CH-38-40 Bankruptcy – Smith and Robersons Business Law : Book Guide

This Document Contains Chapters 38 to 40 Chapter 38 BANKRUPTCY ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. (a) Benson goes into bankruptcy. His estate is not sufficient to pay all taxes owed. Explain whether Benson’s taxes are discharged by the proceedings. (b) Benson obtained property from Anderson on credit by representing that he was solvent when in fact he knew he was insolvent. Explain whether Benson’s debt to Anderson is discharged by Benson’s discharge in bankruptcy. Answer: Discharge. (a) Benson's taxes are not discharged in the bankruptcy proceedings. Section 523, Bankruptcy Code. (b) Benson's obligation to Anderson is not discharged in the bankruptcy proceedings, as it a liability for obtaining money or property by false pretenses or false representations. See Section 523, Bankruptcy Code. 2. Bradley goes into bankruptcy under Chapter 7 owing $25,000 as wages to his four employees. There is enough in his estate to pay all costs of administration and enough to pay his employees, but nothing will be left for general creditors. Do the employees take all the estate? If so, under what conditions? If the general creditors received nothing at all, would these debts be discharged? Answer: Priority of Claims. Section 507 provides a priority for wages, salaries or commissions earned within ninety days before the filing of the petition. To the extent that an employee falls within these limitations he will be paid in full. Even if general creditors receive nothing at all–a situation that occurs in a large percentage of bankruptcy cases–the debts of all general creditors are discharged except for those which are non-dischargeable under Section 523 of the Bankruptcy Code. 3. Jessica sold goods to Stacy for $2,500 and retained a security interest in them. Two months later, Stacy filed a voluntary petition in bankruptcy under Chapter 7. At this time, Stacy still owed Jessica $2,000 for the purchase price of the goods, the value of which was $1,500. (a) May the trustee invalidate Jessica's security interest? If so, under what provision? (b) If the security interest is invalidated, what is Jessica's status in the bankruptcy proceeding? (c) If the security interest is not invalidated, what is Jessica's status in the bankruptcy proceeding? Answer: Voidable Preferences. (a) Possibly. The retention of a security interest in the goods sold would constitute a (1) transfer (2) to a creditor (3) made within 90 days before the date of the filing of the petition (4) that would almost surely result in Jessica's receiving more than she would have otherwise received under Chapter 7. However, since the security interest is a purchase money security interest, if it is perfected within twenty days after it attaches, the trustee may not invalidate Jessica's security interest. If Jessica had not perfected within twenty days, then the trustee may avoid the security interest. Section 547(c)(3). (b) Jessica's status would be that of a general creditor with a claim for $2,000. (c) Jessica has a secured claim for $1,500 and an unsecured claim for $500. 4. A debtor went through bankruptcy under Chapter 7 and received his discharge. Which of the following debts were completely discharged, and which remain as future debts against him? (a) A claim of $9,000 for wages earned within five months immediately prior to bankruptcy. (b) A judgment of $3,000 against the debtor for breach of contract. (c) $1,000 for past domestic support obligations. (d) A judgment of $4,000 for injuries received because of the debtor’s negligent operation of an automobile. Answer: Discharge. Section 523 sets forth which debts are not dischargeable in bankruptcy. (a) Discharged. (b) Discharged. (c) Not discharged. (d) Discharged, unless the debtor was operating the motor vehicle while legally intoxicated. 5. Rosinoff and his wife, who were business partners, entered bankruptcy. A creditor, Baldwin, objected to their discharge in bankruptcy on the grounds that (a) the partners had obtained credit from Baldwin on the basis of a false financial statement; (b) the partners had failed to keep books of account and records from which their financial condition could be ascertained; and (c) Rosinoff had falsely sworn that he had taken $70 from the partnership account when he actually took $700. Were the debtors entitled to a discharge? Answer: Discharge. The debtors were not entitled to a discharge because of (b). (a) The obtaining of credit on the basis of a false financial statement would not bar a discharge of all debts but would make that debt non-dischargeable. (b) Failure to keep books of account would bar both debtors from a discharge. (c) Rosinoff's false oath would bar him from a discharge. 6. Ross Corporation is a debtor in a reorganization proceeding under Chapter 11 of the Bankruptcy Code. By fair and proper valuation, its assets are worth $100,000. The indebtedness of the corporation is $105,000, and it has outstanding $100 par value preferred stock in the amount of $20,000 and $30 par value common stock in the amount of $75,000. The plan of reorganization submitted by the trustees would give nothing to the common shareholders and would issue new bonds of the face amount of $5,000 to the creditors and new common stock in the ratio of 84 percent to the creditors and 16 percent to the preferred shareholders. Should this plan be confirmed? Answer: Reorganization-Chapter 11: Confirmation of Plan. The plan should not be approved in the Chapter 11 reorganization proceedings because it is not fair and equitable. It is unfair because the amount owing by the Ross Corporation to its creditors exceeds the total value of its assets. The corporation is insolvent, and no assets are available for any class of shareholders. All of the securities of the reorganized corporation should go to its creditors, and any pay out to any class of shareholders would be unfair to the creditors. Under Section 1129 of the Bankruptcy Code, fair and equitable with respect to unsecured creditors means that such creditors receive property of value equivalent to the full amount of their claim or that no junior claim or interest receive anything at all. Since the creditors were not paid in full the preferred shareholders could not participate at all. 7. Alex is a wage earner with a regular income. He has unsecured debts of $42,000 and secured debts owing to Betty, Connie, David, and Eunice totaling $120,000. Eunice’s debt is secured only by a mortgage on Alex’s house. Alex files a petition under Chapter 13 and a plan providing payment as follows: (a) 60 percent of all taxes owed; (b) 35 percent of all unsecured debts; and (c) $100,000 in total to Betty, Connie, David, and Eunice. Should the court confirm the plan? If not, how must the plan be modified or what other conditions must be satisfied? Answer: Discharge. No. The plan may not modify the rights of a secured party with a security interest in the debtor's principal residence. The plan must provide for full payment on a deferred basis of all claims entitled to a priority. Therefore, the plan must pay 100% of the taxes unless the taxing authority agrees otherwise. The plan must be accepted by Betty, Connie, David and Eunice or (a) it must provide for Alex to surrender to Betty, Connie, David and Eunice the collateral or (b) it must permit Betty, Connie, David, and Eunice to retain their security interest and the value of property to be distributed to them must be not less than the allowed amount of their claims. 8. John Bunker has assets of $130,000 and liabilities of $185,000 owed to nine creditors. Nonetheless, his cash flow is positive and he is making payment on all of his obligations as they become due. I. M. Flintheart, who is owed $22,000 by Bunker, files an involuntary petition in bankruptcy under Chapter 7 against Bunker. Bunker contests the petition. What will be the result? Explain. Answer: Involuntary Petitions. Decision for Bunker. Where there are fewer than twelve creditors, one creditor owed $10,000 or more may file an involuntary petition in bankruptcy. Thus, Flintheart may file such a petition against Bunker. However, upon Bunker's contesting the petition, the court must dismiss the petition unless the creditor shows that the debtor is not generally paying his undisputed debts as they become due. The facts indicate that Bunker is making payment on all of his obligations as they become due. Accordingly, the court will dismiss the petition and it may award damages in favor of Bunker against Flintheart for (1) costs, (2) reasonable attorney's fees, (3) damages caused by seizure of Bunker's property and (4) if Flintheart acted in bad faith, punitive damages. 9. Karen has filed a voluntary petition for a Chapter 7 proceeding. The total value of Karen’s estate is $35,000. Ben, who is owed $18,000, has a security interest in property valued at $12,000. Lauren has an unsecured claim of $9,000, which is entitled to a priority of $2,000. The United States has a claim for income taxes of $7,000. Steve has an unsecured claim of $10,000 that was filed on time. Sarah has an unsecured claim of $17,000 that was filed on time. Wally has a claim of $14,000 that he filed late, even though Wally was aware of the bankruptcy proceedings. What should each of the creditors receive in a distribution under Chapter 7? Answer: Chapter 7–Liquidation: Distribution of the Estate. (a) Ben receives $14,100 (b) Lauren receives $4,450 (c) US receives $7,000 (d) Steve receives $3,500 (e) Sarah receives $5,950 (f) Wally receives $0 Ben receives $12,000 as a secured creditor and has an unsecured claim of $6,000. Lauren receives $2,000 on the portion of her claim entitled to a priority and has an unsecured claim of $7,000. The United States has a priority of $7,000. After paying $12,000 to Ben, $2,000 to Lauren, and $7,000 to the United States, there remains $14,000 ($35,000-$12,000-$2,000-$7,000) to be distributed pro rata to unsecured creditors who filed on time. Their claims total $40,000 (Ben = $6,000, Lauren = $7,000, Steve = $10,000 and Sarah = $17,000). Therefore, each will receive $14,000 divided by $40,000 or 35 cents on the dollar. Accordingly, Ben receives an additional $2,100, Lauren receives an additional $2,450, Steve receives $3,500 and Sarah receives $5,950. Because there were insufficient assets to pay all unsecured claimants who filed on time, Wally, who filed tardily, receives nothing. 10. Landmark at Plaza Park, Ltd., filed a plan of reorganization under Chapter 11 of the Bankruptcy Code. Landmark is a limited partnership whose only substantial asset is a two-hundred-unit garden apartment complex. City Federal holds the first mortgage on the property in the face amount of $2,250,000. The mortgage is due and payable six years from now. Landmark has proposed a plan of reorganization under which the property now in possession of City Federal would be returned. Landmark will then deliver a nonrecourse note, payable in three years, in the face amount of $2,705,820.31 to City Federal in substitution of all of the partnership’s existing liabilities. On the sixteenth month through the thirty-sixth month after the effective date of the plan, Landmark will make monthly interest payments computed on a property value of $2,260,000 at a rate 3 percent above the original mortgage rate but 2.5 percent below the market rate for loans of similar risk. Finally, the note will be secured by the existing mortgage. Landmark’s theory is that the note will be paid off at the end of thirty-six months by a combination of refinancing and accumulation of cash from the project. The key is Landmark’s proposal to obtain a new first mortgage in three years in the face amount of $2,400,000. City Federal is a first mortgagee without recourse that has been collecting rents pursuant to a rent assignment agreement since the default on the mortgage eleven months ago. City Federal is impaired by the plan and has rejected the plan. May it complete its foreclosure action? Explain. Answer: Chapter 11. Decision for City Federal. For Landmark's plan to be accepted over City Federal's objection, it must be shown that (1) City Federal had retained its lien on the property; (2) that the total stream of deferred cash payments proposed by the plan must at least total the amount of the secured claim; and (3) that the total stream of payments has a value equal to the value of the property. Landmark has shown that its plan satisfies the first two requirements, but fails to satisfy the third. The rate of interest on the $2,260,000 loan that City Federal is supposed to make is 2.5 % lower than the market rate for a loan of similar risk. The second step is to scrutinize the proposed plan with the market rate to determine whether it offers a reasonable prospect of success. It must be shown that confirmation of the plan is not likely to be followed by liquidation or the need for further financial reorganization of the debtor. Factors to be considered include: (1) the adequacy of the capital structure, (2) the earning potential of the business, (3) economic conditions, and (4) the ability of management. The requirement of confirmation of the plan is intended to prevent unrealistic schemes from being forced on creditors. Here, with the market interest rate factored onto realistic income and expense projections substituted for those supplied by Landmark, it appears that confirmation of the plan would likely be followed by liquidation or further reorganization proceedings. So, Landmark's request for confirmation of its plan of reorganization is denied. Matter of Landmark at Plaza Park Ltd. United States Bankruptcy Court, D.N.J., 1980 7 B.R. 653. 11. Freelin Conn filed a voluntary petition under Chapter 7 of the Bankruptcy Code on September 30, 2017. Conn listed BancOhio National Bank as having a claim incurred in October 2016 in the amount of $4,000 secured by an eight-year-old automobile. The car is listed as having a market value of $3,500. During the period from June 30, 2017, to September 30, 2017, Conn made three payments totaling $439.17 to BancOhio. May the trustee in bankruptcy set aside those three payments as voidable preferences? Explain. Answer: Voidable Preference. Judgment for BancOhio. The trustee may avoid the transfer from Conn to BancOhio only if he can show that all five elements of a voidable preference are met. BancOhio has admitted that the first four elements are present. The trustee, however, has failed to show the final element-that the effect of the payments was to enable the creditor to obtain a greater percentage of its debt than it would receive under Chapter 7 of the Bankruptcy Act. BancOhio's claim is secured to the extent of the value of the collateral, the automobile. The market value of the car was listed at $3,500. Conn, however, claims that it is worth much more, and the trustee did not show that it was worth less than BancOhio's claim of $4,000. Thus, the value of the car is held to be equal to the amount of BancOhio's claim, and therefore, it has a fully secured claim. Since the trustee did not establish that the transfer enabled BancOhio to recover more on its claim than other secured creditors, the transfer is not a voidable preference, and the trustee may not recover the payments made to BancOhio. In Re Conn, 9 B.R. 431 (N.D. Ohio, 1981). 12. David files a bankruptcy petition under Chapter 13. After the claims of secured and priority creditors have been satisfied, David’s remaining bankruptcy estate has a value of $100,000. David’s creditors with allowed unsecured claims are owed $250,000 in total. Chris, an unsecured creditor, is owed $13,500. David’s Chapter 13 plan proposes to pay Chris $150 per month for three years. Should the Bankruptcy Court confirm David’s plan? Explain. Answer: Confirmation of Chapter 13 Plan. No. The plan proposes to pay Chris $5,400 in deferred payments. That is the amount Chris would have received under Chapter 7. ($100,000/$250,000 = 0.4; 0.4 X $13,500 = $5,400.) For a Chapter 13 plan to be confirmed by the court, the present value of the property to be distributed to unsecured creditors must be not less than the amount they would receive under Chapter 7. Accordingly, Chris is entitled to payments whose present value is $5,400. However, the present of value of $5,400 paid over three years is less than $5,400. Therefore, this plan cannot be confirmed. 13. Yolanda Christophe filed a bankruptcy petition under Chapter 13. Her scheduled debts consist of $11,100 of secured debt, $9,300 owed on an unsecured student loan, and $6,960 of other unsecured debt. Christophe asserts that the student loan is nondischargeable and that assertion has not been questioned. Christophe’s proposed amended Chapter 13 plan calls for fifty-six monthly payments of $440 a month. The questioned provision in that plan is the division of the unsecured creditors into two classes. Under Christophe’s proposed plan, the general unsecured creditors would receive 32 percent and the separately classified student loan creditor would receive 100 percent. Should this plan be confirmed? Answer: Confirmation of Chapter 13 Plan. Confirmation of Debtor’s Chapter 13 Plan is denied. A bankruptcy judge may not confirm a Chapter 13 plan that is not presented in good faith or unfairly discriminates. A debtor may designate classes of unsecured claims but may not discriminate unfairly against any class of claims. Christophe has proposed to place the student loan claimant in a separate class and proposes to treat it differently from all other unsecured, non-priority creditors. It must be determined whether this disparate treatment constitutes unfair discrimination. The courts have recognized four issues to determine whether discrimination is unfair: (1) whether the discrimination has a reasonable basis; (2) whether the debtor can carry out a plan without the discrimination; (3) whether the plan is proposed in good faith; and (4) whether the degree of discrimination is directly related to the basis or rationale for the discrimination. Discrimination is considered reasonable and fair when it is related to the debtor's objective interest in completing the plan and obtaining a fresh start or maintaining a decent quality of life. The special rights of student loan creditors may form a basis for allowing a debtor to treat them favorably. However, finding a basis for discrimination does determine whether discrimination is unfair. The court must consider whether the basis for the discrimination directly supports the nature and degree of disparate treatment proposed in the Plan. Debtor has not shown that her Plan does not exceed the necessity for discrimination. The missing details that would be particularly relevant to the analysis below are the following: (1) what payments were due; (2) when is the last payment due; (3) whether any arrearages exist; (4) whether the payments have been accelerated before the bankruptcy petition was filed; and (5) whether or not the proposed 100% payout would accelerate payments under the loan agreement. If the student loan creditor is not entitled to 100% repayment of its loan before the scheduled completion of the Chapter 13 plan, then a plan which pays 100% of that student loan during that period would accelerate payment of the student loan debt. That would be unfair to the other unsecured creditors, because the debtor would be forcing them to bear the cost of early payment of the student loan without a corresponding justification. Because Christophe has failed to prove that her Chapter 13 Plan does not discriminate unfairly and is presented in good faith, it must be denied. In re Christophe, 151 B.R. 475 (1993) 14. On December 17 ZZZZ Best Co., Inc. (the debtor), borrowed $7 million from Union Bank (the bank). On July 8 of the following year the debtor filed a voluntary petition for bankruptcy under Chapter 7. During the preceding ninety days, the debtor had made interest payments of $100,000 to the bank on the loan. The trustee of the debtor’s estate filed a complaint against the bank to recover those payments as a voidable preference. The bank asserts that the payments were not voidable because they came within the ordinary course of business exception. The trustee maintains that the exception applies only to short-term, not long-term, debt. Who is correct? Explain. Answer: Voidable Preferences. The Bankruptcy Code authorizes bankruptcy trustees to avoid any transfer of the debtor’s interest in property that: 1) benefits a creditor; 2) is on account of an antecedent debt; 3) is made while the debtor was insolvent; 4) is made within 90 days before the filing of the petition for bankruptcy; and 5) enables the creditor to receive a larger share of the estate than if the transfer had not been made. All five conditions are satisfied in this case. However, the Bankruptcy Code provides an exception for payments made in the ordinary course of business. This exception does not distinguish between long-term debt and short-term debt. Rather, it focuses on whether the debt was incurred, and payment made, in the “ordinary course of business of the debtor and transferee.” Thus, there is no textual support for a contention that the exception’s coverage is limited to short-term debt. The bank is correct in its assertion. 15. A landlord owned several residential properties, one of which was subject to a local rent control ordinance. The local rent control administrator determined that the landlord had been charging rents above the levels permitted by the ordinance and ordered him to refund the wrongfully collected rents to the affected tenants. The landlord did not comply with the order. The landlord subsequently filed for relief under Chapter 7 of the Bankruptcy Code, seeking to discharge his debts. The tenants filed an adversary proceeding against the landlord in the Bankruptcy Court, arguing that the debt owed to them arose from rent payments obtained by “actual fraud” and that the debt was therefore nondischargeable under the Bankruptcy Code. They also sought treble damages and attorney’s fees and costs pursuant to the state Consumer Fraud Act. The Bankruptcy Court ruled in favor of the tenants, finding that the landlord had committed “actual fraud” and that his conduct violated state law. The court therefore awarded the tenants treble damages totaling $94,147.50. Does the Bankruptcy Code bar the discharge of treble damages awarded on account of the debtor’s fraud? Explain. Answer: Dischargeable Debts. Yes. The Bankruptcy Code has long prohibited debtors from discharging liabilities incurred on account of their fraud, embodying a basic policy animating the Code of affording relief only to an “honest but unfortunate debtor.” Section 523(a)(2)(A) continues the tradition, as it prevents discharge of “any debt” respecting “money, property, services, or ... credit” that the debtor has fraudulently obtained. This would include treble damages assessed on account of the fraud. Once it is established that specific money or property has been obtained by fraud, however, “any debt” arising therefrom is excepted from discharge. In this case, petitioner received rent payments from respondents for a number of years, of which $31,382.50 was obtained by fraud. His full liability traceable to that sum $94,147.50 plus attorney’s fees and costs thus falls within the exception, and is nondischargeable in bankruptcy. 16. Krieger is a 53-year-old woman who has not held a job in over twenty-five years since she left the work force to raise a family. Prior to that period, she did not earn more than $12,000 a year in her working career. Krieger is living with her mother, age 75, in a rural community where few jobs are available. She and her mother between them receive only a few hundred dollars from governmental programs every month. She is too poor to move in search of better employment prospects elsewhere. Her car needs repairs and she lacks Internet access, both of which hamper a search for work. Having no assets or income, Krieger filed for, and is entitled to receive, a discharge in bankruptcy. Her largest creditor—Educational Credit Management, which acts on behalf of some federal loan guarantors—seeks to exclude Krieger’s student loans from the discharge. Explain whether Krieger should be discharged from her educational loans. Answer: Dischargeable Debts. Perhaps. Educational loans are generally not discharged in bankruptcy, though they can be if repayment of the loans imposes an undue hardship. The facts in this case may qualify Krieger under this hardship provision to have her student loans discharged. 17. Robert Marrama filed a voluntary bankruptcy petition under Chapter 7. In the filing, Marrama made a number of statements about his principal asset, a house in Maine, which were misleading or inaccurate. He reported that he was the sole beneficiary of the trust that owned the property and he listed its value as zero. He also denied that he had transferred any property other than in the ordinary course of business during the year preceding the filing of his petition. In fact, the Maine property had substantial value, and Marrama had transferred it into the newly created trust for no consideration seven months prior to filing his petition. Marrama later admitted that the purpose of the transfer was to protect the property from his creditors. The trustee stated that he intended to recover the Maine property as an asset of the estate. Thereafter, Marrama sought to convert to Chapter 13, claiming that he had an absolute right to convert his case from Chapter 7 to Chapter 13 under the language of the Bankruptcy Code. Both the trustee and Marrama's principal creditor objected, contending that the request to convert was made in bad faith and would constitute an abuse of the bankruptcy process. Explain whether Marrama should be permitted to convert the case to Chapter 13. Answer: Conversion to Chapter 13. Prepetition bad-faith conduct may cause a forfeiture of the right to convert a Chapter 7 proceeding into a Chapter 13 case. The facts in this case established bad faith case, and therefore the request for conversion should be denied. Marrama v. Citizens Bank, Supreme Court of the United States, 2007, 549 U.S. 365, 127 S.Ct. 1105, 166 L.Ed.2d 956. The principal purpose of the Bankruptcy Code is to grant a “fresh start” to the “honest but unfortunate debtor.” Both Chapter 7 and Chapter 13 of the Code permit an insolvent individual to discharge certain unpaid debts toward that end. Chapter 7 authorizes a discharge of prepetition debts following the liquidation of the debtor's assets by a bankruptcy trustee, who then distributes the proceeds to creditors. Chapter 13 authorizes an individual with regular income to obtain a discharge after the successful completion of a payment plan approved by the bankruptcy court. Under Chapter 7 the debtor's nonexempt assets are controlled by the bankruptcy trustee; under Chapter 13 the debtor retains possession of his property. A proceeding that is commenced under Chapter 7 may be converted to a Chapter 13 proceeding and vice versa. *** The class of honest but unfortunate debtors who do possess an absolute right to convert their cases from Chapter 7 to Chapter 13 includes the vast majority of the hundreds of thousands of individuals who file Chapter 7 petitions each year. Congress sought to give these individuals the chance to repay their debts should they acquire the means to do so. Moreover, the unenforceability of a waiver of the right to convert functions as a consumer protection provision against contracts requiring a debtor to give up the right to convert to Chapter 13 as a nonnegotiable condition *** . A statutory provision protecting a borrower from waiver, however, is not a shield against forfeiture. Nothing in the text of Section 706(a) of the Bankruptcy Code limits the authority of the court to take appropriate action in response to fraudulent conduct by the atypical litigant who has demonstrated that he is not entitled to the relief available to the typical debtor. On the contrary, the broad authority granted to bankruptcy judges to take any action that is necessary or appropriate “to prevent an abuse of process” is adequate to authorize an immediate denial of a motion to convert filed under Section 706(a) of the Bankruptcy Code in lieu of a conversion order that merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors. ANSWERS TO “TAKING SIDES” PROBLEMS Leonard and Arlene Warner sold the Warner Manufacturing Company to Elliott and Carol Archer for $610,000. A few months later the Archers sued the Warners in a state court for fraud connected with the sale. The parties settled the lawsuit for $300,000. The Warners paid the Archers $200,000 and executed a promissory note for the remaining $100,000. After the Warners failed to make the first payment on the $100,000 promissory note, the Archers sued for the payment in state court. The Warners then filed for bankruptcy under Chapter 7 of the Bankruptcy Code. The Archers claimed that the $100,000 debt was nondischargeable because it was for “money obtained by fraud.” Arlene Warner claimed that the $100,000 debt was dischargeable in bankruptcy because it was a new debt for money promised in a settlement contract and thus it was not a debt for money obtained by fraud. (a) What are the arguments that the debt is dischargeable in bankruptcy? (b) What are the arguments that the debt is not dischargeable in bankruptcy? (c) Explain whether the debt is dischargeable in bankruptcy Answer: (a) The settlement agreement and promissory note were a novation, which replaced an original potential debt to the Archers for money obtained by fraud with a new debt. The new debt was not for money obtained by fraud. It was for money promised in a settlement contract. Consequently, it was dischargeable in bankruptcy. (b) All debts arising out of fraud are not dischargeable, no matter what their form. The mere fact that a creditor has previously settled his fraud claim does not change the true nature of the debt. A debt embodied in the settlement of a fraud case still arises out of fraud. (c) It is nondischargeable. Archer v. Warner, U.S. Supreme Court, 2003, 538 U.S. 314, 123 S.Ct. 1462, 155 L.Ed. 2d 454. The Supreme Court held as follows: The Bankruptcy Code provides that a debt shall not be dischargeable in bankruptcy “to the extent” it is “for money . . . obtained by . . . false pretenses, a false representation, or actual fraud.” Can this language cover a debt embodied in a settlement agreement that settled a creditor’s earlier claim “for money . . . obtained by . . . fraud?” In our view, the statute can cover such a debt * * *. * * The dischargeability provision applies to all debts that “arise out of” fraud. A debt embodied in the settlement of a fraud case “arises” no less “out of” the underlying fraud than a debt embodied in a stipulation and consent decree. * * * We conclude that the Archers’ settlement agreement and releases may have worked a kind of novation, but that fact does not bar the Archers from showing that the settlement debt arose out of “false pretences, a false representation, or actual fraud,” and consequently is nondischargeable. Chapter 39 PROTECTION OF INTELLECTUAL PROPERTY ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Keller, a professor of legal studies at Rhodes University, is a diligent instructor. Late one night, while reading a newly published, copyrighted treatise of 1,800 pages written by Gilbert, he came across a three-page section discussing the subject matter he intended to cover in class the next day. Keller considered the treatment to be illuminating and therefore photocopied the three pages and distributed the copies to his class. One of Keller’s students is a second cousin of Gilbert, the author of the treatise, and she showed Gilbert the copies. May Gilbert recover from Keller for copyright infringement? Explain. Answer: Copyrights: Rights. Probably not. It is most probable that Keller will be protected by the Copyright Act's codification of the common law fair use doctrine. Section 107 of the Act provides that it is not an infringement to make fair use of a copyrighted work for purposes of, inter alia, teaching, including multiple copies for classroom use. In determining what is fair use the following factors are to be considered: (1) the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the copyrighted work. In that Keller taught at a nonprofit educational institution, made use of an insubstantial portion of the whole work (less than two-tenths of a percent) and distributed it to a group of undergraduates who would not likely have otherwise purchased the whole work, it appears that Keller comes clearly within the protection of the fair use doctrine. 2. A conceived a secret process for the continuous freeze-drying of foodstuffs and related products and constructed a small pilot plant that practiced the process. A, however, lacked the financing necessary to develop the commercial potential of the process and, in hopes of obtaining a contract for its development and the payment of royalties, disclosed it in confidence to B, a coffee manufacturer, who signed an agreement not to disclose it to anyone else. At the same time, A signed an agreement not to disclose the process to any other person as long as A and B were considering a contract for its development. Upon A’s disclosure of the process, B became extremely interested and offered to pay A the sum of $1,750,000 if, upon further development, the process proved to be commercially feasible. While negotiations between A and B were in progress, C, a competitor of B, learned of the process and requested a disclosure from A, who informed C that the process could not be disclosed to anyone unless negotiations with B were broken off. C offered to pay A $2,500,000 for the process, provided it met certain defined objective performance criteria. A contract was prepared and executed between A and C on this basis, without any prior disclosure of the process to C. Upon the making of this contract, A rejected B’s offer. The process was thereupon disclosed to C, and demonstration runs of the pilot plant in the presence of C’s representatives were conducted under varying conditions. After three weeks of conducting experimental demonstrations, compiling data, and analyzing results, C informed A that the process did not meet the performance criteria in the contract and that for this reason C was rejecting the process. Two years later, C placed on the market freeze-dried coffee that resembled in color, appearance, and texture the product of A’s pilot plant. What are the rights of the parties?? Answer: Appropriation. A may recover against C the profits realized by C for misappropriation of A’s secret process, and is also entitled to an injunction against further use of the process by C. The disclosure of the secret process to C pursuant to the contract was confidential. A had property rights in the secret process which are separate and distinct from patent rights. A and C might differ in opinion as to whether the process met all of the objective performance criteria, but even if the process failed to meet all of the performance criteria, after the confidential disclosure, C would have no right to appropriate and use for his own benefit the knowledge acquired through the disclosure, without becoming accountable thereby to A. 3. B, a chemist, was employed by A, a manufacturer, to work on a secret process for A’s product under an exclusive three-year contract. A employed C, a salesperson, on a week-to-week basis. B and C resigned their employment with A and accepted employment in their respective capacities with D, a rival manufacturer. C began soliciting patronage from A’s former customers, whose names he had memorized. What are the rights of the parties in (a) a suit by A to enjoin B from working for D, and (b) a suit by A to enjoin C from soliciting A’s customers? Answer: Trade Secrets. (a) A is entitled to enjoin B from working for D. Although a court of equity will not compel an individual to perform personal services for another pursuant to a contract, the court will in a proper case enjoin the defaulting employee from performing service for another in breach of contract. The granting of a negative injunction indirectly results in granting specific performance of a portion of the contract. However, such injunction will not be granted unless the court is satisfied that the services of the employee are unique. Ordinarily, the services of a chemist are not unique, but a unique situation exists in this case because B was working on a secret process and undoubtedly acquired confidential information and related know-how which she would impart to A's business rival D. The injury to A would thus be irreparable. (b) Most likely, A will succeed in obtaining an injunction against C. A former employee, even in the absence of an enforceable covenant not to compete, remains under a duty not to use or disclose, to the detriment of the former employer, trade secrets acquired in the course of their employment. Where the former employee seeks to use the trade secrets of the former employer in order to obtain a competitive advantage, then competitive activity can be enjoined or result in an award of damages. Whether a customer list is protected as a trade secret depends on three factual inquiries: (1) whether the list is a compilation of information; (2) whether it is valuable because it is unknown to others; and (3) whether the owner has made reasonable attempts to keep the information secret. The Uniform Trade Secrets Act does not distinguish between written and memorized information. The Act does not require a plaintiff to prove actual theft or conversion of physical documents embodying the trade secret information to prove misappropriation. If A can satisfy the three requirements, he should be protected by the issuance of an injunction. 4. Conrad and Darby were competitors in the business of dehairing raw cashmere, the fleece of certain Asiatic goats. Dehairing is the process of separating the commercially valuable soft down from the matted mass of raw fleece, which contains long coarse guard hairs and other impurities. Machinery for this process is not readily available on the open market. Each company in the business designed and built its own machinery and kept the nature of its process secret. Conrad contracted with Lawton, owner of a small machine shop, to build and install new improved dehairing machinery of increased efficiency for which Conrad furnished designs, drawings, and instructions. Lawton, who knew that the machinery design was confidential, agreed that he would manufacture the machinery exclusively for Conrad and that he would not reproduce the machinery or any of its essential parts for anyone else. Darby purchased from Lawton a copy of the dehairing machinery that Conrad had specially designed. What are Conrad’s rights, if any, against (a) Darby and (b) Lawton? Explain. Answer: Trade Secrets. Conrad is entitled to an injunction and/or damages against Lawton and, possibly, Darby. There is no indication that the machine has been patented. Nevertheless, the process and the new, improved machine used therein are trade secrets. Lawton has appropriated these trade secrets in violation of his agreement with Conrad. The issue here is whether Darby has also appropriated these trade secrets by purchasing a copy of the dehairing machine. In a case based on these facts, the defendant (Darby) was held to be liable for the tort of appropriation of trade secrets. Atlantic Wool Combing Co. v. Norfolk Mills, Inc., 357 F.2d 866 (1st Cir. 1966). 5. Jones, having filed locally an affidavit required under the assumed name statute, has been operating and advertising his exclusive toy store for twenty years in Centerville, Illinois. His advertising has consisted of large signs on her premises reading “The Toy Mart.” Lewis, after operating a store in Chicago under the name of “The Chicago Toy Mart,” relocated in Centerville, Illinois, and erected a large sign reading “TOY MART” with the word “Centerville” written underneath in substantially smaller letters. Thereafter, Jones’s sales declined, and many of Jones’s customers patronized Lewis’s store, thinking it to be a branch of Jones’s business. What are the rights of the parties? Answer: Trade Names. Jones should be entitled to obtain an injunction against Lewis's use of a name or sign which would mislead customers of Jones into thinking that Lewis's store was a branch of Jones business. Unfair competition is a question of fact and no inflexible rule can be stated as to what conduct will constitute unfair competition, the test being whether the public is likely to be deceived or misled. In order for unfair competition to exist in respect to a trade name, the name must have acquired a secondary meaning identifying it with Jones, and Lewis must have unfairly used this name or a simulation thereof. In Radio Station KTLN, Inc. v. Steffen, 140 Colo. 596, 346 P.2d 307, the court says: “In the determination of property interest in trademarks or names, we are guided by concepts that have been developed to protect the owner of a trademark or name and the public at large from unfair competition, confusion, in the public's mind and false or misleading claims.” Courts have been diligent in protecting these property interests and have gone far to widen the scope of equitable relief. If Jones can show that his trade name was widely known and accepted in the City of Centerville and that Lewis's trade name was used to draw Jones's customers by misleading them into believing that they were doing business with Jones, while in fact they were doing business with Lewis, the court would grant an injunction in favor of Jones against Lewis. 6. Ryan Corporation manufactures and sells a variety of household cleaning products in interstate commerce. On national television, Ryan falsely advertises that its laundry liquid is biodegradable. Has Ryan violated the Lanham Act? Answer: Trade Symbols. Ryan has violated Lanham Act, Sect 43(a) by making false descriptions or representation of his own goods. 7. Gibbons, Inc., and Marvin Corporation are manufacturers who sell a variety of household cleaning products in interstate commerce. On national television Gibbons states that its laundry liquid is biodegradable and that Marvin’s is not. In fact, both products are biodegradable. Has Gibbons violated the Lanham Act? Answer: Trade Symbols. Until 1988 a company would have violated the act if it misrepresented its own product, but would not have done so for misrepresenting another person's goods, services, or commercial activities. In 1988, Section 43(a) was amended to prohibit misrepresentation of another person's goods. Thus Gibbons has violated the Lanham Act. 8. George McCoy of Florida has been manufacturing and distributing a cheesecake for more than five years, labeling his product with a picture of a cheesecake, which serves as a background for a Florida bathing beauty and under which is written the slogan “McCoy All Spice Florida Cheese Cake.” George McCoy has not registered his trademark. Subsequently, Leo McCoy of California begins manufacturing a similar product on the West Coast using a label similar in appearance to that of George McCoy, containing a picture of a Hollywood star and the words “McCoy’s All Spice Cheese Cake.” Leo McCoy begins marketing his products in the eastern United States, using labels with the word “Florida” added, as in George McCoy’s label. Leo McCoy has registered his product under the Federal Trademark Act. To what relief, if any, is George McCoy entitled? Answer: Types of Trade Symbols. George McCoy is entitled to injunctive relief against Leo McCoy's use of George McCoy's label in markets where George McCoy's Cheese Cake was sold. George McCoy does not have an easy case to prove because of failure to register his trademark. However, lack of registration would not necessarily be fatal since registration does not give the registrant the absolute right to use a trademark, but rather presents a prima facie presumption of first use. George McCoy may be able to produce evidence to overcome this presumption of this case. See, Hanover Star Milling Co. v. Metcalf, 240 U.S. 403 at 415, 36 S. Ct. 357, 60 L. Ed. 713. Leo McCoy would no doubt claim that the word "Florida" was geographical in nature and not protectable; but copying of geographic names has been enjoined where the name is employed for purposes of unfair competition by one manufacturing a product in other than the geographic area named, even though an injunction would be refused against a competitor manufacturing within the designated area. As for the phrase "All Spice," it is probably descriptive of the product and hence not subject to protection. "The validity of a trademark ends where suggestion ends and description begins." Franklin Knitting Mills v. Fashionit Sweater Mills, 297 F. 247 (D.C.S.D.N.Y). The picture of the bathing beauty is not unique, but the label itself may be protected against deliberate copying of design and colors to prevent unfair competition by Leo through the palming off of his product as that of George McCoy. As for the use of the name McCoy, courts are loathe to interfere with the use of one's own name even though unfair competition may result, but protection may be given to the extent of requiring Leo McCoy in his advertising to use his full name on his labels as well as in his advertising. 9. Sony Corporation manufactured and sold home video recorders, specifically Betamax videotape recorders (VTRs). Universal City Studios, Inc. (Universal) owned the copyrights on some programs aired on commercially sponsored television. Individual Betamax owners frequently used the device to record some of Universal’s copyrighted television programs for their own noncommercial use. Universal brought suit, claiming that the sale of the Betamax VTRs to the general public violated its rights under the Copyright Act. It sought no relief against any Betamax consumer. Instead, Universal sued Sony for contributory infringement of its copyrights, seeking money damages, an equitable accounting of profits, and an injunction against the manufacture and sale of Betamax VTRs. Explain whether Universal will prevail in its action. Answer: Copyrights. Judgment for Sony. The sale of copying equipment does not constitute contributory infringement if the product is widely used for legitimate, unobjectionable purposes. The product need merely be capable of substantial noninfringing uses. Moreover, an unlicensed use of the copyright is not an infringement unless it conflicts with one of the five exclusive rights conferred by the Copyright Act. According to the act, a "fair use" is not an infringement. Here, the Betamax VTRs were widely used to have television programs time-shifted to suit the VTR owner's schedule. Under the "fair use" doctrine, proof that the noncommercial use of the copyrighted work would be harmful, or, if widespread, would adversely affect the potential market for the copyrighted work, is required to render the use an infringement. Sony demonstrated that substantial numbers of copyright holders of commercial television broadcasts would not object to time-shifting. Also, Universal failed to show that time-shifting would cause any substantial harm to the potential market for, or the value of their copyrighted works. The Betamax then is capable of substantial noninfringing uses. Consequently, Sony's sale of such equipment to the general public does not constitute contributory infringement of Universal's rights. Sony Corp. of America v. Universal City Studios, Inc., 464 U.S. 417 (1984). 10. The Coca-Cola Company manufactures a carbonated beverage, Coke, made from coca leaves and cola nuts. The Koke Company of America introduced into the beverage market a similar product named Koke. The Coca-Cola Company brought a trademark infringement action against Koke. Coca-Cola claimed unfair competition within the beverage business due to Koke’s imitation of the Coca-Cola product and Koke’s attempt to reap the benefit of consumer identification with the Coke name. Should Coca-Cola succeed? Explain. Answer: Trademark Infringement. Yes, judgment for Coca-Cola. The name Coke has become associated with a specific product in the minds of consumers. The community assumes that any product named Coke comes from a single source. The name has acquired a secondary meaning which emphasizes the product more than the producer. The original producer, however, is entitled to derive the profits from the consumer response to its product. Even though the name Coca-Cola was derived from its ingredients, the name of the beverage is associated with the final product by consumers and may not be duplicated by another manufacturer. The Coca-Cola Co. v. The Koke Co. of America, 254 U.S. 143, 41 S.Ct. 113, 65 L.Ed. 189 (1920). 11. Vuitton, a French corporation, manufactures high-quality handbags, luggage, and accessories. Crown Handbags, a New York corporation, manufactures and distributes ladies’ handbags. Vuitton handbags are sold exclusively in expensive department stores, and distribution is strictly controlled to maintain a certain retail selling price. The Vuitton bags bear a registered trademark and a distinctive design. Crown’s handbags appear identical to the Vuitton bags but are of inferior quality. May Vuitton recover from Crown for manufacturing counterfeit handbags and selling them at a discount? Explain. Answer: Trademark Infringement. Yes, Vuitton will prevail. Trademark law protects the goodwill of a trademark owner's business and protects the public from buying goods of inferior quality and unknown origin. The Trademark Act provides that: 1) Any person who shall without consent of the registrant– 2) use in commerce any reproduction, counterfeit, copy, or colorable imitation of a registered mark in connection with the sale, offering for sale, distribution, or advertising of any goods or services on or in connection with which such use is likely to cause confusion, or to cause mistake, or to deceive. . . shall be liable in a civil action by the registrant . . . It was Crown's duty under this provision of the Trademark Act to avoid consumer confusion between its handbags and Vuitton's antecedent products. Crown made no attempt to create dissimilar bags or inform the public that its bags were not Vuitton products. Vuitton et Fils v. Crown Handbags, 492 F. Supp. 1071 (S.D.N.Y. 1979). 12. T.G.I. Friday’s, a New York corporation and registered service mark, entered into an exclusive licensing agreement with Tiffany & Co. that allowed Tiffany to open a Friday’s restaurant in Jackson, Mississippi. International Restaurant Group, operated by the owners of Tiffany, applied for a license to open a Friday’s in Baton Rouge, Louisiana, but was refused. In Baton Rouge, International then opened a restaurant, called E.L. Saturday’s, or Ever Lovin’ Saturday’s, which had the same type of menu and decor as Friday’s. Friday’s sues International for trademark infringement. Explain who will prevail. Answer: Trademark Infringement. Judgment for International. The test for trademark infringement is whether confusion about the source of the product is caused. There is no such confusion in this case, however. The names T.G.I. Friday's and Ever Lovin' Saturdays are visually and phonetically dissimilar. In addition, the citizens of Baton Rouge are unfamiliar with Friday's so there can be no source of confusion between the restaurants. T.G.I. Friday's, Inc. v. International Restaurant Group, Inc., 569 F.2d 895 (5th Cir. 1978). 13. As part of its business, Kinko’s Graphics Corporation (Kinko’s) copied excerpts from books, compiled them in “packets,” and sold the packets to college students. Kinko’s did this without permission from the owners of the copyrights to the books and without paying copyright fees or royalties. Kinko’s has more than 200 stores nationwide and reported $15 million in assets and $3 million in profits for 1989. Basic Books, Harper & Row, John Wiley & Sons, and others (plaintiffs) sued Kinko’s for violation of the Copyright Act. The plaintiffs owned copyrights to the works copied and sold by Kinko’s and derived substantial income from royalties. They argued that Kinko’s had infringed on their copyrights by copying excerpts from their books and selling the copies to college students for profit. Kinko’s admitted that it had copied excerpts without permission and had sold them in packets to students, but it contended that its actions constituted a fair use of the works in question under the Copyright Act. What result? Explain. Answer: Copyrights. Judgment for all plaintiffs: Basic Books, Harper & Row, John Wiley & Sons, McGraw-Hill, Penguin Books, Prentice Hall, Richard D. Irwin, and William Morrow. Coined as an "equitable rule of reason," the fair use doctrine has existed for as long as the copyright law. It was codified in Section 107 of the Copyright Act of 1976, Article 17 of the United States Code. The Section reads in its entirety: Notwithstanding the provisions of Section 106, the fair use of a copyrighted work, including such use by reproduction in copies or phonorecords or by any other means specified by that section, for purposes such as criticism, comment, news reporting, teaching (including multiple copies for classroom use), scholarship, or research, is not an infringement of copyright. In determining whether the use made of a work in any particular case is a fair use the factors to be considered shall include– (1) the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the copyrighted work. The use of the Kinko's packets, in the hands of the students, was no doubt educational. However, the use in the hands of Kinko's employees is commercial. Kinko's claims that its copying was educational and, therefore, qualifies as a fair use. Kinko's fails to persuade us of this distinction. Kinko's has not disputed that it receives a profit component from the revenue it collects for its anthologies. The amount of that profit is unclear; however, we need only find that Kinko's had the intention of making profits. Its Professor Publishing promotional materials clearly indicate that Kinko's recognized and sought a segment of a profitable market, admitting that "[t]remendous sales and profit potential arise from this program." Basic Books, Inc. v. Kinko’s Graphics Corporation 758 F.Supp. 1522 (S.D.N.Y. 1991). In 1996, the Sixth Circuit held that (1) a copy shop's preparation of course packs was not fair use; (2) infringement was not willful, for purposes of awarding statutory damages; and (3) injunction prohibiting infringement could extend to future copyrighted works Princeton University Press v. Michigan Document Services, Inc., 99 F.3d 1381(1996). 14. In 1967, a Chicago brewer, Meister Brau, Inc., began making and selling a reduced-calorie, reduced-carbohydrate beer under the name “LITE.” Late in 1968, that company filed applications to register “LITE” as a trademark in the United States Patent Office, which ultimately approved three registrations of labels containing the name “LITE” for “beer with no available carbohydrates.” In 1972, Meister Brau sold its interest in the “LITE” trademarks and the accompanying goodwill to Miller Brewing Company. Miller decided to expand its marketing of beer under the brand “LITE.” It developed a modified recipe, which resulted in a beer lower in calories than Miller’s regular beer but not without available carbohydrates. The label was revised, and one of the registrations was amended to show “LITE” printed rather than in script. In addition, Miller undertook an extensive advertising campaign. From 1973 through 1976, Miller expanded its annual sales of “LITE” from 50,000 barrels to 4,000,000 barrels and increased its annual advertising expenditures from $500,000 to more than $12,000,000. Beginning in early 1975, a number of other brewers, including G. Heileman Brewing Company, introduced reduced calorie beers labeled or described as “light.” In response, Miller began filing trademark infringement actions against competitors to enjoin the use of the word “light.” Should Miller be granted the injunction? Explain. Answer: Trademarks. Preliminary injunction reversed. Miller claims that the original registration is evidence of their exclusive right to use the registered mark. The three registrations on which Miller relies, however, specify “beer with no available carbohydrates” as the goods on which the registered mark is to be used. This limitation came about because the Patent Office refused registration on the applications as initially filed, which described the goods as “beer,” on the ground that “LITE” was “merely descriptive” and therefore not registerable. In response, Meister Brau offered evidence of secondary meaning, “a no-available carbohydrates beer...” which also had “one-third less calories than ordinary draft beer,” and that “LITE” was suggestive rather than merely descriptive of these qualities. Therefore, the registrations provide the right to use the word “LITE” only for beer with no available carbohydrates. Miller Brewing Company v. G. Heileman Brewing Company, Inc. 15. B. C. Ziegler and Company (Ziegler) was a securities company located in West Bend. It had established an internal procedure by which its customer lists were treated confidentially. This procedure included burning or shredding any paper to be disposed of that contained a customer name or information. Nonetheless, Ziegler delivered a number of boxes of unshredded scrap paper to Lynn’s Waste Paper Company for disposal. One of Lynn’s employees, Ehren, who had been in the securities business and had worked for two of Ziegler’s competitors, noticed the information contained in the delivery from Ziegler and purchased six boxes of the Ziegler wastepaper for $16.75 from Lynn’s. Shortly thereafter, Ehren and his daughter sorted through the information and ultimately obtained 11,600 envelopes of information on Ziegler’s customers, including names, account summaries, and other information. Ehren sold this information to Thorson, a broker in competition with Ziegler. Thorson then sent a mailing to the Ziegler customers to solicit security sales for his firm and obtained an abnormally high response rate as a result. Ziegler, with the help of the West Bend Police Department, traced the dissemination of this information to Ehren and sought from the court a permanent injunction against Ehren using or disclosing the information regarding Ziegler’s clients. What is the result? Answer: Trade Secrets. . Ziegler would prevail. The court stated that in determining whether a trade secret exists under the common law, factors to be considered include (1) the extent to which the information is known outside the business of the party asserting trade secret status, (2) the extent to which it is known by the employees and others involved in the business, (3) the extent or measures taken to guard the secrecy of the information, (4) the value the information represents to party seeking to protect it and to that party’s competitors, (5) the amount of effort or money expended by the party developing the information, and (6) the ease or difficulty with which such information could be duplicated by others. Each factor should indicate that trade secrets exist if the information is to be afforded protection. Applying these factors, the court concluded that Ziegler’s customer information qualified for trade secret status. Ehren argued that trade secret status does not survive an accidental or negligent disclosure, but the court stated that trade secret status would be unimpaired even if there was negligent disclosure by Ziegler. Public policy would be harmed and it would be inequitable to allow Ehren to take advantage of Ziegler’s confidential information even though there was no wrongdoing on Ehren’s part in acquiring the information in the first place. 16. Since the 1950s Qualitex Company has used a special shade of green-gold color on the pads that it makes and sells to dry cleaning firms for use on dry cleaning presses. In 1989 Jacobson Products (a Qualitex rival) began to sell its own press pads to dry cleaning firms, and it colored those pads a similar green-gold. In 1991 Qualitex registered the special green-gold color on press pads with the Patent and Trademark Office as a trademark. Qualitex sued Jacobson for trademark infringement. Jacobson argues that the Lanham Act does not permit registering “color alone” as a trademark. Explain whether a trademark violation has been committed. Answer: Trademarks. Lanham Act gives a seller or producer the exclusive right to "register" a trademark, and to prevent his or her competitors from using that trademark. Both the language of the Act (trademarks "includ[e] any word, name, symbol, or device, or any combination thereof) and the basic underlying principles of trademark law would seem to include color within the universe of things that can qualify as a trademark. The courts and the Patent and Trademark Office have authorized for use as a mark a particular shape (of a Coca-Cola bottle), a particular sound (of NBC's three chimes), and even a particular scent (of plumeria blossoms on sewing thread). If a shape, a sound, and a fragrance can act as symbols why, one might ask, can a color not do the same? A color is also capable of satisfying the more important part of the statutory definition of a trademark, which requires that a person "us[e]" or "inten[d] to use" the mark "to identify and distinguish his or her goods, including a unique product, from those manufactured or sold by others and to indicate the source of the goods, even if that source is unknown." Over time, customers may come to treat a particular color on a product or its packaging (such as pink on a firm's insulating material or red on the head of a large industrial bolt) as signifying a brand. And, if so, that color would have come to identify and distinguish the goods. In this circumstance, trademark law says that a word (or a color), although not inherently distinctive, has developed "secondary meaning." In principle, trademark law, by preventing others from copying a source-identifying mark, "reduce[s] the customer's costs of shopping and making purchasing decisions, for it quickly and easily assures a potential customer that this item - the item with this mark - is made by the same producer as other similarly marked items that he or she liked (or disliked) in the past. At the same time, the law helps assure a producer that it (and not an imitating competitor) will reap the financial, reputation-related rewards associated with a desirable product. It would seem, then, that color alone, at least sometimes, can meet the basic legal requirements for use as a trademark. It can act as a symbol that distinguishes a firm's goods and identifies their source, without serving any other significant function. Qualitex's green-gold press pad color has met these requirements; it acts as a symbol. 17. Napster, Inc. (“Napster”) facilitates the transmission of MP3 files (a digital format for the storage of audio recordings) between and among its users. Through a process commonly called “peer-to-peer” file sharing, Napster allows its users to: (1) make MP3 music files stored on individual computer hard drives available for copying by other Napster users; (2) search for MP3 music files stored on other users’ computers; and (3) transfer exact copies of the contents of other users’ MP3 files from one computer to another via the Internet. These functions are made possible by Napster’s MusicShare software, available free of charge from Napster’s Internet site, and Napster’s network servers and server-side software. The plaintiffs include A&M Records, Geffen Records, Sony Music Entertainment, MCA Records, Atlantic Recording Corporation, Motown Record Company, and Capitol Records. The plaintiffs are engaged in the commercial recording, distribution, and sale of copyrighted musical compositions and sound recordings. The plaintiffs allege that Napster is a contributory and vicarious copyright infringer. Explain whether Napster should be enjoined “from engaging in, or facilitating others in copying, downloading, uploading, transmitting, or distributing plaintiffs’ copyrighted musical compositions and sound recordings, protected by either federal or state law, without express permission of the rights owner.” Answer: Cybercrime. Yes. The evidence establishes that a majority of Napster users use the service to download and upload copyrighted music, constituting direct infringement of plaintiffs’ musical compositions, recordings.” Napster users who upload file names to the search index for others to copy violate plaintiffs’ distribution rights. Napster users who download files containing copyrighted music violate plaintiffs’ reproduction rights. Liability for contributory copyright infringement exists if the defendant engages in “personal conduct that encourages or assists the infringement.” Contributory liability requires that the secondary infringer “know or have reason to know” of direct infringement. The district court found that Napster had both actual and constructive knowledge that its users exchanged copyrighted music. Under the facts as found by the district court, Napster materially contributes to the infringing activity. A&M Records, Inc. et al. v Napster Inc., 239 F.3d 1004 (2001). 18. Bernard L. Bilski and Rand A. Warsaw sought patent protection for a claimed invention that explains how buyers and sellers of commodities in the energy market can protect, or hedge, against the risk of price changes. Claim 1 describes a series of steps instructing how to hedge risk. Claim 4 puts the concept articulated in claim 1 into a simple mathematical formula. The remaining claims explain how claims 1 and 4 can be applied to allow energy suppliers and consumers to minimize the risks resulting from fluctuations in market demand for energy. Bilski and Warsaw sought to patent both the concept of hedging risk and the application of that concept to energy markets. Explain whether a patent for this invention should be granted. Answer: Patentability. A patent should not be granted. Laws of nature, physical phenomena, and abstract ideas are not patentable. This problem is based on Bilski v. Kappos, 561 U.S. 593, 130 S.Ct. 3218, 177 L.Ed.2d 792 (Supreme Court of the United States, 2010). Section 101 of the Patent Act specifies four independent categories of inventions or discoveries that are eligible for protection: processes, machines, manufactures, and compositions of matter. The Supreme Court’s precedents provide three specific exceptions to Section 101’s broad patent-eligibility principles: “laws of nature, physical phenomena, and abstract ideas.” Even if an invention qualifies as a process, machine, manufacture, or composition of matter, to receive the Patent Act’s protection, the claimed invention must also satisfy additional requirements including novelty, nonobviousness, and a full and particular description. This case involves an invention that is claimed to be a “process,” which Section 100(b) defines as a “process, art or method, and includes a new use of a known process, machine, manufacture, composition of matter, or material.” Three arguments have been advanced for the proposition that petitioner’s claimed invention is outside the scope of patent law: (1) it is not tied to a machine and does not transform an article, (2) it involves a method of conducting business, and (3) it is merely an abstract idea. Supreme Court precedents establish that the machine-or-transformation test is a useful and important clue, an investigative tool, for determining whether some claimed inventions are processes under Section 101. However, the machine-or-transformation test is not the sole test for deciding whether an invention is a patent-eligible “process.” The machine-or-transformation test may well provide a sufficient basis for evaluating processes similar to those in the Industrial Age—for example, inventions grounded in a physical or other tangible form. But there are reasons to doubt whether the test should be the sole criterion for determining the patentability of inventions in the Information Age. Section 101 similarly precludes the broad contention that the term “process” categorically excludes business methods. The term “method,” which is within Section 100(b)’s definition of “process,” may include at least some methods of doing business. Thus the Patent Act leaves open the possibility that there are at least some processes that can be fairly described as business methods that are within patentable subject matter under Section 101. Petitioners seek to patent both the concept of hedging risk and the application of that concept to energy markets. The patent application at issue here falls outside of Section 101 because it claims an abstract idea. Claims 1 and 4 in petitioners’ application explain the basic concept of hedging, or protecting against risk: “Hedging is a fundamental economic practice long prevalent in our system of commerce and taught in any introductory finance class.” The concept of hedging, described in claim 1 and reduced to a mathematical formula in claim 4, is an unpatentable abstract idea. Allowing petitioners to patent risk hedging would preempt use of this approach in all fields and would effectively grant a monopoly over an abstract idea. ANSWERS TO “TAKING SIDES” PROBLEMS Southwire Company and Essex Group, Inc. are direct competitors in the cable and wire industry. Southwire’s logistics system is a warehouse organizational system with components extending from architectural layout features to customized equipment and modified computer software. Southwire’s logistics system was primarily designed over a three-year period, with a development cost exceeding $2 million, by a project team headed by Richard McMichael. In addition to self-testing and a trial-and-error learning process, development of Southwire’s logistics system also included modifications based on observation of logistics systems in other industries and the adaptation of commercially-available components. The selection and arrangement of components and equipment in the new logistics system is unique to the Southwire logistics system. The new logistics system has resulted in substantial efficiencies to Southwire, with annual savings of $12 million. Because Southwire and its competitors produce basically identical goods for sale, the marketing advantage gained by the important efficiencies that have resulted from the new logistics system has proved especially valuable for Southwire. Essex hired McMichael, and Southwire brought suit against its former employee, McMichael, and his new employer, Essex, to enjoin McMichael from disclosing to Essex any Southwire trade secrets, particularly, trade secrets involving Southwire’s logistics system. (a) What are the arguments in favor of the court not issuing the injunction? (b) What are the arguments in favor of the court issuing the injunction? (c) Explain whether the court should issue the injunction. Answer: (a) Essex could argue that Southwire’s logistics system is not a trade secret because (i) it is composed primarily of computer hardware components and warehouse equipment that are commercially available, (ii) it may be independently discovered or ascertained by others, and (iii) it reflects only McMichael’s general knowledge, skill and experience. (b) Southwire could argue that its logistics system is trade secret even if it used known components and known techniques because it combined these elements to produce a useful process that is not known in the industry. In addition, trade secret information is protected until others have acquired it by proper means. Moreover, McMichael had information that specifically applied to the design and start-up of a logistics system for a cable and wire company. (c) The injunction should be issued. This is based on Essex Group, Inc. v. Southwire Co., 269 Ga. 553, 501 S.E.2d 501 (Georgia Supreme Court, 1998). “The fact that some or all of the components of the trade secret are well-known does not preclude protection for a secret combination, compilation, or integration of the individual elements.” Restatement of the Law 3d, Unfair Competition. Although information is accorded trade secret status in part because it is not “readily ascertainable by proper means,” the Trade Secret Act recognizes that trade secrets may be acquired by others either through independent development or by reverse engineering and that the acquisition of trade secret information by these means is not improper in the absence of any misappropriation. Thus, the Act explicitly recognizes that trade secret information is protectable until others have acquired it by proper means. This position is consistent with that taken in the Restatement. McMichael possessed not only general logistics information but also particularized information learned solely through his position of trust at Southwire. In conclusion, Essex sought to obtain, by the simple act of hiring McMichael, all the logistics information it had taken Southwire millions of dollars and years of testing and modifications to develop as part of Southwire’s plan to acquire a competitive edge over other cable and wire companies such as Essex. Chapter 40 ANTITRUST ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Discuss the validity and effect of each of the following: (a) A, B, and C, manufacturers of radios, orally agree that due to the disastrous, cutthroat competition in the market, they will establish a reasonable price to charge their purchasers. (b) A, B, C, and D, newspaper publishers, agree not to charge their customers more than thirty cents per newspaper. (c) A, a distiller of liquor, and B, A's retail distributor, agree that B should charge a price of five dollars per bottle. Answer: Price Fixing. (a) This horizontal price fixing agreement is a per se violation of Section 1 of the Sherman Antitrust Act. Socony Vacuum Oil Co. v. United States, 310 U.S. 150 (1940). (b) This maximum vertical price fixing agreement is a per se violation of Section 1 of the Sherman Antitrust Act. Albrecht v. The Herald Co., 390 U.S. 145 (1968). (c) This vertical resale price maintenance is a per se violation of Section 1 of the Sherman Act. Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911). 2. Discuss the validity of the following: (a) A territorial allocation agreement between two manufacturers of the same type of products, whereby neither will sell its products in the area allocated to the other. (b) An agreement between manufacturer and distributor not to sell a dealer a particular product or parts necessary for repair of the product. Answer: Market Allocations. (a) An agreement between competitors allocating territories for the sale of their respective products is a per se violation of the antitrust laws (Section 1 of the Sherman Act). United States v. Topco Assoc, 405 U.S. 596 (1972). (b) An agreement between a manufacturer and a distributor not to sell products to a particular dealer is a group boycott and a per se violation of the antitrust laws (Section 1 of the Sherman Antitrust Act). Klor's v. Broadway Hale Stores, 359 U.S. 207 (1959). 3. Universal Video sells 40 percent of the video recording equipment sold in the United States.. One-half of Universal’s sales is to Giant Retailer, a company that possesses 50 percent of the retail market. Giant seeks (a) to obtain an exclusive dealing arrangement with Universal, or (b) to acquire Universal. Please advise Giant as to the validity of its alternatives. Answer: Exclusive Dealing. Both alternatives would violate the antitrust statutes. The exclusive dealership arrangement would tend to create a monopoly or might substantially lessen competition since both companies are rather large and powerful (Universal controls 40% of the total sales market while Giant controls 50% of the retail market). Accordingly, this arrangement would run afoul of Section 3 of the Clayton Act. The acquisition would also violate the Clayton Act, Section 7, in that it might substantially lessen competition or tend to create a monopoly. 4. Z sells cameras to A, B, C, and D for $110 per camera. Y, one of Z’s competitor’s, sells a comparable camera to A for $101.50. Z, in response to this competitive pressure from Y, lowers its price to A to $101.50. B, C, and D insist that Z lower its price to them to $101.50, but Z refuses. B, C, and D sue Z for unlawful price discrimination. Decision? Would your answer differ if Z reduced its price to A to $100? Answer: Robinson-Patman: Meeting Competition. (a) Decision for Z. Z would possess a valid defense against a charge of illegally violating Section 2(a) of the Robinson-Patman Act in that Z was in good faith meeting the price of a competitor. Only A was receiving this lower price and Z could lawfully lower his price to A and not to B, C, and D. Of course, Z could have lawfully lowered his price to A, B, C, and D. (b) If Z lowered his price to A to $100.00 he would be in violation of the Robinson-Patman Act in that he was not meeting competition but was beating competition. In order to lower his price to A to $100.00 Z would have to lower his price to $100.00 to B, C, and D. 5. Discount is a discount appliance chain store that continually sells goods at a price below manufacturers’ suggested retail prices. A, B, and C, the three largest manufacturers of appliances, agree that unless Discount ceases its discount pricing, they will no longer sell to Discount. Discount refuses, and A, B, and C refuse to sell to Discount. Discount contends that A, B, and C are in violation of antitrust law. Explain whether Discount is correct. Answer: Boycotts. Decision for Discount. These facts provide a situation of per se violation of Section 1 of the Sherman Antitrust Act in that A, B, and C have jointly refused to deal (boycotted) with Discount. 6. Magnum Company produces 77 percent of the coal used in the United States. Coal provides 25 percent of the energy used in the United States. In a suit brought by the United States against Magnum for violation of the antitrust laws, what is the result? Answer: Monopolization. There are two issues raised by these facts: (1) Magnum possesses monopoly power in the relevant market–is the relevant market the coal market or all energy utilized in the United States. Seemingly, the relevant market would be the coal industry due to the limited substitutability of other energy sources for a coal system already in place. The interchangeability would be over the long-run and is not the short-run. See United States v. E.I. duPont De Nemours & Co., 351 U.S. 377 (1956). (2) Whether Magnum Company has engaged in any unlawful conduct. Since monopoly power alone is not sufficient to prove a violation of Section 2 of the Sherman Antitrust Act one must also find the illusive "plus" factor. The problem as here presented does not provide any such information; consequently, decision for Magnum. 7. Justin Manufacturing Company sells high-fashion clothing under the prestigious “Justin” label. The company has a firm policy that it will not deal with any company that sells below its suggested retail price. Justin is informed by one of its customers, XYZ, that its competitor, Duplex, is selling the “Justin” line at a great discount. Justin now demands that Duplex comply with the agreement not to sell the “Justin” line below the suggested retail price. Discuss the implications of this situation. Answer: Price Fixing. In a 2007 case, Leegin Creative Leather Products, Inc v. PSKS, Inc., the U.S. Supreme Court ruled that vertical price restraints are to be judged by the rule of reason. This decision overruled a 1911 U.S. Supreme Court decision that established the rule that it is per se illegal under Section 1 of the Sherman Act for a manufacturer to agree with its retailers to set the minimum price the retailer can charge for the manufacturer’s goods. 8. Jay Corporation, the largest manufacturer of bicycles in the United States with 40 percent of the market, has recently entered into an agreement with Retail Bike, the largest retailer of bicycles in the United States with 37 percent of the market, under which Jay will furnish its bicycles only to Retail, and Retail will sell only Jay’s bicycles. The government is now questioning this agreement. Discuss. Answer: Exclusive Dealing. The agreement would violate Section 3 of the Clayton Act in that this exclusive dealing relationship would tend to create a monopoly or might substantially lessen competition. Parties with as much market power as Jay (40%) and Retail (37%) are too powerful to permit to enter into an exclusive dealing agreement. 9. Whirlpool Corporation manufactured vacuum cleaners under both its own name and under the Kenmore name. Oreck exclusively distributed the vacuum cleaners sold under the Whirlpool name. Sears, Roebuck & Co. exclusively distributed the Kenmore vacuum cleaners. Oreck alleged that its exclusive distributorship agreement with Whirlpool was not renewed because an unlawful conspiracy existed between Whirlpool and Sears. Oreck further contended that a per se rule was applicable because the agreement was (a) price fixing or (b) a group boycott, or (c)both. Who should prevail? Why? Answer: Exclusive Dealing/Boycotts. Judgment for Whirlpool. Oreck must demonstrate more than just an agreement between Whirlpool and Sears to eliminate his distributorship. Such an agreement violates Section 1 of the Sherman Act only where it is demonstrated that it is anticompetitive in purpose or effect. As a result, these agreements must be tested by the rule of reason. 10. Indian Coffee of Pittsburgh, Pennsylvania, marketed vacuum-packed coffee under the Breakfast Cheer brand name in the Pittsburgh and Cleveland, Ohio, areas. Folger Coffee, a leading coffee seller, began selling coffee in Pittsburgh. In order to make inroads into the new territory, Folger sold its coffee at greatly reduced prices. At first, Indian Coffee met Folger’s prices but could not continue operating at such a reduced price and was forced out of the market. Indian Coffee brings an antitrust action. Explain whether Folger has violated the Sherman Act. Answer: Monopolization. Judgment for Folger's. Here there is no evidence that Folger's adopted some type of additional predatory practice in addition to the lowered prices. Pricing below marginal costs would be an example of impermissible market conduct. It also is not clear whether Folger's might have acquired its market share as a result of a better product or superior implementation of marketing strategies available to all competitors. 11. Von’s Grocery, a large retail grocery chain in Los Angeles, sought to acquire Shopping Bag Food Stores, a direct competitor. At the time of the proposed merger, Von’s sales ranked third in the Los Angeles area and Shopping Bag’s ranked sixth. Both chains were increasing their number of stores. The merger would have created the second largest grocery chain in Los Angeles, with total sales in excess of $170 million. Prior to the proposed merger, the number of owners operating single stores declined from 5,365 to 3,590 over a thirteen year period. During this same period, the number of chains with two or more stores rose from 96 to 150. The United States brought suit against Von’s to prevent the merger, claiming that the proposed merger violated Section 7 of the Clayton Act in that it could result in the substantial lessening of competition or could tend to create a monopoly. What should be the result? Answer: Horizontal Merger. Judgment for the United States. The fundamental purpose behind Section 7 of the Clayton Act is to prevent economic concentration by keeping a large number of small competitors in business. The language of Section 7 looks not only to a present danger of concentration but also to a merger's impact on future competition. Thus, to preserve competition, a trend toward concentration should be arrested in its early stages, before the market falls into the hands of a few big companies. Here, in the Los Angeles area, the number of single owner stores was decreasing substantially, while the number of chains was on a marked rise. This is the type of trend toward concentration that the Clayton Act addresses. Since the proposed merger between Von's and Shopping Bag contributes significantly to this trend, it is prohibited. Furthermore, Von's cannot argue that the two stores had to merge to save themselves from business failure or from destruction by some larger competitor. Both were already powerful companies merging in a way that would make them even more powerful. US v. Von's Grocery Co., 384 U.S. 270, 86 S.Ct. 1478, 16 L.Ed.2d 555 (1966). 12. Boise Cascade Corporation is a wholesaler and retailer of office products. The Federal Trade Commission issued a complaint charging that Boise had violated the Robinson-Patman Act by receiving a wholesaler’s discount from certain suppliers on products that Boise resold at retail, in competition with other retailers that could not obtain wholesale discounts. Has the Robinson-Patman Act been violated? Explain. Answer: Robinson-Patman Act. Judgment for FTC. This case deals with functional (in this case as a wholesaler) discounts, which occur when one buyer is allowed to purchase a product at a lower price than another buyer. Functional discounts are usually justified by the marketing functions provided by the favored buyer, such as, in the case of a wholesaler, warehousing inventory, publishing product catalogs, and furnishing sales assistance to dealers. Indeed, Boise claims that the discounts on the prices it pays represent the value of the distributional services it performs. Boise, a wholesaler and retailer, however, receives a wholesaler's discount on all goods purchased. It then makes retail sales in competition with dealers who perform distributional functions similar to Boise but who cannot obtain the wholesaler discount because they do not make wholesale sales. Yet the discounts received by Boise on goods resold at retail are only illegal if they cause injury to these competing retailers. Boise maintains that there is no competitive injury since the price difference is no greater than its costs of performing services. The fact remains, though, that Boise purchases goods at lower prices than are available to other dealers and can thus price its goods lower than its competitors at retail. Boise also argues that the discounts it receives are available to other retailers. According to Boise, a retailer can obtain the same prices Boise gets from its suppliers by becoming a wholesaler too, or a retailer can look to other suppliers for equally low prices. The first suggestion is impractical in that it would require the purchaser to change his purchasing status, and as for the second idea, the record indicates that equivalent goods were not available on comparable terms from alternative suppliers. Therefore, the price advantage received by Boise did result in competitive injury to other retailers and was hence a violation of the Robinson-Patman Act. In Re Boise Cascade Corp., 50 ATRR 335 (1986). 13. Great Atlantic and Pacific Tea Company desired to achieve cost savings by switching to the sale of “private label” milk. A&P asked Borden Company, its longtime supplier of “brand label” milk, to submit a bid to supply certain A&P private label dairy products. A&P was not satisfied with Borden’s bid, however, so it solicited other offers. Bowman Dairy, a competitor of Borden’s, submitted a lower bid. At this point, A&P contacted Borden and asked it to rebid on the private label contract. A&P included a warning that Borden would have to lower its original bid substantially in order to undercut Bowman’s bid. Borden offered a bid that doubled A&P’s potential annual cost savings. A&P accepted Borden’s bid. The Federal Trade Commission then brought this action, charging that A&P had violated the Robinson-Patman Act by knowingly inducing or receiving illegal price discrimination from Borden. Discuss whether the FTC is correct in its allegations. Answer: Meeting Competition. Judgment for A&P. A buyer cannot be held liable for knowingly inducing or receiving illegal price discrimination from a seller unless the seller itself could be found liable. Here, Borden has a valid meeting competition defense. Accordingly, since A&P has done no more than accept the lower of two prices competitively offered, it did not violate the price discrimination prohibition of the Robinson-Patman Act. Great Atlantic & Pacific Tea Co. v. Federal Trade Comm. United States Supreme Court, 1979. 440 U.S. 69, 99 S.Ct. 925, 59 L.Ed.2d 153. 14. Clorox is the nation’s leading manufacturer of household liquid bleach (accounting for 49 percent—$40 million—of sales annually) and is the only brand sold nationally. Clorox and its next largest competitor, Purex, hold 65 percent of national sales; and the top four bleach manufacturers control 80 percent of sales. Because all bleach is chemically identical, Clorox spends more than $5 million each year in advertising to attract and keep customers. Procter & Gamble is the dominant national manufacturer of household cleaning products, with yearly sales of $1.1 billion. As with bleach, advertising is vital in the household cleaning products industry. Procter & Gamble annually spends more than $127 million in advertising and promotions. Procter & Gamble decided to diversify into the bleach business because its household cleaning products and bleach are both low-cost, high-turnover consumer goods, are dependent on mass advertising, and are sold to the same customers at the same stores by the same merchandising methods. Procter & Gamble decided to merge with Clorox, rather than start its own bleach division, in order to secure the dominant position in the bleach market immediately. Should the FTC take action against this merger, and, if so, what decision should it make? Answer: Clayton Act/Conglomerate Mergers. The merger between Proctor & Gamble and Clorox violated Section 7 of the Clayton Act. Proctor & Gamble had sought to expand its product line by adding household bleach to it. The Court noted that the markets for the products of each of the companies were highly concentrated markets, that is, they were already dominated by a few companies. Thus, barriers to entry by potential competitors were already high, and competition was at a minimum. Justice Douglas gave the majority opinion: "In the marketing of soaps, detergents, and cleansers, as in the marketing of household bleach, advertising and sales promotion are vital. . . The substitution of Proctor with its huge assets and advertising advantages for the already dominant Clorox would dissuade new entrants and discourage active competition from the firms already in the industry due to fear of retaliation by Proctor." Federal Trade Commission v. Proctor & Gamble Co., 386 U.S. 568, 87 S.Ct. 1224 (1967). 15. The National Collegiate Athletic Association (NCAA) adopted a plan for televising college football games in order to reduce the adverse effect of television coverage on spectator attendance. The plan limited the total number of televised intercollegiate football games and the number of games any one school could televise. No member of the NCAA was permitted to sell any television rights except in accordance with the plan. As part of the plan, the NCAA had agreements with the American Broadcasting Company (ABC) and the Columbia Broadcasting System (CBS) to pay to each school at least a specified minimum price for televising football games. Several member universities now join to bring suit against the NCAA, claiming the new plan is a horizontal price fixing agreement and output limitation and as such is illegal per se. The NCAA counters that the existence of the product, college football, depends upon member compliance with restrictions and regulations. According to the NCAA, its restrictions, including the television plan, have a procompetitive effect. Is the television plan a reasonable restraint? Explain. Answer: Sherman Act/Rule of Reason Application to Horizontal Restraints. The U.S. Supreme Court held that the NCAA's television plan violated Section 1 of the Sherman Act. The court recognized that a certain degree of cooperation was necessary to college sports and applied the rule of reason, rather than a per se analysis. In applying the rule of reason, the court concluded that the television regulations operated to raise the price and reduce the output of televised college football. In this industry, however, the Court found that "horizontal restraints on competition are essential if the product is to be available to all." Thus, many NCAA regulations may be procompetitive and legal under the antitrust laws. The court ruled against the limits on televising college games, however, holding that the television plan restricted, rather than enhanced intercollegiate athletics. National Collegiate Athletic Association v. University of Oklahoma, 468 U.S. 85, 104 S.Ct. 2948 (1984). 16. The National Society of Professional Engineers (Society) had an ethics rule that prohibited member engineers from disclosing or discussing price and fee information with customers until after the customer had hired a particular engineer. This rule against competitive bidding was designed to maintain high standards in the field of engineering. The Society felt that competitive pressure to offer engineering services at the lowest possible price would encourage engineers to design and specify inefficient, unsafe, and unnecessarily expensive structures and construction methods. According to the Society, awarding engineering contracts to the lowest bidder, regardless of quality, would be dangerous to the public health, safety, and welfare. The Society emphasizes that the rule is not an agreement to fix prices. Rather, it claims the rule was drafted by experienced, highly trained professional engineers to prevent public harm and is therefore reasonable. Does the rule unreasonably restrain trade and thus violate §1 of the Sherman Act? Why or why not? Answer: Restraint of Trade. Yes, this rule does violate the Sherman Act. The Rule of Reason analysis focuses directly on the challenged restraint's impact on competitive conditions. "[T]he true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition." Note that the Sherman Act does not require competitive bidding–rather, it prohibits unreasonable restraints on competition. Here the Society seems to view competition as a bad influence. This is contrary to the basic premise of the Sherman Act–that competition is beneficial, yielding lower prices as well as better goods and services. A complete ban on competitive bidding goes too far. The Society must utilize less anti-competitive means to police and control deceptively low bids and inferior engineering work. National Society of Professional Engineers v. U.S., 435 U.S. 6789, 98 S.Ct. 1355, 55 L.Ed.2d 637 (1978). 17. During a period of a few years, intense price competition characterized both the retail and the wholesale oil markets. At times, prices in the wholesale market fell below the manufacturer’s cost. One cause of the volatile situation was the supply of “distress gasoline” placed on the market by seventeen independent refiners. These independent refiners had no retail sales outlets and little storage capacity, so they were forced to sell their product at “distress prices.” In spite of their unprofitable operations, they could not afford to shut down, for, if they did so, they would be apt to lose both their oil connections in the field and their regular customers. In an attempt to remedy this problem, the major oil companies entered into an informal agreement whereby each selected as its “dancing partner” one or more independent refiners having distress gasoline. The major oil company would then assume responsibility for purchasing the independent’s distress supply at the “fair going market price.” As a result, the market price of oil rose and the spot market became stable. Have the companies engaged in horizontal price fixing in violation of the Sherman Act? Why? Answer: Horizontal Price Fixing. .Yes. Although the major oil companies had not explicitly agreed on the price at which they would sell their oil, the court found that the purpose of the arrangement was to curtail competition and raise prices. In so ruling the court rejected the defendants' contention that the agreement was to prevent cutthroat competition which would destroy the oil industry and force numerous oil wells to be closed. Moreover, it would be extremely expensive to re-open these closed wells at a future date. The court judged that reasonableness of prices is no defense. Horizontal agreements with the purpose and effect of raising, depressing, fixing, pegging, or stabilizing prices are illegal per se. United States v. Soconoy-Vacuum Oil Co., 310 U.S. 150 (1940). 18. As part of a corporate plan to stimulate sagging television sales, GTE Sylvania began to phase out its wholesale distributors and began to sell its television sets directly to a smaller and more select group of franchised retailers. To this end, Sylvania limited the number of franchises granted for any given area and required each franchisee to sell Sylvania products only from the location or locations at which it was franchised. A franchise did not constitute an exclusive territory, and Sylvania retained sole discretion to increase the number of retailers in an area in light of the success or failure of existing retailers. The strategy apparently was successful, as Sylvania’s national market share increased from less than 2 percent to 5 percent. In the course of carrying out its plan, Sylvania franchised Young Brothers as a television retailer at a San Francisco location one mile from that of Continental T.V., Inc., one of Sylvania’s most successful franchisees. A course of feuding began between Sylvania and Continental that reached a head when Continental requested permission to open a store in Sacramento, and Sylvania refused. Continental opened the Sacramento store anyway and began shipping merchandise there from its San Jose warehouse. Shortly thereafter, Sylvania terminated Continental’s franchise. Is the franchise location restriction a per se violation of the Sherman Act? Explain. Answer: Market Allocations. No; judgment for Sylvania. In an earlier decision, the Court erroneously held that territorial and customer restrictions on sales by wholesalers in the purchasing and selling of Schwinn bicycles was per se illegal. Per se rules of illegality are appropriate, however, only when they relate to conduct that is manifestly anti-competitive. Vertical market allocation restrictions in franchise agreements are not manifestly anti-competitive, and, therefore, would be judged under the prevailing standard of analysis, the “rule of reason.” Under the rule of reason analysis, the court must weigh all of the circumstances of the case in deciding whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition. The market impact of vertical restrictions is complex because of their potential for a simultaneous reduction of interbrand competition and stimulation of interbrand competition. On one hand, location restrictions and other vertical restraints reduce intrabrand competition by limiting the number of sellers of a particular brand product competing for the business of a given group of buyers. On the other hand, these vertical restrictions promote interbrand competition by allowing the manufacturer to achieve certain efficiencies in the distribution of his products. Overall, the franchise location clause imposed by Sylvania does not impose an unreasonable restraint on trade and, so, does not violate the Sherman Act. Continental T.V. Inc v. GTE Sylvania, Inc., 433 U.S. 36. 19. In 1923, DuPont was granted the exclusive right to make and sell cellophane in North America. In 1927, the company introduced a moistureproof brand of cellophane that was ideal for various wrapping needs. Although more expensive than most competing wrapping, it offered a desired combination of transparency, strength, and cost. Except for its permeability to gases, however, cellophane had no qualities that a number of competing materials did not possess as well. Cellophane sales increased dramatically, and by 1950, DuPont produced almost 75 percent of the cellophane sold in the United States. Nevertheless, sales of the material constituted less than 20 percent of the sales of "flexible packaging materials." The United States brought this action, contending that by so dominating cellophane production, DuPont had monopolized a part of trade or commerce in violation of the Sherman Act. DuPont argued that it had not monopolized because it did not have the power to control the price of cellophane or to exclude competitors from the market for flexible wrapping materials. Who is correct? Explain. Answer: Monopolization. Judgment for DuPont. The first step in determining whether DuPont has monopolized is to determine whether the company has monopoly power in the relevant market. Monopoly power is the power to control prices or to exclude competition in the relevant market. The relevant market consists of commodities reasonably interchangeable by consumers for the same purposes. Control of the relevant market, in turn, depends on the availability and interchangeability of competing products. A measure of this interchangeability is the cross-elasticity of demand between cellophane and the other wrappings — that is, the responsiveness of the sales of cellophane to changes in the price of other wrapping materials. Here, the evidence shows that sales of the other materials were highly sensitive to changes in the price of cellophane, thus indicating that the products compete in the same market. In other words, the interchangeability of cellophane with other wrapping materials suffices to define the relevant market for purposes of determining whether du Pont has monopolized the market for all flexible wrapping materials. Although it accounted for over 17 percent of the sales in that larger market, DuPont cannot be said, by that proportion of sales, to have the power to control prices or exclude competition. 20. Ed O’Bannon, a highly-talented former basketball player at UCLA, alleges an antitrust violation based on the premise that current and former NCAA men’s basketball and Division I-A football players should be allowed to sell the rights to their name, image, and likeness to the NCAA, its licensing division, and outside entities including television and other media networks. The NCAA does not permit this activity, contending that such activity would destroy system of amateurism. The plaintiffs (O’Bannon and “all others similarly situated”) argue that “the NCAA has unreasonably and illegally restrained trade in order to commercially exploit former student-athletes subject to its control, with such exploitation affecting those individuals well into their post-collegiate lives.” Explain who should prevail. Answer: Restraint of Trade. The players should prevail. The NCAA may not stop players from selling the rights to their names, images, and likenesses, thus striking down NCAA regulations that prohibit players from getting anything other than scholarships and the cost of attendance at schools. "The Court finds that the challenged NCAA rules unreasonably restrain trade in the market for certain educational and athletic opportunities offered by NCAA Division I schools. The procompetitive justifications that the NCAA offers do not justify this restraint and could be achieved through less restrictive means. The Court will enter as a remedy a permanent injunction prohibiting certain overly restrictive restraints.” O’Bannon v. Nat. Collegiate Athletic Association, 7 F.Supp.3d 955 (2014). [Note: this case is currently under appeal.] ANSWERS TO “TAKING SIDES” PROBLEMS The California Dental Association (CDA) is a voluntary nonprofit association of local dental societies to which some nineteen thousand dentists belong, about three-quarters of those practicing in the state. The CDA lobbies on behalf of its members’ interests and conducts marketing and public relations campaigns for their benefit. The dentists who belong to the CDA through these associations agree to abide by a Code of Ethics (Code), which includes a regulation limiting their right to advertise. Responsibility for enforcing the Code rests in the first instance with the local dental societies. Applicants who refuse to withdraw or revise objectionable advertisements may be denied membership, and members are subject to censure, suspension, or expulsion from the CDA. The Federal Trade Commission (FTC) brought a complaint against the CDA, alleging that it applied its Code so as to restrict truthful, nondeceptive advertising and therefore violated Section 5 of the FTC Act. The FTC alleged that the CDA unreasonably restricted price advertising—particularly discounted fees—and advertising relating to the quality of dental services. (a) What are the arguments that the per se standard applies to this case? (b) What are the arguments that a rule of reason standard applies to this case? (c) Which standard should apply to this case? Explain. Answer: (a) A regulation which prevents important information from being disseminated is clearly anti-anticompetitive and of no redeeming value. The regulation prevents information on price, quality and other matters that a free market mandates be given to the consumer. (b) To determine the impact of this regulation on the competitive landscape one must look at the pro-procompetitive impact against the anti-anticompetitive impact. A rule of reason test should be applied. (c) Although the Court of Appeals seems to have accepted that the restrictions here were like restrictions on advertisement of price and quality generally, the majority of the Supreme Court held that the California Dental Association’s (CDA’s) advertising restrictions might plausibly be thought to have a net procompetitive effect, or possibly no effect at all on competition. The restrictions on both discount and nondiscount advertising are, at least on their face, designed to avoid false or deceptive advertising in a market characterized by striking disparities between the information available to the professional and the patient. The Court of Appeals was also tolerant in accepting the sufficiency of abbreviated rule-of-reason analysis as to the nonprice advertising restrictions. Although the Court of Appeals acknowledged the CDA’s view that “claims about quality are inherently unverifiable and therefore misleading,” it responded that this concern “does not justify banning all quality claims without regard to whether they are, in fact, false or misleading.” The point is not that the CDA’s restrictions necessarily have the procompetitive effect claimed by the CDA; it is possible that banning quality claims might have no effect at all on competitiveness if, for example, many dentists made very much the same sort of claims. And it is also possible that the restrictions might in the final analysis be anticompetitive. The point, rather, is that the plausibility of competing claims about the effects of the professional advertising restrictions rules out the indulgently abbreviated review to which the Commission’s order was treated. The obvious anticompetitive effect that triggers abbreviated analysis has not been shown. Saying that the Court of Appeals should have conducted a more extended examination of the possible factual underpinnings does not necessarily call for the fullest market analysis. As the circumstances here demonstrate, there is generally no categorical line to be drawn between restraints that give rise to an intuitively obvious inference of anticompetitive effect and those that call for more detailed treatment. What is required, rather, is an enquiry appropriate for the case, looking to the circumstances, details, and logic of a restraint. The object is to see whether the experience of the market has been so clear, or necessarily will be, that a confident conclusion about the principal tendency of a restriction will follow from a quick (or at least quicker) look, in place of a more comprehensive one. A less quick look was required for the initial assessment of the tendency of these professional advertising restrictions. California Dental Association v. Federal Trade Commission, Supreme Court of the United States, 1999 526 U.S. 756, 119 S.Ct. 1604, 143 L.Ed.2d 935. Solution Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637