"CHAPTER 23 The Legal Environment: Business Law and Government Regulation If you have ten thousand regulations, you destroy all respect for the law. —Winston Churchill Regulations grow at the same rate as weeds. —Norman Ralph Augustine Learning Objectives On completion of this chapter, you will be able to: Explain the basic elements required to create a valid, enforceable contract. Outline the major components of the Uniform Commercial Code governing sales contracts. Discuss the protection of intellectual property rights using patents, trademarks, andcopyrights. Explain the basics of the law of agency. Explain the basics of bankruptcy law. Explain some of the government regulations affecting small businesses, including thosegoverning trade practices, consumer protection, consumer credit, and the environment. The legal environment in which small businesses operate is becoming more complex, andentrepreneurs must understand the basics of business law if they are to avoid legalentanglements. Situations that present potential legal problems arise every day in most small businesses, although the majority of small business owners never recognize them. Routinetransactions with customers, suppliers, employees, government agencies, and others have thepotential to develop into costly legal problems. For example, a manufacturer of lawn mowersmight face a lawsuit if a customer injures himself while using the product, or a customer whoslips on a wet floor while shopping could sue the retailer for negligence. A smallmanufacturer who reneges on a contract for a needed raw material when he finds a betterprice elsewhere may be open to a breach-of-contract suit. Even when they win a lawsuit,small businesses often lose because the costs of defending themselves can run quickly intothousands of dollars, depleting their already scarce resources. Amy Brooks, founder of Bubbles by Brooks. Source: Bubbles By Brooks. ENTREPRENEURIAL PROFILE: Amy Brooks: Bubbles by Brooks Amy Brooks, of Rochester, Minnesota, is a cancer survivor. Based on her experience goingthrough treatment, she developed handcrafted soaps designed to reduce skin irritation tocancer patients and began selling her soaps under the name Bubbles by Brooks. However,Brooks Brothers, a Connecticut-based clothing company that also sells a line of fragrancesand cleansing products, filed a trademark objection against Brooks. In the suit, BrooksBrothers demanded that Bubbles by Brooks withdraw its trademark application with the U.S.Patent and Trademark Office to trademark Bubbles by Brooks or face “potentially costlylitigation.” In its cease and desist letter to Brooks demanding that she withdraw her trademarkapplication, attorneys for Brooks Brothers said, “Although „Brooks? may be your surname, itdoes not give you the right to infringe on the Brooks Brothers trademark or otherwisecompete with Brooks Brothers.” Brooks?s attorneys advised her that fighting Brooks Brothers?s in court would cost $200,000. “I?ve grown every year for the last 10 years by wordof mouth,” says Brooks. “I could change my company?s name, but then there?s the dominoeffect. I have custom printed boxes, Web site domains. What does that affect? Absolutelyeverything.”1 Even if small companies have the resources to endure a legal battle, lawsuits are bothersomedistractions that prevent entrepreneurs from focusing their energy on running theirbusinesses. In addition, one big judgment against a small company in a legal case could forceit out of business. Judgments, the financial penalties that a company must pay if it loses alawsuit, take three forms: compensatory, consequential, and punitive damages. As the nameimplies, compensatory damages are the monetary damages that are designed to place theplaintiff in the same position he or she would have been in had a contract been performed. Inother words, compensatory damages require the defendant to pay the actual amount of lossthe plaintiff incurred because of the defendant?s actions. Suppose that a small manufacturercreates a contract to deliver 1,000 plastic barrels for $80 per unit by a particular date. If itfails to do so and the customer must purchase the barrels from another supplier for $88 perunit and pay an additional $500 for rush delivery, the customer?s compensatory damages are$8,500 (1,000 barrels × $8 price difference plus $500 rush delivery charges). Consequentialdamages are awarded to offset the losses suffered by the plaintiff that go beyond simplecompensatory damages because of lasting effects of the damage. If the customer in theprevious example lost $15,000 in sales because it did not receive the barrels on time, it couldrequest consequential damages in that amount. For a party to recover consequential damages,the breaching party must have known the consequences of the breach. Courts typically awardpunitive damages in cases in which the defendant engages in intentionally wrongful behavioror behavior that is so negligent or reckless that it is considered intentional. As the namesuggests, punitive damages are intended to punish the wrongdoer. The due process clause of the Fourteenth Amendment to the U.S. Constitution prohibits grossly excessive punitiveawards, and many states impose limits on punitive damages in court cases. ENTREPRENEURIAL PROFILE: Dena Lockwood: Professional Neurological Services When Professional Neurological Services (a Chicago-area company that sells medical tests todoctors) hired Dena Lockwood, she mentioned to them that she had children. The interviewerasked whether her parental responsibilities would get in the way of working 70 hours a week.Lockwood said that it would not be a problem. Professional Neurological Services hiredLockwood at a salary of $25,000 plus 10 percent sales commission. After being hired,Lockwood learned that the company paid other female sales employees who did not havechildren a base of $45,000 with the same 10 percent commission. After learning of thisdisparity, Lockwood renegotiated her compensation. Although she negotiated the $45,000base, the company cut her commission to 5 percent. Her supervisors told her that if she couldsell $300,000, her commission would be raised to 10 percent and she would receive fivevacation days a year. Lockwood reached her sales goal of $300,000. However, her employerdid not pay her a commission and told her that she would then have to reach a higher level ofsales to earn any commission in the future. When Lockwood tried to take a day off to stayhome with one of her children, her manager informed her that if she did not resign, she wouldbe fired, saying that it “just wasn?t working out.” Lockwood filed a complaint with Chicago?sHuman Rights Commission, which found that she was the victim of blatant discriminationagainst employees with children. The Commission awarded Lockwood $213,000, whichincluded $100,000 in punitive damages, plus another $87,000 for her legal fees.2 Small business owners should know the basics of the laws that govern business practices tominimize the chances that their decisions and actions lead to costly lawsuits. This chapter isdesigned not to make you an expert in business law or the regulations that govern businessesbut to make you aware of the fundamental legal issues of which every business owner should know. Entrepreneurs should consult their attorneys for advice on legal questions involvingspecific situations. The Law of Contracts Contract law governs the rights and obligations among the parties to an agreement (contract).It is a body of laws that affects virtually every business relationship. A contract is simply alegally binding agreement. It is a promise or a set of promises for the breach of which the lawgives a remedy, or the performance of which the law enforces. A contract arises from anagreement, and it creates an obligation among the parties involved. Although almosteveryone has the capacity to enter into a contractual agreement (freedom of contract), notevery contract is valid and enforceable. A valid contract has four elements: Agreement. An agreement is composed of a valid offer from one party that is accepted by theother. Consideration. Consideration is something of legal (not necessarily economic) value that theparties exchange as part of their bargain. Contractual capacity. The parties must be adults capable of understanding the consequencesof their agreement. Legality. The parties? contract must be for a legal purpose. 1. Explain the basic elements required to create a valid, enforceable contract. In addition, to be enforceable, a contract must meet two supplemental requirements:genuineness of assent and form. Genuineness of assent is a test to make sure that the parties?agreement is genuine and not subject to problems such as fraud, misrepresentation, ormistakes. Form involves the writing requirement for certain types of contracts. Although notevery contract must be in writing to be enforceable, the law does require some contracts to be evidenced by a writing. Agreement Agreement requires a “meeting of the minds” and is established by an offer and anacceptance. One party must make an offer to another who must accept that offer. Agreementis governed by the objective theory of contracts, which states that a party?s intention to createa contract is measured by outward facts—words, conduct, and circumstances—rather than bysubjective, personal intentions. When settling contract disputes, courts interpret the objectivefacts surrounding the contract from the perspective of an imaginary reasonable person.Agreement requires that one of the parties to a contract make an offer and the other anacceptance. ENTREPRENEURIAL PROFILE: Republic Bank v. West Penn Allegheny Health System Republic Bank had taken ownership of a CT scanner, a CT workstation, an ultrasoundmachine, and an ultrasound table when the buyer defaulted on a lease. Republic hired TetraFinancial Services to find potential buyers for the equipment. Mark Loosli, a Tetra employeeacting on behalf of Republic, offered in an e-mail to sell the CT scanner to West PennAllegheny Health System for $750,000. He also offered to sell the company the ultrasoundequipment for an additional $30,000. Michele Hutchison, West Penn?s negotiator, sent Looslian e-mail that said, “We are interested in the 64 slice scanner, CT work station, ultrasoundand ultrasound table. Our offer is as follows: Scanner—$600,000 CT Workstation—$50,000Ultrasound and ultrasound table—$26,500. If there is a good time for us to talk live, let meknow.” Loosli e-mailed Hutchison, stating that he had conveyed her offer to Republic?spresident, Boyd Lindquist, and that he hoped to have “something concrete in the next day orso.” Loosli later e-mailed Hutchison to let her know the deal had been approved. A fewweeks later, the deal for the CT scanner fell apart. West Penn claimed it was not contractuallybound to purchase any of the items because West Penn had not yet signed a purchase order or sales agreement. Republic maintained that there was offer and acceptance via e-mail.Republic auctioned the equipment for $350,303.76, which was a difference of $299,694.24from the agreed-on price between West Penn and Republic. Republic then sued West Pennfor the difference. The Tenth Circuit Court of Appeals found that given the e-mailcommunications between West Penn and Tetra/Republic, Republic?s response was a validacceptance and that West Penn understood it as such. Therefore, West Penn was liable forbreach of contract.3 Offer An offer is a promise or commitment to do or refrain from doing some specified thing in thefuture. For an offer to stand, there must be an intention to be bound by it. The terms of theoffer must be defined and reasonably certain, and the offeror (the party making the offer)must communicate the offer to the offeree (the party to whom the offer is made). The offerormust genuinely intend to make an offer, and the offer?s terms must be definite, not vague.The following terms must either be expressed or be capable of being implied in an offer: theparties involved, the identity of the subject matter (which goods or services), and thequantity. Other terms of the offer should specify price, delivery terms, payment terms, timing,and shipping terms. Although these elements are not required, the more terms a partyspecifies, the more likely it is that an offer exists. Courts often supply missing terms in a contract when there is a reliable basis for doing so.For instance, the court usually supplies a time term that is reasonable for the circumstances. Itsupplies a price term (a reasonable price at the time of delivery) if a readily ascertainablemarket price exists; otherwise, a missing price term defeats the contract. On rare occasions,courts supply a quantity term, but a missing quantity term usually defeats a contract. Forexample, a small retailer who mails an advertising circular to a large number of customers isnot making an offer because one major term—quantity—is missing. Most ads are not offers but are invitations for an offer. Similarly, price lists and catalogs sent to potential customersare not offers. In general, an offeror can revoke an offer at any time prior to acceptance, but two exceptionsto this rule exist: an option contract and a merchant?s firm offer. In an option contract, theparties create a separate contract to keep an offer open for a particular time period. Optioncontracts are common in real estate transactions. For instance, the owner of a fast-foodfranchise created an option contract with the owner of a piece of land that the franchisee wasconsidering purchasing. The landowner made an offer to sell the property to the franchisee,who wanted time to study the demographics, traffic count, and other data at the potentiallocation but did not want to lose a promising piece of real estate by having the owner sell it tosomeone else. The franchisee and the landowner created an option contract; the franchiseepaid the landowner $5,000 for a six-month option on the land, meaning that the landownercould not revoke his offer to sell the property during the six-month option. The other exception to the revocation-before-acceptance rule is a merchant?s firm offer. If amerchant seller (a merchant is defined later in this chapter in the section on the UniformCommercial Code) makes a promise or assurance to hold an offer open in a signed writing,the offer is irrevocable for the stated time period or, if no time is stated, for a reasonable timeperiod. Neither time period can exceed 90 days, however. An offeror must communicate the offer to the other party because one cannot agree to acontract unless he or she knows it exists. The offeror may communicate an offer verbally, inwriting, or by action. Offers do not last forever. Several actions by either the offeror or the offeree can cause anoffer to terminate. In addition, the law itself can cause an offer to cease to exist. As you havelearned, an offeror can revoke an offer as long as he or she does so before the offeree acceptsit. The offeree can cause an offer to terminate by rejecting the offer (e.g., saying “no” to it) or by making a counteroffer. For instance, suppose that an entrepreneur offers to purchase apiece of land for $175,000. The landowner responds, “Your price is too low, but I?ll sell it toyou for $190,000.” When the landowner made the counteroffer, the entrepreneur?s originaloffer terminated. An offer terminates by operation of the law if the time specified in the offerhas elapsed (“This offer is good until noon on October 7”), if the subject matter of the offer isdestroyed before the offeree accepts, or if either the offeror or the offeree dies or becomesincapacitated before the offeree accepts the offer. Acceptance Only the person to whom the offer is made (the offeree) can accept an offer and create acontract. The offeree must accept voluntarily, agreeing to the terms exactly as the offerorpresents them. When an offeree suggests alternative terms or conditions to those in theoriginal offer, he or she is implicitly rejecting the original offer and making a counteroffer.Common law requires that the offeree?s acceptance exactly match the original offer. This iscalled the mirror image rule, which says that an offeree?s acceptance must be the mirrorimage of the offeror?s offer. Generally, silence by the offeree cannot constitute acceptance, even if the offer containsstatements to the contrary. For instance, when an offeror claims, “If you do not respond tothis offer by Friday at noon, I conclude your silence to be your acceptance,” no acceptanceexists even if the offeree does remain silent. The law requires an offeree to act affirmativelyto accept an offer in most cases. An offeree must accept an offer by the means of communication authorized by and within thetime limits specified by the offeror. Generally, offers accepted by alternative media or afterspecified deadlines are ineffective. If the offeror specifies no means of communication, theofferee must use the same medium used to extend the offer (or a faster method). According tothe mailbox rule, if an offeree accepts by mail, the acceptance is effective when the offeree drops the letter in the mailbox, even if it never reaches the offeror. In addition, all offers mustbe properly dispatched; that is, they must be properly addressed, noted, and stamped. Mostcourts have extended the mailbox rule to electronic communications, which meansacceptance occurs instantaneously at the time the offeree accepts via e-mail or other Web- based communication. Consideration Contracts are based on promises, and because it is often difficult to distinguish betweenpromises that are serious and those that are not, courts require that consideration be present invirtually every contract. Consideration is something of legal value (not necessarily economicvalue) that the parties to a contract bargain for and exchange as the “price” for the promisesgiven. Consideration can be money, but parties most often swap promises for promises. Forexample, when a buyer promises to buy an item and a seller promises to sell it, the partieshave exchanged valuable consideration. The buyer?s promise to buy and the seller?s promiseto sell constitute the consideration for their contract. To comprise valuable consideration, apromise must impose a liability or create a duty. For a contract to be binding, the two parties involved must exchange valuable consideration.The absence of consideration makes a promise unenforceable. A promise to performsomething that one is already legally obligated to do is not valuable consideration. Becauseconsideration is something that a promisor requires in exchange for his promise, pastconsideration is not valid. In addition, under the common law, new promises require newconsideration. For instance, if two businesspeople have an existing contract for performanceof a service, any modifications to that contract must be supported by new consideration. Inmany states, promises made in exchange for “love and affection” are not enforceable becausethe contract lacks valuable consideration. One important exception to the requirement for valuable consideration is promissory "