Contracts form the basis for many personal and business transactions. A contract is an agreement between two parties. In our personal lives, contracts are used in marriage and divorce, as well as when you buy and sell a house. In business, contracts are used when a company hires another company or individual, when property is bought or sold, and when services are exchanged (see Figure M1.2).

Figure M1.2

A Valid Contract

Another common business law concept is torts. Atortis a wrongful act, resulting in injury or damages. A tort differs from a breach of contract in that a tort is a violation of a right given by law, whereas a breach of contract occurs when there has been a violation of a right acquired by contract. In some instances, a circumstance can be both a tort and a breach of contract. There are different types of torts: intentional, negligence, and strict liability.

• Intentional torts are actions meant to injure another person or person’s property, such as battery, assault, fraud, misrepresentation, trespass, slander, and defamation.

• Negligence is a failure to exercise reasonable care to avoid causing harm to others. Because negligence is not intentional, it cannot result in an intentional tort.

• Strict liability (or absolute liability) is the legal responsibility for damages or injury, even if the person found strictly liable was not at fault or negligent. Strict liability is usually associated with defectively manufactured or designed products and is often referred to as product liability. In product liability cases, the injured party needs to prove only that the item was defective and that the defect caused some type of harm, rather than proving that the producer of an item was somehow negligent. Failing to warn buyers about the incorrect use of products or their inherent dangers can also result in product liability lawsuits.

A case in which a 79-year-old woman incurred third-degree burns after spilling McDonald’s coffee on her lap is a classic example of not only a failure to warn but also a product defect. The woman sued McDonald’s for knowingly serving coffee so hot it could cause third-degree burns in two to seven seconds if spilled. Even though McDonald’s had a printed warning on its coffee cups that its coffee was hot, the print was small and hard to read. The case went to trial and was settled in the woman’s favor. McDonald’s subsequently reduced the serving temperature of its coffee and increased the size of the warning on its cups.

No doubt you can recall other cases in which companies were held liable for damages associated with faulty products. Bridgestone/Firestone recalled nearly 6.5 million Firestone tires after defective products caused death and serious injuries to the owners of Ford Explorers, some of whom filed lawsuits against the company. Mattel settled product liability claims for toys made in China containing high levels of lead paint. And Toyota recalled millions of automobiles in response to product liability claims of unintended acceleration and braking problems. Sometimes, when product deficiencies affect many individuals, the individuals will form a group and together file a class-action lawsuit. In these situations, the group of injured individuals (referred to as the class) is jointly represented and acts as one claimant. Class-action lawsuits are usually more powerful than individuals filing separate lawsuits and are often less costly for the individual. If the lawsuit is decided in favor of the class, then the award is split among the group members.

Tort reform—proposals to limit tort filings and proceedings and to cap damage awards—is an ongoing source of debate and discussion. The economic effects of the current tort system are the biggest driver of the debate. Manufacturers argue that the cost of litigation and the multibillion-dollar awards raise the cost of insurance and force companies to increase product prices. Some people feel society has become too litigious and that frivolous lawsuits are out of control. Other people argue that tort reform makes it more difficult for those who are legitimately injured by products to file lawsuits and be fairly compensated. What are your thoughts?

Intellectual property laws are put in place to protect intellectual property—creations of the mind, such as ideas, inventions, and literary and artistic works as well as symbols, names, images, and designs used in commerce. Intellectual property laws cover patents, trademarks, copyrights, trade secrets, and digital rights. Intellectual property protection encourages innovation, research and development, and cultural exploration by ensuring that the resulting output is protected, and the creator is fully compensated.

• Patents. A patent is a property right on a new and useful invention granted by the U.S. Patent and Trademark Office (USPTO). A patent grants the patent holder the exclusive right to his or her invention, excluding others from using, making, or selling the same invention for 14 or 20 years, depending on the type of patent issued. There are three types of patents: utility patents, design patents, and plant patents. Utility patents protect inventions for processes, machinery, manufactures, or composites of matter (such as a newly synthesized chemical compound or molecule). Design patents protect the appearance of an object rather than its functionality (which is covered by the utility patent). Plant patents protect new, reproducible plants (organic matter).

  A person who owns a patent can assign, or sell, it for a lump-sum payment to another party. More often, though, the owner licenses the patent to a company that markets the invention. The inventor still owns the patent but receives a license fee and royalty payments based on the revenues generated from the invention.

• Trademarks. A trademark is any word, name, symbol, or device (or any combination of these) used to identify and distinguish a good. A service mark is used to identify a service. Trademarks and service marks are often referred to as “brands” or “brand names.” Generally, consumers associate products bearing trademarks with certain standards of quality (see Figure M1.3). What reactions do you have when you see the Nike swoosh, McDonald’s golden arches, or Apple’s apple? Trademark rights exclude others from using a similar mark, thus protecting the trademark owner against any potential fraud. Only those trademarks registered with the USPTO bear the symbol ^®, but anyone can use the ^TM or ^SM to identify a mark, even though it might not be registered with the USPTO. Trademarks can be licensed, which is generally the case with franchising arrangements.

  Figure M1.3

  Corporate Logos

  

• Copyrights. A copyright is a form of protection provided to creators of original works for a limited period of time. Copyrights protect works such as books, music, photographs, art, movies, and computer programs and apply to both published and unpublished works. A copyright makes it illegal for anyone other than the creator to reproduce, distribute, or make a derivative of the work (such as a movie from a novel), publicly perform it (such as music or plays), or publicly display it (such as paintings).

• Trade secrets. A trade secret is undisclosed information that provide a competitive advantage. Trade secrets can be any formula, pattern, physical device, idea, process, or compilation of information. Unlike trademarks and patents, trade secrets are not protected under federal statutes; they are protected only under state laws. Another distinction from trademarks and patents is that trade secrets are protected only when the secret is not disclosed. Employees of companies who, by the nature of their positions within their firms, have firsthand knowledge of trade secrets usually are asked to sign a nondisclosure agreement—an agreement not to reveal his or her employer’s proprietary information. Violation of such an agreement can lead to imprisonment. For example, two employees of Coca-Cola were sentenced to five- and eight-year federal prison terms for conspiring to steal and sell company trade secrets to Pepsi.

• Digital rights. Digital intellectual property is the digital (or electronic) representation of an individual’s intellect that holds value on the commercial market. Unlike other intellectual property protected by patents, trademarks, and copyrights, protecting digital intellectual property is much more difficult because it is often easy to electronically copy and distribute quickly and inexpensively to a vast number of individuals. In 1998, the United States passed the Digital Millennium Copyright Act (DMCA) to try to prevent digitized works from being illegally reproduced and distributed, thereby enforcing two 1996 treaties of the World Intellectual Property Organization. The DMCA extends the reach of a copyright by criminalizing the creation and distribution of technology, devices, or services that control access to copyrighted works and tightening the penalties for copyright infringement in the digital environment. Some believe, however, that the DMCA does little to really reduce the confusion that still surrounds the protection of digital works. There are ongoing debates as to whether the works are indeed protected or whether the current copyright laws, as they apply to digital media, become a detriment to consumers and impair the evolution of the technology.1

Many laws govern the sales of goods. The most comprehensive of these laws is the Uniform Commercial Code (UCC), a set of model laws that govern businesses selling goods within the United States and its territories. The UCC covers the sale of goods, transfer of ownership, leases, contracts, securities, as well as how money can be borrowed. The UCC laws are “model laws” because they first must be adopted by a state—either verbatim or in a modified form. Once adopted, they become state law. All 50 states and territories have adopted some version of the UCC.

Table M1.1 outlines the articles and general provisions of each article in the UCC. Everyday business transactions involve provisions in Articles 3, 4, and 5. Article 3 involves negotiable instruments, such as checks, paper money, and commercial paper (short-term debt issued to finance short-term credit needs). The debt for these instruments is unsecured, that is, issued without any form of collateral. Article 4 pertains to banking matters, and Article 5 applies to letters of credit. A letter of credit is a letter from a bank that guarantees payment to a seller will be made, regardless of the buyer’s current financial situation.

A healthy economy depends on businesses being able to compete with each other in free and open markets. Competition benefits consumers by providing more choices, keeping prices low and the quality of products high, and fostering innovation. Antitrust laws are designed to promote fair competition between companies and to prevent actions that might hurt consumers or unfairly harm other businesses.

The first American antitrust law, the Sherman Act of 1890, was created to prevent large, powerful companies from coming together as “trusts” and dominating industries. The Clayton Antitrust Act of 1914 added further substance to antitrust legislation, addressing specific practices such as mergers, that the Sherman Act did not clearly prohibit. The Robinson-Patman Act made it illegal for some companies to purchase products at more favorable prices than other businesses. Today, the FTC’s Bureau of Competition reviews and analyzes agreements between businesses to prevent anticompetitive conduct and to ensure that competition is maintained.

Through such scrutiny of competitive business practices, the FTC strives to ensure that consumers have choices in price, selection, quality, and innovation. Antitrust laws are designed to prevent companies from unfairly stifling competition through the formation of monopolies, certain mergers, and illegal cooperation between competing businesses.

• Monopolies: Competition between businesses is usually beneficial to the consumer. Competition often fosters innovation and encourages businesses to provide high-quality products at reasonable prices. Companies that are dominant in their industry lack the benefit of competition and are often able to charge consumers higher prices and offer inferior products. Antitrust laws strive to prevent companies from becoming too large or eliminating competition.

• Mergers: The FTC monitors mergers to ensure that a combination of two or more businesses will not result in market dominance by the larger, newly formed company. Not all mergers result in monopolies, and many mergers are beneficial. Mergers can create more efficient and competitive organizations by combining operations and eliminating duplicate functions (two sales departments, two human resources departments, and so on). When Staples tried to buy Office Depot in 1997, the FTC blocked the merger of the two large office supply retail stores. Why? At the time, the FTC reasoned that the merger would reduce the number of competing stores in some parts of the country. By 2013, however, the competitive environment had changed. In reviewing the proposed merger of Office Depot and Office Max in 2013, the FTC allowed the merger, concluding that because of the availability of office products through online sites such as Amazon and retailers such as Walmart, the merger of Office Depot and Office Max would not severely limit competition in the office supplies market.2

  

• Price collusion: The FTC also watches out for companies that work together on price-related matters that then might either make it difficult for competitors to enter a market or artificially inflate the prices consumers pay. For example, the FTC concluded that Apple and five large U.S. publishers had conspired to increase the prices of electronic books.3 The U.S. Justice Department filed suit against Apple and the five companies, and in 2013, they were found guilty. Apple agreed to pay $450 million to settle the case.

• Manufacturer/dealer agreements: The FTC monitors any agreements between manufacturers and product dealers. Often these agreements make sense and benefit consumers, such as when a computer manufacturer arranges works with software developer to install certain application on new computers before their sale. But the FTC watches for instances when a manufacturer forces an unwanted associated product onto a dealer. This is what happened when Microsoft bundled its web browser Internet Explorer with its Windows operating system in the early 1990s. Doing so gave Microsoft an unfair advantage in the web browser market, the FTC concluded.

There are also many federal and state regulatory agencies, such as the Federal Communications Commission, the FDA, and the Federal Aviation Agency, to name a few, that are in place to protect the public. However, in the late 1970s and 1980s, many felt some regulated industries were being artificially held back from competition and economic growth, so a trend toward deregulation—breaking up the government regulatory controls on some industries—ensued. Deregulation started with the Railroad Revitalization and Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980. These acts enabled railroads to better compete against the growing trucking and airplane industries. Similarly, the Airline Deregulation Act of 1978 was passed to promote broader competition among air carriers. And the breakup of AT&T in 1984 began deregulation of the telephone industries and was followed by the Telecommunications Act of 1996 to ease the oversight and regulation on cable and Internet communication industries.

The rapid growth of business and industry can have a significant negative impact on the environment. To protect the environment for future generations, in the 1960s and 1970s, U.S. laws were passed to regulate air and water quality, and the Environmental Protection Agency (EPA) was established.4 The EPA is responsible for maintaining and enforcing national environmental standards as well as conducting research and providing education on environmental issues. Additional regulations have been passed to control the disposal of hazardous waste. More recently, it has been debated whether regulations should be passed to help curb global warming.

Consumers are inundated with advertisements that tout product features and benefits. Companies engage in advertising, some of which is expensive, with the hopes of enticing us to purchase their products. Advertising accounts for nearly 20 percent of U.S. economic activity.5 The FTC regulates all forms of business advertising.

• Truth-in-advertising rules help to ensure advertisements are truthful and nondeceptive, that there is sufficient evidence to support the claims they make, and that the advertisements are not unfair (and subsequently cause unavoidable consumer injury that is not outweighed by the benefit).

  

• Product labeling laws include laws that mandate that food products have specific nutritional and product information on their labels, cigarette packages must include warning labels, and any products that might be hazardous to children must contain warnings.

In addition, there are specific product advertisements that the government regulates, including advertisements for cigarettes, alcoholic beverages, automobiles, Internet services, health and fitness products, housing and real estate, and telephone services.

There are hundreds of laws in place that regulate how companies hire and treat employees. Employment laws mandate that companies in their hiring practices do not discriminate against a job applicant or candidate based on his or her disabilities, age, race, religion, sexual orientation, or nationality. These laws include Equal Employment Opportunity laws, the Civil Rights Act, the Americans with Disabilities Act, and the Age Discrimination in Employment Act. See Chapter 9 for more details on employment laws.

Employee laws ensure that all workers and employees are treated fairly with respect to their wages, working conditions, medical care resulting from a workplace injury, and employee benefits, to name a few. Table M1.2 lists some of the major employee laws.

Bankruptcy is the legal status of an insolvent person or organization by which their debts are relieved through court action. Bankruptcy can be filed voluntarily or involuntarily; and after all debts have been paid, the debtor is free to begin anew. The source of funds from which creditors can collect is first determined by how the business is structured. For example, when a sole proprietorship files for bankruptcy, the business’s assets are first used to pay off its debts. Once business assets are exhausted, the business owner’ personal assets (such as homes, cars, and bank accounts) can also be used to pay off any remaining debts. Corporations, limited liability companies, and some forms of partnerships protect personal assets, allowing only business assets to be used to pay off debts incurred by the entity.

There are three types of bankruptcy, and they are named for the specific chapter of the U.S. Bankruptcy Code:

• Chapter 7. All business (and sometimes personal) assets are liquidated, and outstanding debts are paid off in a Chapter 7 bankruptcy. Any outstanding debts remaining after all assets are used are discharged. The business ceases operation.

• Chapter 11. A business under Chapter 11 bankruptcy is allowed to continue operating and develops a reorganization plan to pay its creditors over time.

• Chapter 13. Chapter 13 is the most common form of bankruptcy for individuals. Chapter 13 allows an individual to use proceeds from the sale of some assets and pay off remaining debts with operating income by following a three- to five-year repayment plan. This enables an individual to keep his or her home and potentially a car and other productive assets.

Although bankruptcy can be a solution to insolvency, it should be only a last resort. Companies and individuals who survive bankruptcy often find it hard to reestablish good credit ratings. As a result, banks and other lenders may not extend credit or will do so only with high interest rates.