Answer Guide:

liability arises only if the directors or officers induced the breach of contract to harm the third person or to further their personal interest. No such liability arises when the directors or officers act solely to benefit the corporation. Phillips produced no evidence to show that the individual defendants acted to hurt him or to benefit themselves. The individual defendants therefore were not liable. Only the corporation was liable for the breach of the corporate contract. [Phillips v. Montana Education Ass'n, 610 P. 2d 154 (Mont.)]

5.

Christy Pontiac, a corporation, was indicted for theft by swindle and forgery involving a GM cash rebate program. Hesli, a middle-management employee of Christy Pontiac, had forged the cash rebate applications for two cars so that the rebate money was paid to Christy Pontiac instead of its customers. When confronted by a customer who should have received a rebate, the president of the dealership attempted to negotiate a settlement.

The president did not contact GM headquarters until after an investigation was begun by the state attorney general. Christy Pontiac argued that it could not be held responsible for a crime involving specific intent because only natural persons, as opposed to corporations, can form such intent. Decide. [State v. Christy Pontiac-GMC, Inc., 354 N.W.2d 17 (Minn.)]

Answer: Criminal liability of the corporation. Judgment against the corporation. Christy Pontiac, not Hesli, received the GM rebate money, so it is clear that Hesli acted in furtherance of the corporation‘s interests. When one of the buyers complained to the corporation‘s president, he attempted to negotiate a settlement and did not contact GM headquarters. The rebate money was obtained, accepted, and kept by Christy Pontiac until someone notified state officials. This evidence established that the theft by swindle and the forgeries of the rebates constituted the acts of the corporation. [State v. Christy Pontiac-GMC, Inc., 354 N.W. 2d 17 (Minn.)]

6.

A Lululemon stockholder claimed that directors of Lululemon Athletica Inc. breached their duty to the company by approving a $5 million severance package for a former CEO accused of ―pervasive misconduct.‖ The derivative suit accused nine directors of ignoring ―red flags‖ and improperly addressing allegations that CEO Laurent Potdevin ―created a toxic culture at lululemon and engaged in a pattern and practice of harassment and sexual favoritism while CEO.‖ The plaintiffs did not demand action by the board before filing the derivative suit. Are the directors liable to the corporation? [Shabbouel v. Potdevin et al.

No.2018-0847-JRS (Del Ch.)] Answer: Director liability. The shareholders have several problems with this case. First, the shareholders should have made a demand on the board before filing suit. There was no evidence of conflicting interests that excused a demand on the board. Second, the board

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Solution and Answer Guide:

is covered by the business judgment rule. In its April 2 memorandum opinion, the Court ruled that plaintiff deferential business judgment rule gave the directors the latitude to settle with Potdevin to avoid a legal battle‘s cost, risk, and embarrassment. ―It is the board‘s prerogative to decide when it had enough information to decide how to separate Potdevin from the company.‖ The board also approved a code of ethics and a whistleblower hotline as part of its investigation and eventual termination deal with Potdevin. Although this case was dismissed, the #MeToo movement spawned several lawsuits against boards of major companies including Nike, Inc., and Google parent, Alphabet, Inc. Such lawsuits typically allege companies inflated their share price by concealing the alleged misconduct or accuse companies‘ boards of insufficient oversight.

[Shabbouel v. Potdevin et al. No. 2018-0847-JRS (Del Ch. Apr. 2, 2020)] 7.

Discuss the power of a corporation‘s president to employ a sales manager and to agree that the manager should be paid a stated amount per year plus a percentage of any increase in the dollar volume of sales that might take place.

Answer: Power of corporate president. Courts differ as to the right of the president to hire a person who is as important to the corporation as a sales manager. If the president is also the general manager of the corporation, the president will ordinarily be regarded as possessing the power to hire a sales manager. If the president is not the general manager, some courts refuse to find authority to hire key personnel. In that situation, it would be necessary for the corporate president to have express authorization, as in the case of an ordinary agent.

Under any view, the president would not have authority by virtue of being president to make the contract insofar as the compensation is concerned. The promise to pay the new sales manager a percentage of the increased sales means that the manager would receive a percentage of the gross sales, even though the net selling results might be a loss. Such a contract would be so unusual that the power to make such a contract should not be regarded as being incidental to the general powers of a corporate president or a general manager.

8.

Richard Grassgreen was executive vice president and then president and chief operating officer of Kinder-Care, Inc., the largest proprietary provider of child care in the country.

The company was restructured in 1989 and changed its name to the Enstar Group, Inc. Between 1985 and 1990, while Grassgreen served as the corporation‘s investment manager, he invested millions of dollars of company money in junk bond deals with Michael Milken, and he secretly retained some $355,000 in commitment fees. When the

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Solution and Answer Guide:

corporation discovered this, Grassgreen repaid the corporation. It sued him to recover any compensation paid him over the five-year period during which the secret payments were made, some $5,197,663. Grassgreen defended that his conduct caused little, if any, damage to the corporation because the corporation did not lose any money on any of the investments for which he received personal fees. Decide. [Enstar Group, Inc. v. Grassgreen, 812 F. Supp. 1562 (M.D. Ala.)] Answer: Secret profits of corporate officers. Judgment against Grassgreen. The corporation did lose the commitment fees over the five-year period before it was discovered, and only after he was caught did Grassgreen return the fees to the corporation. Clearly the fact that Grassgreen elected to secretly divert the fees to himself was a violation of his fiduciary duty of loyalty to the corporation to act solely for the benefit of the corporation. Under basic agency law, an officer found to have violated the duty of loyalty may be required to forfeit all compensation during the period in question, including salary and bonuses. In this case, because violations were so flagrant, the court ordered that Grassgreen forfeit all compensation paid him by the corporation during the period, some $5,197,663. [Enstar Group, Inc. v. Grassgreen, 812 F. Supp. 1562 (M.D. Ala.)] 9.

Danny Hill, the general manager of Southeastern Floor Covering Co., Inc. (SE), had full authority to run the business. His responsibilities included preparing and submitting bid proposals to general contractors for floor coverings and ceilings on construction projects.

Hill prepared and submitted a bid for a job for Chata Construction Co. for asbestos encapsulation, ceramic tile, ceilings, carpets, and vinyl tile flooring. However, because SE was not licensed by the EPA, the asbestos work was withdrawn. In the past, SE had used Larry Barnes‘s company, which was EPA licensed, to do asbestos work under a subcontract agreement. Hill did not pursue a subcontract with Barnes for the Chata job. Rather, Hill and Barnes worked up a bid together and submitted it to Chata for the asbestos work. The bid was accepted, and Hill made $90,000 from the Chata job. Two years later, SE found out about Hill‘s role in the asbestos work done for Chata, and the corporation sued him for the lost profits. Hill argued that SE was not licensed by the EPA to do asbestos work and thus could not claim a lost corporate opportunity when it was not qualified to do the work.

Decide. Are any ethical principles applicable to this case? [Hill v. Southeastern Floor Covering Co., 596 So. 2d 874 (Miss.)]

Answer: Appropriation of business opportunity; ethical principles of conflict of interest, loyalty, fairness, doing no harm, integrity [Preface]. Judgment for SE. Officers, such as general managers, may avail themselves of opportunities outside the field of their business when the opportunities come to them on an individual basis. Hill learned about

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Solution and Answer Guide:

the Chata job through his position with SE. Moreover, while SE did not have an EPA license to do the work, neither did Hill. And the steps he took on his own behalf to get the job with Barnes could also have been taken on behalf of SE. This is especially so because SE had subcontracted asbestos work to Barnes in the past. Hill was thus held liable for the $90,000 profit.

Certain ethical principles set forth in Figure 1 of the Preface were violated in this case. Hill acted in conflict with SE‘s interests when he took for himself the opportunity that should have been obtained for SE. This was a breach of his duty of loyalty. The principles of fairness, doing no harm, and integrity were also violated in that it was not fair and it did harm to the SE corporation to divert the $90,000 to himself rather than SE. And not to inform the corporation of the opportunity, but to pursue the matter in a secret fashion, lacked integrity and basic honesty. [Hill v. Southeastern Floor Covering Co., 596 So. 2d 874 (Miss.)]

10. A director of a corporation cannot lend money to the corporation because that would create the danger of a conflict of interest between the director‘s status as a director and as a creditor. Appraise this statement.

Answer: Conflict of interests. The statement is not correct. There is no flat rule against a director‘s lending money to the corporation. This is so, even though it does give rise to a situation of conflicting interests because as creditor, the director will desire to take steps to collect the debt, regardless of the effect on the corporation. In contrast, as director, there will be the desire to prevent the enforcement of the debt if that would harm the corporation. Despite this possible conflict, it is proper for a director to lend money to the corporation when there is full disclosure to the board of directors and the transaction is fair to the corporation. This generally means that the loan is made to the corporation on terms that are as favorable as those that would be obtained elsewhere, or are more favorable, or the circumstances are such that it would have been impossible for the corporation to obtain the loan elsewhere. When these conditions are satisfied, the borrowing from the director is in effect the lesser of two evils.

Once it is concluded that the lending transaction was proper, the director may then enforce rights as creditor without regard to the effect on the corporation. That is, the director stands in the same position as any other creditor and is not required to ―go easy‖ just because it is the corporation that owes the money.

11. Hamway and other minority shareholders brought an action against majority shareholders

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Solution and Answer Guide:

of Libbie Rehabilitation Center, Inc., including Frank Giannotti, CEO-director; Alex Grossman, president-director; Henry Miller, vice president-director; Ernest Dervishian, secretary and corporate attorney; and Lewis Cowardin, treasurerdirector. The minority shareholders contended that the corporation paid excessive salaries to these directorofficers and was wasting corporate assets. Prior to coming to Libbie, Giannotti had been a carpet and tile retailer, Grossman a pharmacist, Miller a real estate developer, Dervishian a lawyer, and Cowardin a jeweler. The evidence showed that the extent of their work for the corporation was very limited. For example, Cowardin, Libbie‘s finance officer, who was paid $78,121, demonstrated no knowledge of the Medicare and Medicaid programs, the principal source of Libbie‘s income. Although he claimed to have spent 20 to 25 hours a week on corporate duties, he reported on the tax return for his jewelry business that he spent 75 percent of his working time in that business. One expert witness for the plaintiff testified that the five men were performing the management functions of one individual.

The director-officers contended that the business was making a profit and that all salaries were approved by a board of directors that had extensive business experience. Were the directors within their rights to elect themselves officers and set pay for themselves as they saw fit? Did they violate any legal or ethical duty to their shareholders?

Answer: Appropriation of a corporate opportunity; ethical principles regarding conflict of interest, loyalty, doing no harm, integrity [Preface]. The directors had an obligation to act in a fiduciary capacity for the benefit of the shareholders and not themselves. They were not free to set salaries for themselves as officers that amounted to a waste of corporate assets.

Their fiduciary duties owed to the corporation and the shareholders forbade the officers from wasting corporate assets. In this case, the directors elected themselves officers and approved pay for themselves that was excessive, oppressive, and a waste of corporate assets. The court found that their conduct was so oppressive to the minority shareholders that the corporation should be liquidated.

The directors violated the ethical principles of doing no harm, loyalty, and conflict of interest in that they took corporate funds under the guise of pay though little time or talent was actually devoted to the business of the corporation. In fact, the five director officers performed the duties of one individual, which is contrary to the ethical principle of efficiency and effectiveness.

12. Anthony Yee was the president of Waipahu Auto Exchange, a corporation. As part of his corporate duties, he arranged financing for the company. Federal Services Finance Corp. drew 12 checks payable to the order of Waipahu Auto Exchange. These were then indorsed by its president, ―Waipahu Auto Exchange, Limited, by Anthony Yee, President,‖

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and were cashed at two different banks. Bishop National Bank of Hawaii, on which the checks were drawn, charged its depositor, Federal Services, with the amount of the checks.

Federal Services then sued Bishop National Bank to restore to its account the amount of the 12 checks on the ground that Bishop National Bank had improperly made payment on the checks because Anthony Yee had no authority to cash them. Did Yee have authority to indorse and cash the checks? [Federal Services Finance Corp. v. Bishop Natl Bank of Hawaii, 190 F.2d 442 (9th Cir.)] Answer: Authority of president. No. The president of a corporation is not the fiscal officer and therefore has no implied authority to cash checks drawn to the order of the corporation. Ordinarily, checks drawn to the corporation would be deposited in its account, and any money to be spent would then be paid on the basis of a check drawn by the fiscal officer of the corporation. There was no proof that the corporation expressly authorized Yee to indorse and cash the checks, and he did not have such authority as an incident to financing for the corporation because financing is distinct from cashing checks received by the corporation. [Federal Services Finance Corp. v. Bishop Nat'l Bank of Hawaii, 190 F. 2d 442 (9th Cir.)] 13. Klinicki and Lundgren incorporated Berlinair, Inc., a closely held Oregon corporation.

Lundgren was president and responsible for developing business. Klinicki served as vice president and director responsible for operations and maintenance. Klinicki owned onethird of the stock, and Lundgren controlled the rest. They both met with BFR, a consortium of Berlin travel agents, about contracting to operate some charter flights. After the initial meeting, all contracts with BFR were made by Lundgren, who learned that there was a good chance that the BFR contract would be available. He incorporated Air Berlin Charter Co. (ABC) and was its sole owner. He presented BFR with a contract proposal, and it awarded the contract to ABC. Although Lundgren was using Berlinair‘s working time and facilities, he managed to keep the negotiations a secret from Klinicki. When Klinicki discovered Lundgren‘s actions, he sued him for usurping a corporate opportunity for Berlinair. Lundgren contended that it was not a usurpation of corporate opportunity because Berlinair did not have the financial ability to undertake the contract with BFR. Decide. Are any ethical principles applicable to this case? Consider the applicability of Chief Justice Cardozo‘s statement in Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928), concerning the level of conduct for fiduciaries: ―A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior . . . .‖ [Klinicki v. Lundgren, 695 P.2d 906 (Or.)] Answer: Appropriation of a corporate opportunity; ethical principles regarding conflict of

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interest, loyalty, doing no harm, integrity. Judgment for Berlinair Inc. An officer may take advantage of a corporate opportunity only after full disclosure and only if the opportunity is rejected by a majority of disinterested directors—or, if there are no disinterested directors, by a majority of disinterested shareholders. However, if after full disclosure, disinterested directors or shareholders unreasonably fail to reject the offer, the officer may proceed to take the opportunity if he or she can prove that the taking is fair to the corporation.

In this case, Lundgren did not offer the opportunity to Berlinair. He thus breached his fiduciary duty to that corporation. The court refused to accept the argument that Berlinair did not have the financial ability to fulfill the opportunity because Lundgren never gave the corporation the opportunity to consider the venture.

Certain ethical principals set forth in Figure 1 appear to apply to this case. You might ask your students whether Lundgren had a conflict of interest when he formed a new corporation to bid for the BFR charter contract. Were the ethical principles of loyalty, fairness, doing no harm, and integrity violated by Lundgren, who was president of Berlinair, when he secretly, and on corporate time, formed the new corporation to obtain the BFR charter contract? Discussion on the legal and ethical principle of loyalty may be generated from the Cardozo quotation. The remedy applied in this case was the imposition of a constructive trust on ABC in favor of Berlinair and an accounting. [Klinicki v. Lundgren, 695 P. 2d 906 (Or.)] 14. Rudolph Redmont, the president of Abbott Thinlite Corp., left Abbott to run Circle Corp. in competition with his former employer. It was claimed that he diverted contracts from his former employer to his new one, having gained the advantage of specific information about the deals in progress while employed by Abbott. Abbott sued Redmont and Circle Corp. to recover lost profits. Redmont contended that all of the contracts in question were made after he left Abbott, at which time his fiduciary duty to Abbott had ceased. Decide.

[Abbott Thinlite Corp. v. Redmont, 475 F.2d 85 (2d Cir.)] Answer: Liability relating to fiduciary duties. Judgment for Abbott. The court stated: A former employee may, of course, go into competition with his ex-employer and can use general information concerning the method of business and names of customers of his ex-employer in his new venture . . . . But he cannot, as here, utilize specific information he obtained during his employment to deprive his ex-employer of customers with whom he knows a deal is in the process of completion. The use of specific information on deals in

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progress obtained while in Abbott‘s employ, and the degree of likelihood that but for Redmont‘s competition Abbott would have been awarded the contract, dictate our holding that Redmont violated his fiduciary obligations to Abbott by submitting competing bids. [Abbott Thinlite Corp. v. Redmont, 475 F. 2d 85 (2d Cir.)] 15. William Gurtler was president and a board member of Unichem Corp., which produced and sold chemical laundry products. While president of Unichem, he encouraged his plant manager to leave to join a rival business, which Gurtler was going to join in the near future. Moreover, Gurtler sold Unichem products to his son, G. B. Gurtler, at a figure substantially below their normal price and on credit even though G. B. had no credit history. Gurtler made the sales with full knowledge that G. B. was going to start a rival business. Also at that time, Gurtler was aware that his wife was soliciting Unichem employees to join the new Gurtler Chemical Co., and he helped her design Gurtler‘s label so that it would look like Unichem‘s. Gurtler guaranteed a $100,000 bank loan for the new Gurtler Chemical Co. with funds to be disbursed after he left Unichem. One month later, he became president of Gurtler Chemical Co. Unichem sued Gurtler for breach of fiduciary duty and for the loss of profits that resulted. Gurtler contended that his sales to G. B. guaranteed needed revenue to Unichem and constituted a sound business decision that should be applauded and that was protected under the business judgment rule. Decide.

Are any ethical principles applicable to this case? [Unichem Corp. v. Gurtler, 498 N.E.2d 724 (Ill. App.)] Answer: Conflict of interests. As president, Gurtler had a fiduciary duty to the corporation.

He clearly violated this duty by encouraging the plant manager to leave, selling products to his son at reduced prices to be resold to Unichem‘s customers, obtaining a loan for $100,000 to compete with Unichem, and assisting his wife‘s copying of Unichem‘s label.

The business judgment rule would not shield Gurtler in this case. He clearly did not act in good faith.

Gurtler‘s action were so improper that it might be argued that he knew nothing of the law relating to an officer‘s duties to a corporation. The basic ethical principles of loyalty, integrity, conflict of interest, fairness, and doing no harm all appear applicable to this case.

[Unichem Corp. v. Gurtler, 498 N.E. 2d 724 (Ill. App.)] [return to top] End of Chapter: CPA Questions and Answers

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Solution and Answer Guide:

Correct answers in boldface.

1.

2.

Davis, a director of Active Corp., is entitled to: a.

Serve on the board of a competing business.

b.

Take sole advantage of a business opportunity that would benefit Active.

c.

Rely on information provided by a corporate officer.

d.

Unilaterally grant a corporate loan to one of Active‘s shareholders.

Absent a specific provision in its articles of incorporation, a corporation‘s board of directors has the power to do all of the following except:

3.

a.

Repeal the bylaws.

b.

Declare dividends.

c.

Fix compensation of directors.

d.

Amend the articles of incorporation.

Which of the following statements is correct regarding fiduciary duty? a.

A director‘s fiduciary duty to the corporation may be discharged by merely disclosing his or her self-interest.

b.

A director owes a fiduciary duty to the shareholders but not to the corporation.

c.

A promoter of a corporation to be formed owes no fiduciary duty to anyone, unless the contract engaging the promoter so provides.

d.

A majority shareholder as such may owe a fiduciary duty to fellow shareholders.

[return to top] Answers to AICPA Questions 1.

Davis, a director of Active Corp., is entitled to: a.

Serve on the board of a competing business.

b.

Take sole advantage of a business opportunity that would benefit Active.

c.

Rely on information provided by a corporate officer.

d.

Unilaterally grant a corporate loan to one of Active‘s shareholders.

(c) A director of a corporation is entitled to rely on information provided by a corporate officer (unless the director had reason to believe that such information was incorrect). Answer (a) is incorrect since it would be a conflict of interest for a director to sit on the boards of competing businesses. Answer (b) is incorrect since a director

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would breach his/her fiduciary duty by taking advantage of a corporate business opportunity. Answer (d) is incorrect since directors do not act alone, but as a ―board.‖ Thus, the director has no actual or apparent authority to individually grant a corporate loan.

2.

Absent a specific provision in its articles of incorporation, a corporation‘s board of directors has the power to do all of the following except: a.

Repeal the bylaws.

b.

Declare dividends.

c.

Fix compensation of directors.

d.

Amend the articles of incorporation.

(d) Normally, the board of directors of a corporation has the power to adopt, amend, and repeal the bylaws. It also has the power to declare dividends and fix the compensation of the directors. However, it does not have the power to amend the Articles of Incorporation. Therefore, answers (a), (b), and (c) are incorrect.

3.

Which of the following statements is correct regarding fiduciary duty? a.

A director‘s fiduciary duty to the corporation may be discharged by merely disclosing his or her self-interest.

b.

A director owes a fiduciary duty to the shareholders but not to the corporation.

c.

A promoter of a corporation to be formed owes no fiduciary duty to anyone, unless the contract engaging the promoter so provides.

d.

A majority shareholder as such may owe a fiduciary duty to fellow shareholders.

(d) Generally, a shareholder owes no fiduciary duty to the corporation; his primary concern is his own self-interest. An exception to this rule is the duty of the majority, or controlling, shareholders to the minority shareholders. The courts have held that a group with de facto control of a corporation may not use that control to injure, oppress, or defraud the minority shareholders. Answer (c) is incorrect because a promoter is said to be a fiduciary of the not-yet-formed corporation and has a fiduciary duty to act in good faith and in the corporation‘s best interest. Answer (a) is incorrect because the director, in addition to his duty of disclosure, has a duty to act with fundamental fairness. If any contract is determined not to be in the corporation‘s best interest, it may be rescinded, and the breaching director may be liable for any loss resulting to the corporation from the transaction. Answer (b) is incorrect because a director owes a fiduciary duty both to the corporation and to its

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 46: Real Property

shareholders. [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 46: Real Property

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 462 Questions and Case Problems .......................................................................................................... 462

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

In 1972, Donald and Joyce Carnahan purchased a 1-acre lot located on a 22-acre lake. The purchase included a portion of the lakebed. The Carnahans used the lake for recreational activity in both winter and summer, and their activities included motorboats, jet skis, and wave runners. In 1991, the Moriah Property Owners Association, Inc., acquired title to the majority of the lots along the lake and imposed restrictive covenants on the use of the lake, including one that prohibited all motors on the lake except for those powered by 12volt batteries. The Carnahans filed suit to establish a prescriptive easement in their right to use the lake for all their activities. Do you think the Carnahans acquired an easement by prescription? [Carnahan v. Moriah Property Owners Association, Inc., 716 N.E.2d 437 (Ind.)] Answer: Adverse possession. The deference of the Carnahans to the neighbors on the use of their boat shows that they understood their rights to be permissive and not adverse and that they were not acquiring a property right through the use of their boat. No, there is no prescriptive easement because the use was not adverse, but permissive. [Carnahan v.

Moriah Property Owners Association, Inc., 716 N.E. 2d 437 (Ind.)]

2.

Bunn and his wife claimed that they had an easement to enter and use the swimming pool on neighboring land. A contract between the former owners of the Bunns‘ property and the adjacent apartment complex contained a provision that the use of the apartment complex‘s swimming pool would be available to the purchaser and his family. No

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Solution and Answer Guide:

reference to the pool was made in the contract between the former owners and the Bunns, nor was there any reference to it in the deed conveying the property to the Bunns. Decide.

[Bunn v. Offutt, 222 S.E.2d 522 (Va.)] Answer: Licenses. Judgment against the Bunns. The only right to use the swimming pool was the one given by contract to the original purchaser and family. No expressed statement was made in either this contract with or the deed to the original purchaser stating that subsequent owners could also use the swimming pool. The right to use the swimming pool given to the first purchaser was therefore merely a license and was not transferred to a subsequent purchaser of the land. [Bunn v. Offutt, 222 S.E. 2d 522 (Va.)] 3.

Harald Dude‘s real estate dealings began breaking bad in 2003. After securing a $1.9 million loan from Washington Mutual on a house he owned in Aspen, Mr. Dude quickly sought to borrow another $500,000 from Wells Fargo. The Washington Mutual mortgage was not yet recorded because of a defect in the property description. To satisfy Wells Fargo, Mr. Dude had to complete a form for the bank‘s title insurance company, Stewart Title. On that form, he was asked to disclose existing liens and loans on the property, at least those that hadn‘t already turned up in Stewart Title‘s title search. Knowing that the company had failed to discover the existence of the Washington Mutual loan and worried that disclosing it now might scotch any chance he had of winning a second loan from Wells Fargo, Mr. Dude decided to conceal its existence. The plan worked: Stewart Title and Wells Fargo proceeded with the second loan just as Mr. Dude had hoped. Discuss who will have priority in the land if Mr. Dude defaults. Does it matter that Mr. Dude failed to disclose the loan and lien of Washington Mutual? What can we learn from situations such as this one? [Stewart Title Guaranty Company v. Dude, 708 F.3d 1191 (10th Cir.)] Answer: Recording; priorities. The court held that Wells Fargo is second because Stewart Title failed to do an effective search for prior interests. The record shows that Stewart Title did look for recorded loans and liens on the property and failed to find the Washington Mutual loan only because the deed was defectively recorded. The deed was defectively recorded because the Washington Mutual documentation contained no legal description of the property and so wasn't clearly associated with the property in the clerk's files. And, under Colorado law, we know that, even when it comes to real property law, ―a recorded deed of trust that completely omits a legal description is defectively recorded and cannot provide constructive notice to a subsequent purchaser of another party's security interest in the property.‖ Sender v. Cygan (In re Rivera), –––P.3d ––––, ––––, No. 11 SA261, 2012 WL 1994873, (Colo. June 4, 2012). However, the court held that there was recovery from Dude because he lied on the Stewart Title form. [Stewart Title Guaranty Company v. Dude, 708 F.

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Solution and Answer Guide:

3d 1191 (10th Cir.)] 4.

After executing the various deeds, J. M. Fernandez Jr. placed them in a closet (with other valuable papers) for safekeeping until they could be physically delivered to the various grantees, including Sylvia Sheppard, when she returned to Key West. This closet was in the home that Fernandez shared with Betty DeMerritt. They were not married but lived together the final 15 years of Fernandez‘s life. Shortly thereafter, Fernandez was debilitated by a stroke and became a total invalid. He never regained his health and died before Sylvia Sheppard could return to Key West to receive physical delivery of the deed personally from him. When Sylvia Sheppard did arrive in Key West, Betty DeMerritt gave her the deed. This took place two or three days after the death of Fernandez. When questioned as to why she turned the deed over to Sylvia, Betty DeMerritt stated, ―I knew he wanted me to do it . . . because he couldn‘t do it.‖ She was speaking of Fernandez‘s physical disability. Does Sylvia have title to the property? Was there delivery? [Kerr v.

Fernandez, 792 So. 2d 685 (Fla.)] Answer: Deeds; delivery. It is to be noted from the trial testimony that all involved agree that J.M. Fernandez, Jr., never varied from his intention to deliver the deeds to all of the grantees, including the Sheppard/Kerr deed. Ultimately all the deeds were delivered by Betty DeMerritt in the same fashion (including that deed in which Dora Fernandez, the estate's representative, was named as grantee) and all the grantees accepted such delivery, with no protest from the estate, or from one another. The validity of the method of delivery was accepted by all.

It is true that delivery of a deed is essential to its effectiveness. This does not mean, however, that a delivery, in order to be effective, must always be a physical handing over of the deed by the grantor to the grantee. For example, the grantor's recording of the deed can in some instances be equivalent to delivery. Acts other than manual delivery (or recording), accompanied by an unchanging and clear intention to pass title can be equally efficacious in establishing delivery.

"Actual manual delivery and change of possession are not always required in order to constitute an effectual delivery. The intention of the grantor is the determining factor . . . .‖ The uncontradicted testimony is that J.M. Fernandez, Jr., evinced an intention to deliver the deed personally to Sylvia Sheppard, which intention never changed, but he fell ill and died before he could carry it out. We conclude that the facts here demonstrate an effective delivery. [Kerr v. Fernandez, 792 So. 2d 685 (Fla.)]

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Solution and Answer Guide:

5.

Kenneth Corson, 10, lived with his mother, Lynda Lontz, in an apartment building owned

by Bruno and Carolyn Kosinski. While playing with other children who lived in the same building, Corson was drawn to a stairwell that provided access to the building‘s laundry room and roof. Corson and the other children climbed to the roof and discovered an area where they could jump from the roof of their building to that of the building next door.

The children engaged in roof-hopping for several days. On the last day, Corson misjudged his jump and fell the three stories to the ground below. Corson and his mother filed suit against the Kosinskis to collect damages for Corson‘s injuries. What theory might be used to hold the Kosinskis liable? [Corson by Lontz v. Kosinski, 801 F. Supp. 75 (N.D. Ill.)] Answer: Duty of landowner; liability of landowner for injuries. One view is that the children were invitees and the Kosinski‘s owed a duty to the children to control access. Also, that the children‘s activity was ongoing for the children is a problem for the Kosinskis. The doctrine of attractive nuisance probably applies here in that the conditions on the land attracted children to a foreseeable danger. [Corson by Lontz v. Kosinski, 801 F. Supp. 75 (N.D. Ill)]

6.

Determine whether the following would be fixtures or personal property. a.

Refrigerator in a home

b.

Refrigerators in an apartment complex with

b.

furnished units

c.

Refrigerators in a restaurant kitchen

d.

Refrigeration/freezer units in a grocery store

e.

Mini-refrigerator in a student dorm

Answer: Fixtures.

7.

a.

Personal property

b.

Generally, fixtures

c.

Trade fixtures

d.

Trade fixtures

e.

Personal property

F.W.T. owned property next to his father‘s where he operated a business. F.T., the father, obtained a drone and began flying it over his son‘s property. At one point, the drone was swooping in on the heavy equipment being operated as part of F.W.T.‘s business. An operator of one piece of equipment said that the drone flew straight into his line of vision.

The drone never touched the surface of the son‘s property. What rights does the son have

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Solution and Answer Guide:

with respect to his father‘s drone-flying? [F.W.T. v. F.T., 101 N.E.3d 336 (Mass. App.)] Answer: The court held that the father‘s drone-flying had not violated any regulations on drone-flying, but it was an invasion of the son‘s air rights and would permit actions by the son for trespass and nuisance. [F.W.T. v. F.T., 101 N.E.3d 336 (Mass. App. 2018)] 8.

At approximately 3:00 a.m., on February 3, 2000, Sonya Winchell was driving two of her friends through a Fort Wayne Taco Bell drive-thru. When Winchell arrived in line, there was one car in front of her at the speaker. Winchell noticed that the occupants of the car, Remco Guy and Ariel Graham, were taking a long time placing their order and then got out of their car. At that point, Winchell yelled out her window, ―Can we get moving, we are hungry!‖ Guy approached Winchell‘s car, stuck his head in the window, and ―started cussing everybody out.‖ Guy removed his head from the window, stuck it back in, and asked, ―You got an f-ing problem?‖ Winchell responded by ―drill[ing] him in the nose.‖ Guy then pulled a gun out of his pants and shot Winchell. One of Winchell‘s passengers and others summoned police officers who were in a nearby parking lot. Winchell survived the shooting, and Guy was convicted of attempted murder. Winchell filed a civil action against Guy and Graham, and against Taco Bell, alleging negligence. Is Taco Bell liable for the injuries that occur on its property? [Winchell v. Guy, 857 N.E.2d 1024 (Ind.)] Answer: Premises liability; invitees. Landowners have a duty to take reasonable precautions to protect their invitees from foreseeable criminal attacks. Taco Bell did owe a duty to its customers, including Winchell, to use reasonable care to protect them from injuries caused by other patrons and guests on their premises.

The line of sight between the employees of Taco Bell and the drive-thru was obstructed, with the video monitoring system was in a closet and not readily accessible to Taco Bell employees. No security guard was on duty that night. There had been previous calls to the police from the Taco Bell, including one in which there was also violence.

Taco Bell owed Winchell a duty as a matter of law and there were questions of fact regarding the elements of breach and causation. The trial court improperly granted Taco Bell‘s motion for summary judgment. Reversed. [Winchell v. Guy, 857 N.E. 2d 1024 (Ind.)]

9.

Miller executed a deed to real estate, naming Zieg as grantee. He placed the deed in an envelope on which was written ―To be filed at my death‖ and put the envelope and deed in a safe deposit box in the National Bank that had been rented in the names of Miller and Zieg. After Miller‘s death, Zieg removed the deed from the safe deposit box. Moseley, as

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Solution and Answer Guide:

executor under Miller‘s will, brought an action against Zieg to declare the deed void.

Decide. [Moseley v. Zieg, 146 N.W.2d 72 (Neb.)] Answer: What constitutes delivery of deed. The deed was void. It was never delivered by Miller to Zieg with the intent that it should be effective at that time. The fact that she obtained possession of the deed after his death had no significance because a delivery must be made while the grantor lives.

The court pointed out that the conclusion that there was no intent by Miller to transfer title prior to his death was confirmed by the fact that he continued to make the same use of the property as before. [Moseley v. Zieg, 146 N.W. 2d 72 (Neb.)] 10. Suppose that the purchaser of a new home had problems with water in his basement. The builder has told the buyer that the developer is to blame because of the manner in which the developer of the subdivision graded the lots. Could the home buyer recover from the developer? [Forest City Stapleton v. Rogers, 393 P.3d 487 (Colorado)] Answer: The court held that the warranty does not go back to the developer as between the homeowner and the developer. However, the builder might have a cause of action against the developer for the improper grading of the lot. [Forest City Stapleton v. Rogers, 393 P.3d 487 (Colorado 2017)] 11. Bradt believed that his backyard ran all the way to a fence. Actually, a strip on Bradt‘s side of the fence belonged to his neighbor, Giovannone, but Bradt never intended to take land away from anyone. Bradt later brought an action against Giovannone to determine who owned the strip on Bradt‘s side of the fence. Who is the owner? Why? [Bradt v.

Giovannone, 315 N.Y.S.2d 96] Answer: Adverse possession. The strip of land in question is owned by Bradt by adverse possession. This is true even though such possession was based on a mistake and there was no intention to deprive anyone of title to the land. Bradt possessed the land to the exclusion of the rest of the world and did so on the belief that he was the owner of the land, which was therefore a possession adverse to everyone else in the world. This assumes that the statutory period for adverse possession has expired. [Bradt v.

Giovannone, 315 N.Y. S. 2d 96)] 12. Robert E. Long owned land in the City of Hampton that he leased to Adams Outdoor Advertising Limited Partnership. Adams had an advertising billboard placed on the

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Solution and Answer Guide:

property. On October 6, 1993, Long notified Adams that he was terminating the lease.

Adams accepted the termination and told Long that it would have the electrical service disconnected and would schedule demolition of the billboard for the first week in November. Long wanted to use the billboard to advertise his own business and filed suit to enjoin Adams from destroying the billboard. Long maintained that the billboard was part of the land and that it belonged to him. Adams asserted that it owned the billboard as a lessee. The trial court found for Long, and Adams appealed. Decide. [Adams Outdoor Adv., Ltd., Part. v. Long, 483 S.E.2d 224 (Va.)] Answer: Fixtures. The billboard at issue is a structure permanently affixed to the land.

Whether such a structure remains permanently, owned by the person who erected the structure, or becomes part of the realty, and thus owned by the landowner, is determined either by an agreement establishing the nature and ownership of the structure. The record in this case establishes that the lease agreements between successive landlords and tenants addressed the issue of ownership rights in the billboard.

The billboard was erected more than 65 years ago by Consolvo & Cheshire, an advertising agency. At that time, Consolvo & Cheshire negotiated a lease which provided that ―[a]ll boards and materials placed on the premises‖ by the lessee were the property of the lessee and that the lessee could ―remove their boards‖ from the premises on the termination of the lease. Similar language regarding ownership was contained in leases executed between Consolvo & Cheshire and successive landowners in 1938 and 1945.

Subsequent leases executed in 1949, 1957, 1968, and 1977 between successor landowners and different lessees, stated that ―signs, structures and equipment‖ erected by the lessee were the property of the lessee and could be removed by the lessee.

Adams claims to be the owner under the terms of the 1977 lease or, alternatively, because all the leases show an intent that the lessee retain ownership of the billboard. We agree that each lease does address the ownership of the billboard, but places ownership in the lessee who erected the billboard. Consolvo & Cheshire erected the billboard in this case, and, therefore, Adams does not qualify as the owner of the billboard under the terms of any lease. Because the lease agreement clearly addresses ownership of the billboard, application of the test enunciated in Danville is unnecessary, and the trial court correctly rejected Adams‘ ownership claim.

The trial court also correctly held that Long was the owner of the billboard. When tenants retain ownership of structures they erect on property and are allowed to remove the structures, the removal generally must occur within a reasonable period after the end of

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the tenancy. If the structure is not removed, it becomes the property of the landlord because it is affixed to the land. This rule is based on a presumption of abandonment and protects subsequent parties from interruption by a tenant who returns to remove the fixtures. The entry of a former tenant on the land to remove the structure would itself constitute a trespass.

In this case, the tenant that constructed the billboard, Consolvo & Cheshire, did not remove it at the conclusion of its tenancy or within a reasonable time thereafter.

Consequently, the billboard, which was permanently affixed to the land, became part of the realty and the property of the landowner. When Long acquired the land, he acquired the billboard as part of the land purchased. Affirmed as to the finding that the billboard belongs to Long. [Adams Outdoor Adv., Ltd., Part. v. Long, 483 S.E. 2d 224 (Va.)] 13. Danetta Garfink owns a condominium unit at The Cloisters at Charles Condominiums.

Garfink purchased her unit (one of the model units) in 1991 during the development and construction phase of the project. The original construction included installed household appliances in each unit, a clothes dryer among them. As originally installed, the clothes dryer was connected and vented into the furnace room, rather than to the outside of the building, contrary to the terms of the construction contract, and in violation of prevailing building codes and regulations.

In 2000, the clothes dryer malfunctioned and Garfink purchased a replacement from Sears, Roebuck & Co. After viewing the existing vent system, however, Sears refused to install the replacement because a ―fire hazzard [sic] was identified.‖ Garfink took it upon herself to have the venting system rerouted. The new system was routed from the dryer through the wall of the laundry room into the adjoining garage, then through the garage and then the exterior wall. Garfink‘s immediate neighbor, Dr. Oscar Kantt, found that the new vent was within 17 feet of the front door of his residence, and Dr. Kantt complained about the discharge. Garfink says she has an easement for the dryer vent. Analyze whether she does have an easement. Be sure to think through the types of easements. [Garfink v. Cloisters at Charles, Inc., 897 A.2d 206 (Md. 2006)] Answer: Easements. Cathel, Judge. The Condominium‘s Declaration states in Article 15.2: In addition to any easement established by law, each unit shall have, appurtenant thereto, an easement in the common elements for the purposes of providing maintenance, support, repair or service for such unit to and for the ducts, pipes, conduits, vents,

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plumbing, wiring and other utility services to the unit.

The traditional law of easements applies to condominiums. Furthermore, the Condominium‘s Declaration specifically provides in Article 6.1 that ―[e]ach unit in the Condominium has all the incidents of real property and the owner of a unit shall have such estate therein as may be acquired in real property….‖ The generally accepted rule for an express easement is "that [because] an easement is a restriction upon the rights of the servient property owner, no alteration can be made by the owner of the dominant estate which would increase such restriction except by mutual consent of both parties." There are, however, instances in which a dominant and servient estate may both benefit and shoulder the burden of a particular covenant or easement.

This can occur in the situation of an implied negative reciprocal easement.

In the case sub judice the language in Article 15.2 of the Condominium‘s Declaration creates an express easement. An easement is granted to the dominant estate, appurtenant to the individual condominium units (in this case petitioner‘s unit), ―in the common elements,‖ i.e., the exterior of the unit, by the servient estate, the Condominium…. This easement was properly established when the Declaration was filed along with the Bylaws and Condominium plat, establishing the Condominium.

The Court of Special Appeals contends that there is an inherent conflict created by such a grant of an easement in the context of a condominium. The court argues that because the individual condominium unit owner is also a member of the Condominium unit owners as a whole, she has an interest in ―both the servient and dominant estate[s].‖ In other words, petitioner is granted an easement over or through the common elements as the dominant estate represented by her condominium unit, but, as a member of the Condominium, she also has an interest in the servient estate by virtue of her interest in the common elements.

We find no conflict in this situation. While petitioner ―can be said to have a tenancy in common in the general common elements with all of the other Condominium unit owners,‖ petitioner owns her individual condominium unit in fee simple. These are two wholly different types of estates. There is no conflict extant between the two types of ownership in regard to the existence of the express easement.

Our job now is to interpret what exactly the easement provides for. In doing this, we look to standard constructs of contract interpretation. The establishment of an easement in a condominium declaration is analogous to the establishment of an easement by deed.

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[i]t is evident that condominium unit owners were to be provided with the ability to perform maintenance, support, repair or service on those items (ducts, pipes, conduits, vents, plumbing, wiring and other utility services) which pierced the ―shell‖ of the unit, passing through the exterior walls or common element spaces. This type of easement is a logical extension of certain rights of individual unit owners. Otherwise, anytime something untoward occurred to one of the above-listed items the unit owner would be required to receive permission from respondent in order to remedy the situation.

The problem that arises in the case of petitioner‘s exercise of this easement, is that her particular exterior dryer installation was defective because the exhaust had not been properly vented at the time the unit was constructed and at the time of purchase in 1991, nor, in fact, did it exist when the Declaration establishing the easement was filed. There appears to be no dispute that a vent was contemplated for the respective unit but failed to be installed during the construction phase—otherwise building codes and probably fire codes would have been violated. The fact that petitioner‘s unit was improperly constructed by the developer of The Cloisters does not negate this aspect of the easement.

It was reasonable for petitioner to remedy the hazard created by the improper original construction of the dryer exhaust system. In order to reasonably enjoy the grant of the easement, petitioner was entitled to install an exterior dryer exhaust vent.

The installation of an exterior dryer exhaust vent is reasonable and necessary, and was fully contemplated, for the proper, and more importantly, safe, operation of the dryer and its presence and maintenance.

Respondent concedes that the easement grants unit owners control over certain systems which run through the common elements of the Condominium, but asserts that the easement does not ―serve to grant a unit owner the unfettered right to install a completely new system in an area in which it has previously not been installed.‖ In support of this, respondent contends that such a holding would open and let loose a virtual Pandora‘s box of monstrosities on the Condominium.

Respondent‘s concerns are not valid in this case. The installation of the exterior dryer exhaust vent by petitioner is not something that is new or in addition to the original construction of the other forty-seven condominium units. Every other condominium unit in The Cloisters already has such an exterior dryer exhaust vent system and the owners are able to maintain those systems without the approval of the Board. Our holding does not allow unit owners the unfettered ability to make changes to the exterior of their

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condominium unit without prior approval by respondent. Rather, it reasonably allows only the petitioner, where an obvious construction defect exists relating to safety, to install the exterior vent in reliance on the rights granted by the express easement (and for that matter in exercise of the rights inherent in an exception contained in the Bylaws).

The Circuit Court and the Court of Special Appeals, along with respondent, state that there were several alternate locations that the exterior vent could have been placed in order that it not interfere with Dr. Kantt‘s enjoyment of his property. The record, however, does not reflect this.

It is not a viable alternative to, effectively, completely remodel petitioner‘s condominium unit by tearing down walls and dropping ceilings in order to be able to provide exterior ventilation for the clothes dryer in a different location. Petitioner had the vent installed in the most logical place. We find the location of petitioner‘s original installation of the exterior dryer exhaust vent to be the most reasonable option under the facts presented in the case sub judice.

Reversed. [Garfink v. Cloisters at Charles, Inc., 897 A.2d 206 (Md. 2006)] 14. Martin Manufacturing decided to raise additional long-term capital by mortgaging an industrial park it owned. First National Loan Co. agreed to lend Martin $1 million and to take a note and first mortgage on the land and building. The mortgage was duly recorded.

Martin sold the property to Marshall, who took the property and assumed the mortgage debt. Does Marshall have any personal liability on the mortgage debt? Is Martin still liable on the mortgage debt? Explain.

Answer: Transfer of interest. A purchaser who assumes the mortgage debt becomes personally liable on the mortgage debt. In addition, the original mortgagor is still liable unless released by the mortgagee. In the event the original mortgagor is not released and is required to pay, the original mortgagor may seek recovery from the party who assumed the mortgage.

15. Christine and Steve Mallock buried their son in a burial plot purchased at Southern Memorial Park, Inc. Each year the Mallocks conducted a memorial service for their son at his burial plot. On the seventh anniversary of their son‘s death, the Mallocks went to their son‘s grave at 11:00 a.m. for the annual service, which generally took 30 minutes. When they arrived, they discovered that a tent and chairs set up for funeral services on the plot next to their son‘s grave were actually resting on his gravesite. The Mallocks asked Southern‘s management if the tent and chairs could be moved until they could conduct

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 47: Environmental Law and Land Use Controls

their service. The managers refused, and the Mallocks went ahead with their ceremony, cutting it to five minutes, after they moved the chairs and tents by themselves. Southern‘s managers called the police and had the Mallocks evicted. Southern claimed that the Mallocks had no rights on the property except for the grave and that their deed for the plot did not award an easement for access. Did the Mallocks have the right to access to the gravesite? [Mallock v. Southern Memorial Park, Inc., 561 So. 2d 330 (Fla. Ct. App.)] Answer: Right of way; easement. Yes, the Mallocks had a right of access to the burial plot.

Without such access, the plot was not accessible for services or visits, two common uses of graveyards. [Mallock v. Southern Memorial Park, Inc., 561 So. 2d 330 (Fla. Ct. App.)] 16. O conveys property to A on December 1, 2020. O conveys the same property to B who does not know about A and who records his deed on December 2, 2020. O then conveys the same property to C. Who has title to the property?

Answer: O  A December 1, 2020 O  B (bfp) B records OC B has title under race (first to record) B has title under notice (last bfp to take) B has title under notice (first bfp to record) [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 47: Environmental Law and Land Use Controls

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Answers to the End-of-Chapter Questions ...................................................................................................... 474 Questions and Case Problems .......................................................................................................... 474

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Hold Fast Tattoo (Plaintiff) wished to open a tattoo studio on North Sheridan Road in the city of North Chicago and obtained a prospective lessor at its desired location. In accordance with North Chicago‘s zoning ordinance, Hold Fast Tattoo applied for a special use permit to operate a tattoo studio at that location. On June 21, 2007, the Zoning Board of Appeals of North Chicago recommended approval of the permit to its city council. The proposal was discussed at two council meetings, on July 9, 2007, and July 16, 2007, and Hold Fast Tattoo‘s request for a special use permit was ultimately denied. The city council informed Hold Fast that its special use permit was denied because it was ―not the kind of business‖ the council wanted in North Chicago. Hold Fast filed suit. What should the court decide and why? [Hold Fast Tattoo, LLC v. City of North Chicago, 580 F. Supp. 2d 656 (N.D. Ill. 2008)] Answer: Validity of zoning laws. The court held that there were no First Amendment violations in prohibiting the tattoo parlor because the tattoo parlor was not speaking; its clients were the ones speaking and they were not prohibited from having tattoos. This control only related to where they could obtain tattoos. The court also held that cities are permitted to have zoning plans and regulations that restrict certain types of businesses as long as there is a public purpose. The city was worried about the level of traffic and congestion from the business and the court found that there was a legitimate public purpose in excluding tattoo parlors from the area. *Other states have held that tattoos are a form of protected speech and refused to allow denial of licenses and zoning permits solely based on the tattoo reasoning. Coleman v.

City of Mesa, 284 P.3d 853 (Ariz. 2012); Jucha v. City of North Chicago, 63 F. Supp. 2d 820 (N.D. Ill. 2014); Anderson v. City of Hermosa Beach, 621 F.3d 1051 (9th Cir. 2014). The tattoo-zoning issue has a split among the federal circuits as well as in the states and may require a U.S. Supreme Court decision. [Hold Fast Tattoo, LLC v. City of North Chicago, 580 F. Supp. 2d 656 (N.D. Ill. 2008)]

2.

Federal Oil Co. was loading a tanker with fuel oil when the loading hose snapped for some unknown reason and about 1,000 gallons of oil poured into the ocean. Federal Oil was

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prosecuted for this water pollution. It raised the defense that it had exercised due care, was not at fault in any way, and had not intended to pollute the water. What statutes could be used to prosecute Federal Oil? What are the potential penalties?

Answer: Oil Pollution Act. Federal Oil could be charged with a violation of the Oil Pollution Act which could cost him fines of up to $3,000 per barrel per day if the spill was the result of negligence. Even with no negligence the penalties are $25,000 per day and $1,000 per barrel. Willful violations carry more substantial penalties but the fact that Federal Oil had done all it could to prevent spills does not mean there is not liability under OPA or even under other federal water pollution statutes.

3.

Philip Carey Co. owned a tract of land in Plymouth Township, Pennsylvania, on which it deposited a large pile of manufacturing waste containing asbestos. Carey sold the land to Celotex, and Celotex sold the land to Smith Land & Improvement Corp. The EPA notified Smith that unless it took steps to eliminate the asbestos hazard, the EPA would do the work and pursue reimbursement. Smith cleaned up the land to the EPA‘s satisfaction at a cost of $218,945.44. Smith asked Celotex and Carey for reimbursement. Which firms have liability for the cleanup costs? [Smith Land & Improvement Corp. v. Celotex, 851 F.2d 86 (3d Cir.)] Answer: Criminal liability; enforcement. Philip Carey, Celotex, and Smith Land all have liability as owners or former owners. [Smith Land & Improvement Corp. v. Celotex, 851 F. 2d 86 (3d Cir.)]

4.

The McConnells bought a home in Sherwood Estates. The land was subject to a restrictive covenant that ―no building, fence, or other structure‖ could be built on the land without the approval of the developer of the property. The McConnells built a dog pen in their yard that consisted of a cement base with fencing surrounding the base. They claimed that approval was not required on the theory that the restrictive covenant did not apply because it showed an intent to restrict only major construction, not minor additions to the landscape. A lawsuit was brought to compel the McConnells to remove the dog pen because prior approval had not been obtained. Are restrictive covenants applied this expansively to homeowners? Must the McConnells have prior approval? [Sherwood Estates Homes Ass’n, Inc. v. McConnell, 714 S.W.2d 848 (Mo. App.)] Answer: Restrictive covenants. The dog pen was a violation of the restrictive covenant. The pen was a structure by the ordinary meaning of the word: Anything that is put together is constructed and is a structure. Nothing in the word limits ―structure‖ to major buildings.

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Therefore, anything built on the land constituted a structure, and the dog pen and fence were violations of the restrictive covenant. The McConnells were required to obtain the association‘s approval before they could construct the pen. Therefore, the pen must be removed. [Sherwood Estates Homes Ass'n, Inc. v. McConnell, 714 S.W. 2d 848 (Mo. App.)] 5.

General Automotive operates Grand Auto Parts Stores, which receive used automotive batteries from customers as trade-ins. General‘s policy in disposing of these batteries had been to drive a screwdriver through each spent battery and then sell them to a batterycracking plant operated by Morris P. Kirk & Sons, Inc., which extracted and smelted the lead. After the lead was extracted from the batteries, Kirk washed and crushed the battery casings, loaded them into a dump truck, and then dumped them. Tons of pieces of crushed batteries were dumped onto Catellus Development Corp.‘s property. Under CERCLA, Catellus sought to recover from General the costs of cleaning up the hazardous battery parts from its property. General maintained that it was not liable because it sold the batteries to Kirk, and Kirk did the dumping. Was General correct? [Catellus Development Corp. v. United States, 34 F.3d 748 (9th Cir.)] Answer: Environmental; CERCLA. No, General cannot insulate itself under CERCLA—all parties here are liable. [Catellus Development Corp. v. United States, 34 F. 3d 748 (9th Cir.)]

6.

Twenty-six individuals who lived near hog-farming operations in eastern North Carolina brought suit against Murphy-Brown, LLC, the owner and operator of the hog operations.

Their nuisance claims related to the large operations that raised hogs for slaughter and included the following: a.

A smell like rotten eggs and ammonia

b.

Wet livestock waste that is stored in lagoons and waste lagoons breaching during hurricanes

c.

The sound of animals squealing

d.

Flies and buzzards

e.

Truck traffic because of the need for transporting hogs from the 14,000 hog facilities

Discuss whether the individuals have a claim for nuisance and be sure to discuss other state laws that might apply in the case. [In Re North Carolina Swine Farm Nuisance Litigation 2017 WL 5178038 (E.D.N.C. 2017)] Answer: Farm nuisances. The cases on farm nuisance, particularly the hogs, have gone back and forth in North Carolina, on procedural bases and otherwise. The list clearly constitutes the makings of a good nuisance case. However, there is the reality of the

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importance of hog-farming to North Carolina. There is also a reality to the cases that animal rights activists have been an inspiration for many of the suits. There is also statutory protection for farmers when individuals have moved to the nuisance. In some of the cases, some compromises have been achieved with farmers adopting better methods for disposing of livestock waste—accommodations. Shutting down the hog farms does not appear to be the solution. [In Re North Carolina Swine Farm Nuisance Litigation, 2017 WL 5178038 (E.D.N.C. 2017)] 7.

Taback began building a vacation home on a parcel of wooded land. It was to be a threestory house, 31 feet high. This height violated the local zoning ordinance that limited residential homes to two and one-half stories, not exceeding 35 feet. When Taback learned of this violation, he applied for a zoning variance. Because of the delay of the zoning board and because winter was approaching, Taback finished the construction of the building as a three-story house. At a later hearing before the zoning board, he showed that it would be necessary for him to rebuild the third floor to convert the house into a two and one-half story house. The zoning board recognized that Taback‘s violation could not be seen from neighboring properties. Was Taback entitled to a zoning variance?

[Taback v. Town of Woodstock Zoning Board of Appeals, 521 N.Y.S.2d 838 (App. Div.)] Answer: Public zoning, variance. Yes. The building was within the maximum height limitation and therefore satisfied the principal purpose of the zoning regulation. To require the owner to rebuild the third floor in order to make it a half floor would subject him to a substantial expense without conferring any particular benefit on the public. The variance would therefore be granted. [Taback v. Town of Woodstock Zoning Board of Appeals, 521 N.Y. S. 2d 838 (App. Div.)]

8.

The EPA has increased its BACT standards to impose greenhouse gas emissions standards for passenger cars, light-duty trucks, and mediumduty passenger vehicles and all businesses that emit greenhouse gases. The emissions from these small businesses and vehicles are not per se pollutants, but, rather, greenhouse gases. Does the EPA have the authority to regulate these emissions in vehicles? What about the costs associated with additional permits? [Utility Air Regulatory Group v. E.P.A., 134 S. Ct. 2427] Answer: Air pollution. The question combines the doctrines of the Massachusetts v. EPA case and the Transport Rule. The EPA can regulate greenhouse gas and the Transport Rule has also been upheld by the EME Homer City Generation, LP case. [Utility Air Regulatory Group v. E.P.A., 134 S. Ct. 2427]

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9.

The Stallcups lived in a rural section of the state. In front of their house ran a relatively unused, unimproved public county road. Wales Trucking Co. transported concrete pipe from the plant where it was made to a lake where the pipe was used to construct a water line to bring water to a nearby city. In the course of four months, Wales made 825 trips over the road, carrying from 58,000 to 72,000 pounds of pipe per trip and making the same number of empty return trips. Because the heavy use of the road by Wales cut up the dirt and made it like ashes, the Stallcups sued Wales for damages caused by the deposit of dust on their house and for the physical annoyance and discomfort it caused.

Wales defended its position on the ground that it had not been negligent and that its use of the road was not unlawful. Decide. [Wales Trucking Co. v. Stallcup, 465 S.E.2d 44 (Tex. App.)] Answer: What constitutes a nuisance. Judgment for Stallcups. The conduct of the Wales Trucking Company interfered unreasonably with the use and enjoyment by the Stallcupses of their land. This constitutes a nuisance, and the person causing such nuisance is liable for the damages caused thereby, even though that person‘s conduct in itself is neither negligent nor unlawful. It is the consequence of a person‘s act, rather than the nature of the act, that determines whether there is a nuisance. [Wales Trucking Co. v. Stallcup, 465 S.E. 2d 44 (Tex. App.)]

10. Some sections of the city of Manitou Springs have hills of varying degrees of slope. To protect against water drainage and erosion, the city adopted a hillside zoning ordinance that required homes on hillsides to be surrounded by more open land than in the balance of the city. Sellon owned land on a hillside and claimed that the hillside ordinance was unconstitutional because it did not treat all homeowners equally. Was the ordinance valid?

[Sellon v. City of Manitou Springs, 745 P.2d 229 (Colo.)]

Answer: Zoning ordinances. Yes. The city and the people living in the city were confronted with problems because of the presence of the hills. The hillside ordinance was an attempt to solve these problems by maintaining a lower population density for the hillside areas.

Thus, it was aimed at furthering the public welfare, and Sellon was not deprived of any constitutional right because his land, which was physically different from nonhill land, was not zoned the same way as nonhill land. [Sellon v. City of Manitou Springs, 745 P. 2d 229 (Colo.)]

11. Patrick Bossenberry owned a house in a planned community area. Each lot in the area was limited by a restrictive covenant to use for a single-family dwelling. The covenant defined family as a blood or marital relationship between most of the occupants. Bossenberry

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rented his building to Kay-Jan, Inc., which wanted to use the building as a care home for not more than six adult mentally retarded persons. The neighbors sought to enjoin this use as a breach of the covenant. A number of Michigan statutes had been adopted that advanced the public policy of providing care for mentally retarded persons. Could the neighbors prevent the use of the property as a care home for mentally retarded adults?

[Craig v. Bossenberry, 351 N.W.2d 596 (Mich. App.)] Answer: Zoning ordinances, constitutionality of restrictive covenants. Constitutionally, the objections to the adult homes have not been upheld. However, in this case, there is not an ordinance or objection to group homes. Rather, there is a covenant on family relations which has been upheld. There are variations in court challenges and rulings. [Craig v.

Bossenberry, 351 N.W. 2d 596 (Mich. App.)] 12. Kenneth and Mary Norpel purchased a house, and Kenneth attached a 35-foot flagpole to it. He did not obtain the permission of the architectural committee of the Stone Hill Community Association. This consent was required by a restrictive covenant to which the Norpel house was subject. The association objected to the flagpole from which Norpel then flew the American flag. The association brought an action to compel the removal of the pole. Norpel claimed that as a combat veteran of World War II, he had a constitutionally protected right to fly the American flag. Can he be compelled to remove the flagpole?

Answer: Parties bound by the restrictive covenant. Yes. It was not a question of interfering with Norpel‘s right to display the American flag. It was a question of whether he had the right to erect a flagpole in violation of the restrictive covenant. When he purchased the house subject to the restrictive covenant against additions made without the consent of the architectural committee of the association, Norpel became bound thereby and could not use his right to display the flag as an excuse for violating the restrictive covenant.

13. In 1997, Isbell purchased a building in San Diego with the intent to open an adult entertainment establishment there. Because this building was located within 1,000 feet of a residential area, however, a San Diego zoning ordinance precluded him from operating there. Isbell applied for a variance but was unsuccessful. He then filed suit, arguing that the city‘s ordinance violates the First Amendment, and that its standards for variances violate the equal protection clause. Can the city restrict the operation of this business?

What must the city be able to establish? [Isbell v. City of San Diego, 258 F.3d 1108 (9th Cir.)]

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Answer: Zoning. The San Diego ordinance in issue is designed to separate adult entertainment establishments from each other and from several other types of uses.

Dispersal ordinances of this type that are aimed at controlling the secondary effects of adult establishments are constitutional if they are "designed to serve a substantial governmental interest and allow for reasonable alternative avenues of communication."

The court found the ordinance was reasonable and justified but found that it could not be upheld as valid unless the city could show that there were alternative sites available to business owners. The court held that the study performed by the City examined only two communities, and apparently disregarded 43 out of the 45 communities in San Diego.

These two communities were selected because they had the highest concentration of adult entertainment businesses. In arriving at the conclusion that there were 45 existing adult businesses in San Diego, however, the City apparently examined two additional neighborhoods.

The initial burden to demonstrate available sites rests on the City. The court concluded that the City did not provide a reasonable list of potentially available properties and that the ordinance could not be upheld. [Isbell v. City of San Diego, 258 F. 3d 1108 (9th Cir.)] 14. Explain why a company would want to perform a self-audit to determine whether it has any environmental violations.

Answer: Self-audits. The benefits of a self-audit are: a.

Penalties are less

b.

Can eliminate or reduce potential liability by getting the issue resolved and any clean-up done before anyone is harmed by it

c.

Can provide insight on recovery from others who owned the company or land before and could have liability

d.

Allows company to control release of information and minimize effect on earnings

e.

Develops relationships with regulators

15. Gregory Mills lives next to Dean Kimbley. Mills kept a journal of Kimbley‘s activities, and even videotaped a few of the activities, including Kimbley‘s smoking marijuana and standing drunk in his backyard and yelling, ―Hi, neighbor!‖ Kimbley also threw a snowball into Mills‘ yard and nearly hit Mills‘ girlfriend with it. When Mills listed his property for sale because of the issues with Kimbley, Kimbley sent a pizza delivery man to Mills‘ door and told him to offer $125,000 to buy Mills‘ home. Kimbley then hired a real estate agent and took a tour of Mills‘ home with that real estate agent. Kimbley also drove an All Terrain

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Cycle onto Mills‘ lawn. Is this a nuisance case? Are these the elements of nuisance? Explain why or why not. [Mills v. Kimbley, 909 N.E.2d 1068 (Ind. App.)] Answer: Nuisance. The court found there was no nuisance, but the case has been questioned since its decision. Further, the court allowed the case to proceed on the grounds of trespass and invasion of privacy.

In Indiana, nuisances are defined by statute. Wernke v. Halas, 600 N.E. 2d 117, 120 (Ind. Ct. App. 1992). Indiana Code section 32-30-6-6 (2006) defines an actionable nuisance as follows: ―Whatever is: (1) injurious to health; (2) indecent; (3) offensive to the senses; or (4) an obstruction to the free use of property; so as essentially to interfere with the comfortable enjoyment of life or property, is a nuisance, and the subject of an action.‖ This court has traditionally distinguished between two types of nuisance: a public nuisance, which affects an entire neighborhood or community; and a private nuisance, which affects only one individual or a determinate number of people. See Hopper v. Colonial Motel Props., Inc., 762 N.E. 2d 181, 186 (Ind. Ct. App. 2002), trans. denied. A private nuisance arises when it is demonstrated that one party uses his property to the detriment of the use and enjoyment of the property of another. Id. Both public and private nuisances are further subdivided into nuisances per se, or nuisances at law, and nuisances per accidens, or nuisances in fact. Wernke, 600 N.E. 2d at 120. ―A nuisance per se, as the term implies, is that which is a nuisance in itself, and which, therefore, cannot be so conducted or maintained as to be lawfully carried on or permitted to exist.‖ Id. (quotation omitted). A house of prostitution and an obstruction that encroaches on the right-of-way of a public highway, for example, are nuisances per se. Id. On the other hand, an otherwise lawful use may become a nuisance per accidens by virtue of the circumstances surrounding the use. Id. It is logical, therefore, that the determination that something is a nuisance per se is a question of law, and the determination of a nuisance per accidens, a question ―for the jury or the judge as trier of fact.‖ Id. This latter determination is to be made by the trier of fact in light of all the surrounding facts and circumstances, with the dispositive question being ―whether the thing complained of produces such a condition as in the judgment of reasonable persons is naturally productive of actual physical discomfort to persons of ordinary sensibility, tastes, and habits.‖ Id. at 120-21 (quoting Wendt v. Kerkhof, 594 N.E. 2d 795, 797 (Ind. Ct. App. 1992)). Summary judgment, which by definition resolves only those cases lacking material factual disputes, is rarely appropriate in per accidens nuisance cases. Id. at 121.

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Here, Mills does not allege that Kimbley's use of his land is illegal or that it affects persons other than himself and his household. Accordingly, he is alleging a private, per accidens nuisance. Mills's nuisance claim during the summary judgment proceedings was based upon Kimbley's alleged loud music. Yet the record on appeal does not contain Mills's apparent ―declaration‖ regarding this alleged loud music, and none of the specified portions of Exhibit A reference such loud music. Although Mills's designated Exhibits C and D indicate that he told Kimbley not to play loud music and that he and Kimbley agreed during the June 22, 2006, mediation proceeding that Kimbley's music should not be heard in Mills's home, Mills points to no specifically designated evidence contained in the record on appeal supporting his allegation that loud music was played. Mills's failure to provide adequate record support for his challenge to the trial court's summary judgment waives his claim on this ground. See Ind. Appellate R. 46(A)(8)(a) (providing that the appellant's argument must be supported by cogent reasoning and citations to authorities and parts of the appendix relied on).

Although Mills's designated evidence includes the allegation that Kimbley's marijuana smoke drifted onto his property, he did not develop a marijuana-related argument with respect to his nuisance claim or argue that the marijuana smoke constituted a nuisance per se to be reviewed as a question of law. Indeed, Mills's nuisance challenge is based entirely upon his claim that the nuisance allegations presented questions of fact.

Accordingly, we will not address Mills's marijuana claim or develop an analysis in this opinion to address nuisances per se.

To the extent Mills's nuisance claim was based upon allegations other than those regarding loud music, his nonspecific catchall references to ―those facts as explicitly identified supra,‖ most of which are not part of the record on appeal, and ―all of those nuisance-related facts and instances set forth in extreme detail as contained in Appellant's 88-page, single-spaced, 10-point font Journal‖ are not adequately specific to support his claim that a genuine issue of material fact remains on his nuisance claims. Appellant's Br. p. 11. Accordingly, we deem any additional allegations of nuisance by Mills waived. See id; see also Filip, 879 N.E. 2d at 1081 (requiring parties to designate specific parts of documents upon which they rely). [Mills v. Kimbley, 909 N.E. 2d 1068 (Ind. App.)] [return to top]

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 48: Leases

Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 48: Leases

Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 483 Questions and Case Problems .......................................................................................................... 483

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

Johnny C. Carpenter and Harvey E. Hill died of asphyxiation when a fire broke out in their Hattiesburg, Mississippi, apartment on the morning of February 20, 1983. There were no smoke detectors in the apartment at the time of the fire, as required under Hattiesburg City Ordinance 2021. The administrators of the estates of Carpenter and Hill filed suit against London, Stetelman, and Kirkwood, the owners and managers of the apartment complex. Who is liable? [Hill v. London, Stetelman, and Kirkwood, Inc., 906 F.2d 204 (5th Cir.)] Answer: Warranty of habitability. The issue is whether the lack of a small detector makes the premises uninhabitable or if it was negligent not to have a smoke detector. Courts have split on this issue in both negligence and habitability cases with later decisions permitting negligence recovery.

Ordinance 2021 of the Fire Code provides: ―except that existing conditions not in strict compliance with the requirements of this Code may be permitted to continue if it can be proven that they do not constitute a distinct hazard to life or property.‖ While it is clear that the absence of smoke detectors was an ―existing condition,‖ there are no facts that establish that the failure to install these devices did not endanger the lives of the occupants. As a matter of law, the defendant‘s failure to install a smoke alarm constituted a distinct hazard to life and property. A tenant in an apartment building is a member of the class protected by the installation of a device designed to save the tenant from injury or death. Because the ordinance required the installation of a smoke detector, because the defendant failed to satisfy this ordinance, because the plaintiffs were the intended beneficiary of the ordinance, plaintiffs are entitled to a jury instruction of negligence per se. Judgment reversed and case remanded for trial.

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In a majority of jurisdictions, a finding of negligence per se only creates a mandatory finding of negligence that can be attacked on the grounds that the violation of the ordinance was not the proximate cause of the injury. In its opinion, the court laid out the element of the tort of negligence as they applied to this case. ―Because the plaintiffs were the intended beneficiary of the ordinance‖ and ―Because the ordinance required the installation of a smoke detector‖ [Duty]. ―Because the defendant failed to satisfy this ordinance‖ [Breach of Duty]. Plaintiffs are entitled to a jury instruction of negligence per se [Whether the Breach was the Proximate Cause of the injury is for the jury to decide]. [Hill v.

London, Stetelman, and Kirkwood, Inc., 906 F. 2d 204 (5th Cir.)] 2.

Petra Valoma and her three roommates rented an apartment in New York City with a security deposit of $2,850, two months of rent for $5,700, and a property loss payment of $800. Less than a month after the group of four took possession of the property, they found bedbugs. The manager sent an exterminator each week for six weeks, with no effective results. The four had to move out and lost most of their furniture because it was infected with bedbugs. The four sought to recover the rent that they had paid as well as damages for their lost furniture. What can they recover? [Valoma v. G-Way Management, LLC, 918 N.Y.S.2d 401 (N.Y. Cir. Ct.)]

Answer: Warranty of habitability. The court was sympathetic with the tenants: As for claimants' demand for the recovery of rent for the months of March and April 2010, the court is mindful that although they did not have full use and enjoyment of the apartment for those months, they maintained possession of the premises. Since claimants were deprived of full use and enjoyment of the premises, an abatement of rent for the two months is appropriate. The court is also mindful that while the extermination was not successful, defendant was fairly prompt in its response by getting an exterminator within five days of the initial complaint, with follow-up visits, and a change of exterminator when the problem was not improved. Unfortunately, it is not unusual that the bedbugs are not eradicated after a few attempts. Taking all these factors into account, an abatement of 50% per month for the two months is awarded (see Assoc. v. CW, 24 Misc. 3d 1225(A) [Civ. Ct. Bronx Cty., 2009]; Ludlow Properties v. Young, 4 Misc. 3d 515, 780 N.Y. S. 2d 853). Thus, the monthly rent of $2,850.00 per month is abated to $1,425.00 for March and April.

Claimants paid both March and April in full, thus, they are entitled to receive $2,850.00 as an abatement for both months, or $712.50 per claimant.

Finally, as to the claim for loss of property, claimants testified that they had to throw out practically all their furniture and personal items. They, however, did not have any receipts

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or any evidence to support this claim. There was also no testimony as to the value of any of the items now discarded, or how much furniture they had to begin with. In any event, absent any evidence to assign a value to the loss of claimants' property, the usual rule applied in personal items is ―by considering all of the circumstances in a rational way and assessing damages through the exercise of good sense and judgment by the triers of fact‖ (Kemp v. Midtown Movers, 2003 WL 21911078 [App. Term 2nd and 11th Judicial Dists., 2003] quoting MacGregor v. Watts, 254 App. Div. 904, 5 N.Y. S. 2d 525 [App. Div. 1st Dept., 1938]). An amount of $100.00 is awarded to each of the claimants. Additionally, defendant's request to offset the judgment to claimant in the amount of $2,950.00 for the broker's fee, is denied. There is no reason to compel an offset due to landlord's breach of the implied warranty of habitability.

Accordingly, judgment is in favor of claimant Petra Valoma, index SCK 4704/10, in the amount of $1,525.00; claimant Samuel Bromell index SCK 3796/10 in the amount of $1,525.00; claimant Audrey Hailes index SCK 3797/10 in the amount of $1,525.00; and Chad D. Kistler index SCK 3545/10 in the amount of $1,525.00. [Valoma v. G-Way Management, LLC, 918 N.Y. S. 2d 401 (N.Y. Civ. Ct.)] 3.

Rod had a five-year lease in a building owned by Darwood and had agreed to pay $800 a month rent. After two years, Rod assigned his rights under the lease to Kelly. Kelly moved in and paid the rent for a year and then, owing two months‘ rent, moved out without Darwood‘s knowledge or consent. Darwood demanded that Rod pay him the past-due rent. Must Rod do so? Why or why not?

Answer: Tenant‘s assignment of lease. Yes. The tenant is not released from liability under the original lease by either the act of assignment or subletting or the landlord‘s agreement to it.

4.

Sue A. Merrill injured her right shoulder when she fell as she was ascending the front steps leading to the porch and front door of the mobile home that her daughter, Sherri Pritchard, rented from Alvina Jansma. The step became loose during the time Ms. Pritchard rented the home. Prior to the fall, Ms. Pritchard had attempted to repair the step by securing it with nails. When that failed, she informed the manager of the property that the step was loose. The manager suggested that Ms. Pritchard try using screws to secure the step. Ms. Pritchard told the manager that she did not have a screw gun. The manager had one and said she would screw the step into place. Subsequently, and without Ms. Pritchard‘s knowledge, the manager attempted to repair the step. Apparently, that effort was unsuccessful and Ms. Merrill fell when the step separated from the porch as she

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stepped on it. Ms. Merrill filed a negligence claim against Ms. Jansma to recover for her medical expenses, lost wages, and damages for emotional distress and pain and suffering.

Could Ms. Merrill recover? [Merrill v. Jansma, 86 P.3d 270 (Wyo.)] Answer: Liability of sublessee. No. A sublessee is not liable to the landlord without an expressed contract imposing such liability. [Merrill v. Jansma, 86 P. 3d 270 (Wyo.)] 5.

Jennifer Sanchez and her three children lived in a two-story townhome operated by CAA (the Cincinnati Community Action Agency). CAA is a nonprofit entity that provides housing for single mothers in financial need. Sanchez requested maintenance on an area behind her toilet on the second floor of the townhome. Josh Hill, a maintenance employee for CAA, came to fix the area. Hill‘s plan was to simply plaster over the moist area. However, Ms. Sanchez‘s boyfriend and the father of her children, Ruben, was present and offered his expertise as someone who earned a living doing drywall work. He loaned Hill a box cutter to cut out the moist portion of the wall and Ruben walked Hill through the repair. As Hill finished the work, Ms. Sanchez called Ruben downstairs and Hill left.

The two-and four-year-olds ended up in the bathroom near the repair area and found the box cutter. In a fight over the box cutter, the four-yearold (V.R.) sliced her finger trying to seize it from the two-year-old. V.R. had to have several surgeries for nerve and tendon damage. Ms. Sanchez, Ruben, and V.R. sued CAA alleging that it had breached its duty as a landowner and caused the injury for their failure to maintain the premises. Can they recover? [In re V.R., 2014 WL 6090396 (Ohio App.)] Answer: Landlord liability for injuries. The court upheld a summary judgment for CAA because the premises were habitable and the duty to warn could not possibly include warnings about tools the tenant gives to a maintenance man. An excerpt from the court‘s opinion appears below: To establish a cause of action for negligence, a plaintiff must show (1) the defendant owed the plaintiff a duty of care, (2) the defendant breached that duty, (3) the defendant's breach proximately caused the plaintiff's injury, and (4) damages. Lang v. Holly Hill Motel, Inc., 122 Ohio St. 3d 120, 2009-Ohio-2495, 909 N.E. 2d 120, ¶ 10. A duty may be established by common law, by legislative enactment, or by the particular facts and circumstances of the case. Chambers v. St. Mary's School, 82 Ohio St. 3d 563, 565,697 N.E. 2d 198 (1998). {¶ 10} As a general matter, a property owner has no common-law duty to warn

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individuals lawfully on the premises against known or open and obvious dangers— also known as the open-and-obvious doctrine. Robinson v. Bates, 112 Ohio St. 3d 17, 24, 2006-Ohio-6362, 857 N.E. 2d 1195. The rationale for the open-and-obvious doctrine is that an invitee or occupier of the property can reasonably be expected to discover known or obvious dangers and protect against them. Daniels v. Verai Ents., 1st Dist. Hamilton No. C-110440, 2012-Ohio-2264, ¶ 12, citing Armstrong v.

Best Buy Co., Inc., 99 Ohio St. 3d 79, 2003-Ohio-2573, 788 N.E. 2d 1088, ¶ 5. {¶ 11} In derogation of the common-law duties of landlords, the Ohio legislature created various obligations upon landlords in the Landlord-Tenant Act. See R.C. 5321.04. A landlord's violation of a provision of the Landlord-Tenant Act constitutes negligence per se, meaning that duty and breach have been conclusively established. Cipollone v. Hoffmeier, 1st Dist. Hamilton No. C-060482, 2007-Ohio3788. The common law, open-and-obvious doctrine will not protect a landlord from liability for breaches of statutory duties under the Landlord-Tenant Act; however, if no statutory breach occurred, the open-and-obvious doctrine remains a bar to a common-law negligence claim. See Robinson; Mann v. Northgate Investors LLC, 2012-Ohio-2871, 973 N.E. 2d 772 (10th Dist.). {¶ 12} In response to CAA's summary-judgment motion, appellants argue that CAA breached its statutory duty to repair under the Landlord-Tenant Act. R.C. 5321.04(A)(2) provides that a landlord must ―[m]ake all repairs and do whatever is reasonably necessary to put and keep the premises in a fit and habitable condition[.]‖ In order to maintain a claim under R.C. 5321.04(A)(2), a plaintiff must show that the premises are unfit and uninhabitable. January Invests., LLC v. Ingram, 12th Dist. Warren No. CA2009-09-127, 2010-Ohio-1937, ¶ 26, citing Cipollone, 1st Dist. Hamilton No. C-060482, 2007-Ohio-3788, at ¶ 22. This court has held that R.C. 5321.04(A)(2) requires the defects in the premises to be ―so substantial as to amount to a constructive eviction‖ and constitute ―more than nuisances or trifles.‖ (Internal quotation omitted.) Cipollone at ¶ 22. {¶ 13} Appellants make no argument, nor point to any evidence in the record, demonstrating that the premises were unsafe or uninhabitable such that they were constructively evicted under R.C. 5321.04(A)(2). In the absence of any other statutory duty breached by CAA, CAA is entitled to summary judgment on appellants' negligence-per-se claim. {¶ 14} As to the common-law negligence claim, the open-and-obvious doctrine bars

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the appellants' claim that CAA breached a duty with regard to the boxcutter. The evidence in the record demonstrates that Ruben loaned Hill the boxcutter and directed and observed Hill throughout the repair. Only when Hill finished using the boxcutter and nearly completed the repair did Ruben head downstairs. {¶ 15} Although Ruben averred in his affidavit that Hill left Sanchez's home without notice, Ruben testified that he knew Hill was finished with the job and was not going to come back when he saw Hill exit from the townhome. Appellants cannot, ―without sufficient explanation,‖ contradict deposition testimony in an affidavit to defeat summary judgment. Ruben further testified that after he had gone downstairs, he neglected to take his boxcutter with him, and he simply ―lost total track‖ of it as he became occupied with something else. Ruben knew his boxcutter remained upstairs where one of his children could reasonably be expected to come across it when playing upstairs unsupervised. The boxcutter was a known risk to Ruben, and he failed to guard against that risk to protect his children. Thus, appellants failed to establish that CAA owed them a duty with respect to the boxcutter. [In re V.R., 2014 WL 6090396 (Ohio App.)] 6.

On June 21, 1997, Julio Ramos was helping his cousin move out of a second-floor apartment. He positioned himself on the outer side of the secondfloor balcony railing, his feet between its spindles, to pass furniture to a friend on the ground below. While perched in this precarious position, Ramos held onto the railing with one hand and used his other hand to move the furniture. The reason for this method of removing the furniture was that many pieces were too large to be taken down the stairs. After approximately an hour of moving furniture in this manner, Ramos heard some cracking and felt the railing giving way. He released the furniture and attempted to grab onto the railing with both hands, but the spindles broke, and Ramos fell to the ground.

Ramos brought suit against the landlord to recover for his injuries. How does this case compare to the Tan case? Should the landlord in this case be held liable? [Ramos v.

Granajo, 822 A.2d 936 (R.I.)] Answer: Liability of landlord. Landlord not held liable because the railing was stressed by movement and used as support for furniture. The Tan case is not maintenance, but thirdparty activities. Maintenance is always a landlord's duty! Third-party acts must be forseeable. [Ramos v. Granajo, 822 A. 2d 936 (R.I.)] 7.

A tenant leased an apartment in which so much noise emanated from surrounding

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apartments late at night and in the wee hours of the morning that he could not get much sleep. The tenant brought suit against the landlord, alleging that the landlord had breached the implied warranty of habitability. Is the tenant correct? Can noise be a breach of the warranty of habitability? [Nostrand Gardens Co-op v. Howard, 634 N.Y.S.2d 505] Answer: Constructive eviction/warranty of habitability. The noise is not within the traditional categories of habitability such as water, heat, etc. The noise might constitute constructive eviction. [Nostrand Gardens Co-op v. Howard, 634 N.Y. S. 2d 505] 8.

James Santelli was staying at a motel owned by Abu Rahmatullah for several months as he worked at a nearby construction project.

Joseph Pryor had been previously employed at the motel as a general maintenance man.

There was no criminal background check done on Pryor. Pryor had a prior conviction and was wanted at the time he was hired for probation violations. When he left his job at the motel, Pryor kept his master keycard. Pryor used the keycard to enter Santelli‘s room and later confessed to robbing and killing him, with a resulting sentence of 85 years. Mr. Santelli‘s widow brought suit against Rahmatullah for his negligence in hiring Pryor. Can Rahmatullah be held liable for Mr. Santelli‘s death? [Santelli v. Rahmatullah, 966 N.E.2d 661 (Ind. App.)] Answer: Lessor‘s liability to lessee for crime of third person. The court held that there was joint and several liability for the death. Any negligence on Mr. Santelli‘s part with regard to security was only partially responsible. The court remanded the case for a new trial noting that in the new trial the widow should be able to introduce evidence of a shoot-out at the hotel six months prior to Pryor‘s crimes. The failure to do background checks on maintenance people is a failure to exercise the minimum duty a landlord owes a tenant.

[Santelli v. Rahmatullah, 966 N.E. 2d 661 (Ind. App.)]

9.

During the remodeling of an apartment building, tenants had so much dust from the construction settle in their apartment that they experienced damage to their expensive sound and recording equipment. They had rented the very specialized and large apartment because it was suitable to use as a recording studio. Would the presence of the dust be grounds for constructive eviction? Would it be a breach of the warranty of habitability? [Minjak Co. v. Rudolph, 528 N.Y.S.2d 554] Answer: Habitability. Yes, it is possible that dust can violate the warranty of habitability, the dust presents a health hazard. [Minjak Co. v. Rudolph, 528 N.Y. S. 2d 554]

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10. Cantanese leased a building for the operation of his drugstore from Saputa. He moved his drugstore from Saputa‘s building to another location but continued to pay rent to Saputa.

Saputa, fearing that he was losing his tenant, entered the premises without Cantanese‘s permission and made extensive alterations to the premises to suit two physicians who had agreed to rent the premises from Saputa. Cantanese informed Saputa that he regarded the making of the unauthorized repairs as grounds for canceling the lease. Saputa then claimed that Cantanese was liable for the difference between the rent that Cantanese had agreed to pay and the rent that the doctors would pay for the remainder of the term of the Cantanese lease. Was Cantanese liable for such rent? [Saputa v. Cantanese, 182 So. 2d 826 (La. App.)] Answer: Tenant‘s exclusive possession; eviction by alterations not consented to by tenant.

No. Cantanese properly claimed that the lease had been canceled by the landlord‘s improper disturbance of his possession in the making of alterations to fit the place for the use by the doctors, which would necessarily make it unfit for use as a drugstore. This was an interference with the possession of Cantanese, even though Cantanese did not exercise his right to be in possession but moved his store to a different location. [Saputa v.

Cantanese, 182 So. 2d 826 (La. App.)] 11. Sargent rented a second-floor apartment in a building owned by Ross. Anna, Sargent‘s four-year-old daughter, fell from an outdoor stairway and was killed. Sargent brought suit against Ross for her daughter‘s death. Ross contended that she did not have control over the stairway and therefore was not liable for its condition. Was this defense valid? [Sargent v. Ross, 308 A.2d 528 (N.H.)] Answer: Liability of lessor for condition of premises. This court held that the defense was not valid. A court applying the majority common law rule would hold that the defense was valid. By the common law, control is the criterion for liability. By the decision of this court, representing the modern minority, foreseeability is the criterion. Applying the foreseeability criterion, the court held that persons renting property to others must exercise reasonable care to protect them, their families, and visitors from unreasonable exposure to the danger of injury. This duty exists without regard to whether the part of the premises involved in an injury was under the control of the lessor or the lessee. The design of the stairway made it reasonable to foresee that persons using it could fall and be seriously injured. Because this danger was foreseeable, Ross was liable when the harm that was foreseeable was sustained. [Sargent v. Ross, 308 A. 2d 528 (N.H.)]

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12. Charles leased a house from Donald for four years. The rent agreed on was $850 per month. After two years, Charles assigned his rights under the lease to Smith, who moved in and paid rent regularly for a year. Owing rent, Smith moved out sometime later without Donald‘s knowledge or consent. Donald demanded that Charles pay the rent. Is Charles liable?

Answer: Sublease; assignment. The tenant is not released from liability through assignments or sublease. Charles remains obligated on the lease.

13. Green rented an apartment from Stockton Realty. The three-story building had a washroom and clothesline on the roof for use by the tenants. The clothesline ran very near the skylight, and there was no guard rail between the clothesline and the skylight. Green‘s friend, who was 14 years old, was helping Green remove clothes from the line when she tripped on an object and fell against the skylight. The glass was too weak to support her weight, and she fell to the floor below, sustaining serious injuries. Is the landlord responsible for damages for the injury sustained? Decide. [Reiman v. Moore, 180 P.2d 452 (Cal.)] Answer: Landlord‘s liability to third persons. The landlord is liable because the landlord is under an affirmative obligation to exercise reasonable care to inspect and repair such parts of the premises for the protection of the lessee, and this duty extends also to members of the tenant‘s family, invitees, guests, and others on the land in the right of the tenant, because their presence is a part of the normal use of the premises for which the lessor holds them open. [Reiman v. Moore, 180 P. 2d 452 (Cal.)] 14. Suzanne Andres was injured when she fell from the balcony of her second-floor apartment in the Roswell-Windsor Village Apartments. Andres was leaning against the railing on the balcony when it gave out, and she and the railing fell to the ground. Andres filed suit against Roswell-Windsor for its failure to maintain the railing. Roswell-Windsor maintains that the railing was not in a common area and was in Andres‘s exclusive possession and that she was responsible for its maintenance or at least letting the manager know the railing needed repairs. Should Andres recover from the landlord for her injuries? [Andres v.

Roswell-Windsor Village Apartments, 777 F.2d 671 (11th Cir.)] Answer: Liability to third parties. The court held Roswell-Windsor not liable because the railing was not a common area. Tenants need to periodically check their premises and make maintenance requests. [Andres v. Roswell-Windsor Village Apartments, 777 F. 2d 671 (11th Cir.)]

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Solution and Answer Guide: Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 49: Decedents‘ Estates and Trusts

15. Aisha M. Gawad and Natalia Ospina were roommates in an apartment owned by Dalia Aviad. Their lease began on May 1, 2010, and the women found bedbugs in their apartment on May 23, 2010. They vacated the apartment on May 23, 2010.

They brought suit in small claims court seeking return of their rent for the last nine days in May as well as their security deposits and the cost of utilities in the apartment for those nine days. The court awarded the rent for the eight days left in May along with costs. Aisha was awarded $1,986.78 in damages, and Natalia was awarded $2,234. Aviad appealed because he was not told about the bedbugs until they moved out and he needed notification in order to fix any issues his tenants had. What should the court do and why?

[Gawad v. Aviad, 960 N.Y.S.2d 50 (Sup. Ct. N.Y.)] Answer: Warranty of habitability. In our view, there was ample evidence introduced at the trial to establish the existence of a bedbug condition in the apartment, and that this condition rendered the apartment uninhabitable as of May 23, 2010 and constructively evicted plaintiffs therefrom. Thus, plaintiffs are not liable for the rent accruing beginning with June 1, 2010 and they are each entitled to the return of their respective $625 security deposits. However, plaintiffs are not entitled to recover, as damages for a breach of the warranty of habitability the rent that they paid for the last nine days of May 2010, as defendant was not notified of the bedbug condition until May 23, 2010, and a landlord must be allowed a reasonable amount of time to correct a condition. In addition, plaintiffs are not entitled to recover any damages for breach of the duty owed pursuant to the Multiple Dwelling Law, as plaintiffs did not introduce competent proof to establish that defendant had been on notice before May 23, 2010 of the bedbug condition Finally, no basis was shown for an award to plaintiffs of the utility charges they had incurred after May 23, 2010. Consequently, we find that substantial justice between the parties requires that the award to each plaintiff be reduced to the principal sum of $625, and we modify the judgments accordingly. [Gawad v Aviad, 960 N.Y. S.2d 50 (Sup. Ct. N.Y. 2012)] [return to top]

Solution and Answer Guide Twomey/Anderson, Business Law & The Legal Environment, 2022, Core ISBN: 9780357363744; Chapter 49: Decedents’ Estates and Trusts

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Table of Contents Answers to the End-of-Chapter Questions ...................................................................................................... 493 Questions and Case Problems .......................................................................................................... 493

Answers to the End-of-Chapter Questions Questions and Case Problems 1.

After an eleven-month struggle with esophageal cancer, Leonard R. Brener died on December 8, 2001, at age 85. He had never married. He had no children. He had a long and successful career as a stockbroker. The value of his estate approximated $8 million.

Several nieces and nephews survived him. He had originally left nearly all of his estate to the Carroll Center for the Blind, the Perkins School for the Blind, and Beth Israel Deaconess Medical Center, Inc. The gifts to these nonprofit organizations during Brener‘s life and through his will were complicated and made through detailed living, testamentary, and pour-over trusts. During the last five weeks of his life he was hospitalized and drafted and executed the final version of his will, which made one niece and her husband the primary beneficiaries of his estate. The nonprofit organizations sought to have the will set aside for lack of testamentary capacity.

During those five weeks of terminal illness, Brener spoke of suicide by jumping out of the window, complained of depression, and often complained to his lawyer that he did not understand all the estate planning tools that were being used in his will. The staff at the hospital testified that Brener did not seem confused and was aware that he was dying and wanted to be sure his affairs were in order. [Maimonides School v. Coles, 881 N.E.2d 778 (Mass. App.)] Answer: Capacity. The fact that a testator is depressed during the final stages of a terminal illness and expresses a desire to pass away did not mean that he lacked capacity.

Also, where doctor‘s testimony is contradictory, the presumption rests with the doctor who has testified to sufficient capacity. The fact that Brener constantly complained that he did not understand the language in the wills and trusts did not mean that he lacked testamentary capacity. Contractual capacity is different from testamentary capacity and the latter only requires an understanding that property is to be transferred, how much will be transferred, and to whom. Brener‘s niece was a loyal visitor during his final illness and helped take care of his needs with the health care workers. She was a logical beneficiary as well as a relative. The will executed during the final five weeks was valid and the testator

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had sufficient capacity to make it. [Maimonides School v. Coles, 881 N.E. 2d 778 (Mass.

App.)] 2.

Gerald ―Pat‖ Arrington was diagnosed with a brain tumor. At the time of the diagnosis, he was married to Brenda Arrington, but they were separated pending their divorce. Brenda and Pat had no children, but Pat had five children from a previous marriage. Patricia Daley had lived with Pat since she was born. Pat referred to her as his only ―stable‖ child. After Patricia married David Daley, the two stayed with Pat at his ranch and helped him with the cattle and working the land.

Pat executed a new will one year before his death and following the brain tumor diagnosis that left everything to Patricia because Pat felt that Brenda would just sell his ranch and he did not want it to be sold. After Pat died, Patricia, as executrix of the estate, had the will admitted to probate. Brenda challenged the admission of the will to probate because she said that he gave his property to someone who was not legally his child and that showed he lacked capacity. The will was witnessed by two employees of a bank and both testified that Pat seemed to be his usual self and that he had done business at the bank for 20 years. What should the court do with the will and the challenge to it and why? [In re Estate of Arrington, 365 S.W.3d 463 (Tex. App.)] Answer: Capacity to make will. The court held that there was sufficient mental capacity— the mind need not be in perfect shape and the disposition logical in order to have testamentary capacity. The excerpt below summarizes the court‘s ruling in favor of admitting the will to probate: The jury in this case also heard testimony about Pat's health problems, including testimony about a 1983 electric shock accident, his headaches, and his declining health in 2005. Brenda conceded that Pat performed his daily work after the accident; he worked cattle on horseback. Members of Pat's family testified that Pat possessed all his mental faculties after the accident, noticing no change in his daily behavior beyond some difficulty walking. The jury heard testimony that, in December 2004, Pat suffered from headaches and was taking steroids to treat the symptoms of his brain tumor. Pat's sisters, a son, a daughter, and a co-worker each testified that, despite this condition, Pat acted like himself during that time. They recalled that Pat provided them with driving directions to his doctor's office. After doctors biopsied his tumor in 2005, Pat became partially paralyzed. Pat no longer cared for himself but relied on his family to care for him.

Nevertheless, Pat's sisters testified that he maintained his mental faculties until his death.

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Brenda argues that the evidence that Patricia adduced is legally insufficient. She claims that, because no evidence demonstrates that Pat discussed his children or the approximate nature of his property with the witnesses on the date he executed his will, Pat lacked the capacity to make a judgment about bequeathing his property. She asserts that Pat did not know who his children were because his will names a child whom he never adopted in a legal proceeding, and it omits an alleged sixth child. But a finding of testamentary capacity does not hinge entirely on direct evidence that the testator discussed the details of his children, wealth, or disposition at the time he signed his will.

See Prather, 76 Tex. at 584-85, 13 S.W. at 545-46. The jury heard direct evidence of Pat's general mental condition on the day he executed his will and the attending months before and after: this evidence supports its determination that Pat knew that he was executing his will and that he had deliberately chosen Patricia to be his sole beneficiary. The evidence at trial ―would enable reasonable and fair-minded people to reach the verdict under review.‖ See City of Keller, 168 S.W. 3d at 827.

We hold that the evidence is legally sufficient to support the jury's finding of testamentary capacity. See Collins v. Smith, 53 S.W. 3d 832, 843 (Tex. App. Houston [1st Dist.] 2001, no pet.) (testimony that testator was of sound mind and knew what he was doing when he executed his will was sufficient to remove any suspicion surrounding the wills execution); Horton v. Horton, 965 S.W. 2d 78, 86 (Tex. App. Fort Worth 1998, no pet.) (evidence testator had taken pain medication and experienced hallucinations was not sufficient to show incapacity where witnesses testified testator was of sound mind when he executed his will and no direct evidence demonstrated he experienced hallucinations at the time he signed the will). [In re Estate of Arrington, 365 S.W. 3d 463 (Tex. App.)] 3.

John C. Ramsey Sr. (Senior) executed a will in the last months of his life that left the bulk of his estate to Melody Taylor, his paramour. Senior‘s relationships with his son and grandsons were strained, and his will included the following clause: I have intentionally provided significant, yet smaller amounts for my son and grandsons because they have for several years alienated my affections by being irresponsible, contentious, and constantly seeking financial support from me rather than providing for themselves.

I have made provisions for MELODY J. TAYLOR because MELODY J. TAYLOR provides me care and support.

Senior was suffering from cancer and renal failure, and his pain was extraordinary. His

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doctors prescribed high doses of morphine that Melody administered. Senior died from an overdose of morphine.

John Ramsey Jr. (Junior), Senior‘s son, challenged the validity of the will on the grounds of undue influence as well as felonious killing of a testator by a beneficiary. The trial court found there was undue influence and refused to admit the will to probate. Melody appealed. What should the court do and why?

Answer: Undue influence; disinheritance. Judgment for Melody. There was a long history of bad blood between Junior and Senior. Further, Senior had disinherited Junior long before Melody came into the picture. The clear statement in the will that he knew he was leaving out Junior and why was indicative of clear thinking and lack of duress from Melody. Senior also had independent advice on his will and took his time in executing it. Melody‘s administration of the fatal drug dose was pursuant to physician‘s instructions, and she was still entitled to inherit under the valid will that was admitted to probate. [Ramsey v. Taylor, 999 P.2d 1178 (Or. App. 2000)] 4.

Logsdon, who had three children, disliked one of them without any reason. In his will, he left only a small amount to the child he disliked and gave the bulk of his estate to the remaining two. On his death, the disliked child claimed that the will was void and had been obtained by undue influence. How would you resolve the issue raised by the disinherited child? [Logsdon v. Logsdon, 104 N.E.2d 622 (Ill.)] Answer: Will contest. No proof of undue influence existed. The fact that one child was disliked without cause or that there was an unequal distribution of property among children does not show a lack of testamentary capacity or prove the existence of undue influence. The will was therefore valid because there was no other evidence to attack it.

[Logsdon v. Logsdon, 104 N.E. 2d 622 (Ill.)]

5.

Field executed a will. On her death, the will was found in her safe deposit box, but the part of it containing the fifth bequest had been torn from the will. This torn fragment was also found in the box. There was no evidence that anyone other than Field had ever opened the box. A proceeding was brought to determine whether the will was entitled to be probated. Had the will been revoked? Was the will still valid with a portion torn from it?

[Flora v. Hughes, 228 S.W.2d 27 (Ky.)] Answer: Revocation by act of testator. Under the circumstances, it was proper to conclude that the physical tearing of the will was done by Field. The preservation of the balance of

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the will therefore justified the conclusion that the testatrix intended to revoke only the fifth bequest and to preserve the balance as her will. [Flora v. Hughes, 228 S.W. 2d 27 (Ky.)] 6.

Miller wrote a will that was 11 pages long and enclosed it in an envelope, which she sealed. She then wrote on the envelope ―My last will & testament‖ and signed her name below this statement. This was the only place where she signed her name on any of the papers. Was this signature sufficient to allow this writing to be admitted to probate as her will? [Miller’s Executor v. Shannon, 299 S.W.2d 103 (Ky.)] Answer: Signature on will. No. A will must be signed at the end. Signing on the envelope was not signing at the end, even though in point of time it might have been the last thing she did. [Miller's Executor v. Shannon, 299 S.W. 2d 103 (Ky.)]

7.

Ms. Lingenfelter‘s will was offered for probate and was opposed. Ms. Lingenfelter (the testatrix) was sick, highly nervous, and extremely jealous, and she committed suicide a week after executing the will. She had, however, seemed to understand the will when she discussed it with an attorney. The will disinherited her husband because she feared he was not faithful to her despite the fact that he was seriously ill when she wrote the will. He died the day after she executed the will, and she grieved his death terribly for one week before committing suicide. Did she have the capacity to make a will? Should it be admitted to probate? [In re Lingenfelter’s Estate, 241 P.2d 990 (Cal.)] Answer: Capacity of the testator. Yes, the will was entitled to probate. The physical and psychological condition of the testatrix and the commission of suicide were not in themselves proof that she lacked testamentary capacity. Under the circumstances, the will was entitled to probate. [In re Lingenfelter's Estate, 241 P. 2d 990 (Cal.)]

8.

Copenhaver wrote a will in ink, which was found with her other papers in her bedroom at her death. Pencil lines had been drawn through every provision of the will and the signature. There was no evidence as to the circumstances under which this had been done.

Was the will revoked? Why or why not? [Franklin v. Maclean, 66 S.E.2d 504 (Va.)] Answer: Revocation of will. Yes, the will was revoked. The fact that it was written in ink did not prevent revocation by a pencil line through each sentence and the signature of the will. In view of the fact that the will was found in the descendant‘s possession, it was to be presumed that the lines had been drawn by the descendant with the intent to revoke the will. The will was therefore revoked by cancellation. [Franklin v. Maclean, 66 S.E. 2d 504 (Va.)]

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Authors‘ Comment: Ask your class whether it is not possible that an individual not mentioned in the will might draw pencil lines throughout portions of the will at the time of the decedent‘s death, knowing that this individual would receive an inheritance if the decedent died intestate. This would certainly make it an interesting evidentiary problem.

9.

George Baxter executed a will that left the bulk of his estate to the Church of Christ in New Boston, Texas. Two members of the church served as the witnesses for the will. Is the will valid? [In re Estate of Gordon, 519 S.W.2d 902 (Tex.)] Answer: Witnesses; execution of will. The students should discuss the differing state views on interested parties as witnesses. In some states, the will is invalid. In others the witnesses can only take what they would have taken intestate. In this situation, the church is a different entity from the witnesses, but they are interested parties. [In re Estate of Gordon, 519 S.W. 2d 902 (Tex.)]

10. Jeanette Wall worked for D. J. Sharron for many years. Sharron executed a will, leaving his entire estate to Jeanette. He re-executed the same will sometime thereafter with the same provisions. Sharron‘s children contested the will, offering evidence that Sharron was a very sick man, physically as well as mentally, and that Wall was active in Sharron‘s business as well as his personal life. They offered no evidence that Wall had any involvement in the procurement of the original or the re-executed will. Who is entitled to the estate? Why? [Wall v. Hodges, 465 So. 2d 359 (Ala. App.)] Answer: Will contests; testamentary capacity. The children would need to establish either testamentary incapacity or undue influence. With the facts presented, the children have raised issues, but they need proof to have the will set aside. [Wall v. Hodges, 465 So. 2d 359 (Ala. App.)] 11. In 1984, Alexander Tolin executed a will under which the residue of his estate was to be devised to his friend Adair Creaig. The will was prepared by Steven Fine, Tolin‘s attorney, and executed in Fine‘s office. Fine retained the original will and gave a blue-backed photocopy to Tolin. In 1989, Tolin executed a codicil to the will that changed the residuary beneficiary from Creaig to Broward Art Guild, Inc. Fine prepared the codicil, and retained the original, giving Tolin a bluebacked photocopy of the original executed codicil.

Tolin died in 1990. Six months before his death, he told his neighbor Ed Weinstein, who was a retired attorney, that he made a mistake and wished to revoke the codicil and

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reinstate Creaig as the residuary beneficiary. Weinstein told Tolin he could do this by tearing up the original codicil. Tolin handed Weinstein a blue-backed document that Tolin said was the original codicil. Weinstein looked at the document; it appeared to him to be the original, and gave it back to Tolin. Tolin then tore up and destroyed the document with the intent and for the purpose of revocation.

Some time after Tolin‘s death, Weinstein spoke with Fine and found out for the first time that Fine had the original will and codicil. Creaig filed a petition to determine if there had been a revocation of the codicil. From a judgment that Tolin‘s destruction of a copy of the codicil was not an effective revocation of the codicil, Creaig appealed. Who is correct about the revocation and why? [In re Estate of Tolin, 622 So. 2d 988 (Fla.)] Answer: Revocation. The implied language of the Florida statute requires the intention of destruction of the original will or codicil in order to constitute a revocation. Judgment was affirmed.

The law requires that the testator destroy the document that has been executed according to the law. What the testator destroyed here was a document that was an exact copy of the fully executed original codicil and was in all respects identical to the original except for the original signatures. Because the testator destroyed a copy of the codicil rather than the original codicil, his attempted revocation was ineffective.

Revocation by act of the testator can also occur by the creation of a subsequent testamentary document if that document declares the earlier will or codicil to be revoked.

However, if the subsequent testamentary document does make this declaration, the subsequent document only revokes the prior will or codicil to the extent that it is inconsistent with the newer document. [In re Estate of Tolin, 622 So. 2d 988 (Fla.)] 12. Valerie and Flora are the beneficiaries of a trust left to them by their mother upon her death. Their mother named Art Casanelli, a family friend, as the trustee. Flora has seen Art driving a new car and has learned that he just purchased a new and rather large home.

She is concerned about the trust funds and Art‘s unfettered access to them. How can she determine whether Art is using trust funds? What happens if she finds that he is?

Answer: Trusts; duties. She can ask for an accounting of the trust accounts, funds, and management. If Art has used any of the trust funds for personal reasons, it is a breach of his fiduciary duties as a trustee and he is terminated and liable for return of the funds. In most states, there would also be criminal charges associated with the use of the funds.

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13. Can a murderer inherit property from his victim? Why or why not?

Answer: Murder; inheritance. No, a murderer cannot inherit property from his victim because public policy dictates that there would be too much incentive to kill the testator!

14. James Horne‘s will provides that his estate is to be distributed to his heirs per capita. Upon his death, two of his three children are surviving and his deceased child left two children (James‘s grandchildren). His will provides that all his property is to be distributed per capita to these children and grandchildren. How will the property be distributed? How would it be distributed if he had provided for a per stirpes distribution?

Answer: Distribution of estate. Under per capita, each child and grandchild gets one-fourth of the estate because they all share equally. Under per stirpes, each child would get onethird and the two grandchildren would split one-third and get one-sixth each.

15. Justin Whitman is the adult son of Jeffrey Whitman, an attorney who has served as the trustee for a trust of which Justin is the beneficiary. The trust was established for Justin by his grandfather, Jeffrey‘s father. Justin asked his father/trustee for an accounting of the principal and income of the trust. Jeffrey asked for the accounting in 2007 and received nothing by 2008 and filed suit for the accounting. Is Jeffrey entitled to receive the accounting? What could a court do in order to obtain the accounting? [Whitman v.

Whitman, 2012 WL 367055 (Ohio App.)] Answer: Trusts; accounting. A trustee is always obligated to account to the beneficiary. In this case, particularly because the father was a lawyer, the duty was beyond just that of a trustee. The court found the father in civil contempt, sentenced him to serve three days in jail, and ordered him to pay son's attorney fees. The court of appeals affirmed. [Whitman v.

Whitman, 2012 WL 367055 (Ohio App.)] [return to top]

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