This Document Contains Chapters 13 to 15 Chapter 13: Employment Discrimination OVERVIEW Continuing with this unit’s examination of regulation of employment relationships, this chapter covers employment discrimination law with primary coverage of the federal anti-discrimination statutory scheme. The chapter explores the role of protected classes in discrimination law, examines the various theories of discrimination, and considers several employer defenses. The role is of the EEOC and procedural process for filing a claim is also considered. Students are also introduced to examples of how state anti-discrimination statutes differ from federal statutes. KEY LEARNING OUTCOMES Outcome Accreditation Categories Define the term employment discrimination, describe the protections afforded under the major federal anti-discrimination statutes, and explain the role of the Equal Employment Opportunities Commission (EEOC). Knowledge Identify the protected classes under Title VII and explain why membership in a protected class is essential in a employment discrimination claim Knowledge Apply the three theories of discrimination including the concepts of a prima facie case, shifting of the burden of proof, and the major defenses available to employers. Analysis; Critical thinking Explain the role of state law in employment discrimination cases. Knowledge TEACHING OUTLINE A. Definitions, Source of Law, and Statutory Origins [P.367] Points to emphasize: • Employment discrimination is prohibited by federal and state statutes with broad-based definitions encompassing workplace-related discrimination that includes (1) the hiring process; (2) treatment of employees in terms of promotions/donations, work schedules, working conditions, or assignments; and (3) disciplinary action. • Equal Employment Opportunity Commission (EEOC): The administration agency charged with carrying out federal workplace antidiscrimination laws through using its rulemaking authority, investigatory powers, and enforcement action as necessary. o As a practical matter, the EEOC can pursue only a fraction of claims that are made by employees, where those actions have some important legal significance or where the employer’s conduct was particularly egregious or in bad faith. B. Federal Workplace Antidiscrimination Statutes [P.368] Points to emphasize: • The primary federal antidiscrimination statutes are (1) Title VII of the Civil Rights Act; (2) the Age Discrimination in Employment Act (ADEA); and (3) the Americans with Disabilities Act (ADA). • These statutes can be categorized as either laws that require the person in the protected class to receive equal treatment as nonclass members, or laws that require the person in the protected class to receive special treatment. C. Title VII [P.369] Points to emphasize: • Title VII of the Civil Rights Act of 1964 applies to any private sector employer with 15 or more full-time employees as well as labor unions, employment agencies, state and local governments, and most federal government employers and prohibits discrimination in the workplace on the basis of membership in a protected class. • Protected Classes: Under Title VII or any other antidiscrimination laws, statutory protection is only extended to those who have been discriminated against based on their membership in a protected class and the plaintiff need not be in a minority of the protected class in order to be covered. o The protected classes in Title VII are race, color, national origin, gender, pregnancy, and religion. • Theories of Discrimination: There are three basic theories of discrimination (1) disparate treatment; (2) mixed motives; and (3) disparate impact. o Disparate Treatment: Overt and intentional discrimination and occurs when an employer treats an employee differently based on membership in a protected class. • Under the McDonnell Douglass test a plaintiff must make out a prima facie case showing (1) membership of a protected class, (2) that the plaintiff was qualified for and applied for a job, (3) was rejected, and (4) the position was filled by a nonclass member. • In cases involving other types of discriminatory action unrelated to hiring or promotion, the appropriate prong is adjusted accordingly. • Second, the burden shifts to the employer to show a legitimate nondiscriminatory reason for the action. Finally, the burden shifts back to the individual to show the reason given by the employer was not the actual reason for their action. Case 13.1 Aquino v. Honda of America, Inc., 158 Fed. App. 667 (6th Cir. 2005) [P.373] Facts: Aquino, a man of Chinese-Filipino origin, worked on a Honda assembly line and had been suspended on numerous occasions for disciplinary violations. Upon returning from a suspension, Aquino was assigned to an engine installation station. After several instances of vandalism near his work station, Honda conducted an internal investigation and determined that Aquino had committed vehicle tampering and vandalism. Although Aquino was arrested, charges were eventually dropped due to insufficient evidence. Nonetheless, Honda terminated Aquino’s employment. Aquino filed suit claiming his termination was based on the fact that he was the only nonwhite employee assigned to the unit. Issue: Did Aquino satisfy the necessary elements of the McDonnell Douglas standard for disparate treatment? Ruling: No. The court reasoned that Honda’s reasonable belief that Aquino committed the vandalism met their burden to show a legitimate nondiscriminatory reason for his termination and when the burden shifted back to Aquino to show this was pretextual, he could not offer any evidence of pretext. Answers to case questions: 1. Why did Aquino have the burden of proving that Honda’s reason for discharging him was pretext? Didn’t he already prove a prima facie case? Answer: As in all civil cases, the initial burden of proof rests upon Aquino to prove his case. He did in fact establish a prima facie case, at which point a presumption was created that Honda discriminated against Aquino. However, this presumption is rebuttable because the burden of proof then shifts to Honda to provide a nondiscriminatory reason for the decision. Honda did provide a nondiscriminatory reason that was plausible and supported by evidence found in their internal investigations. The burden then shifts back to the Aquino to offer evidence that tends to prove that the reason offered by Honda is a pretext. Aquino was unable to offer any such evidence. 2. Considering the criminal charges against him were dropped, what would Aquino need to have shown in order to meet his burden that Honda’s reasons for dismissing him were pretextual? Answer: Here, it is important to note that the burden of proof in criminal cases (beyond a reasonable doubt) is much more difficult to prove than the burden of proof in civil cases (a preponderance of the evidence). Therefore, just because the criminal charges were dropped does not mean that Honda’s investigation was wrong. Ultimately, Aquino would need to have shown that the vandalism was not the actual reason for Honda’s employment action. o Mixed Motives: The mixed motives theory articulated in PriceWaterhouse v. Hopkins ([P.372]) protects employees when legitimate motives are mixed with illegitimate motives and an employee is discriminated against. • Under this theory, the employee must prove that membership in a protected class was a substantial factor in the decision-making process and the burden then shifts to the employer to offer evidence that it would have made the same employment decision regardless of membership in a protected class. o Disparate Impact: The disparate impact test articulated in Griggs prohibits an employer from using a facially neutral practice that has adverse impact on members of a protected class. o Under the disparate impact theory a plaintiff must prove that the evaluation methods resulted in statistically significant differences that adversely impacted members of a protected class. o Despite EEOC guidelines that define adverse impact statistically and federal court decisions, disparate impact is still a very thorny area of discrimination law. Case 13.2 Ricci v. DeStefano, 557 U.S. 557 (2009) [P.375] Facts: The City of New Haven, Connecticut (the City), administered an objective written exam to any fire department employee who aspired to be promoted. Though the exam was designed and administered by a professional testing service company that specialized in race-neutral testing for police and fire agencies, the results of the exam were such that white candidates outperformed minority candidates. The City decided to discard the test results in an attempt to prevent disparate impact-based lawsuits filed by minority candidates. Ricci, a white firefighter who placed highly on the promotion exam, filed a Title VII lawsuit against the City based on a disparate treatment claim. The City defended on the basis that they were complying with Title VII’s disparate impact provision and both the trial court and the court of appeals ruled in the City’s favor. Issue: Did the City’s action in discarding the exam results violate Title VII’s prohibition against disparate treatment? Ruling: Yes. If employers act in good faith to design a legitimate test to be race-neutral, the fact that the numbers come out differently than the employer expects is not, in and of itself, enough to discard the results of the test. Answers to case questions: 1. The employer in this case is a municipal government agency. Does this case apply to private employers as well? Why or why not? Answer: Yes this case could apply to private employers because Title VII applies to any private sector employer with 15 or more full-time employees as well as labor unions, employment agencies, state and local governments, and most federal government employees. 2. Given the Court’s ruling, what’s an example of circumstances where an employer could discard the results of a promotion test? Answer: An employer could discard the results of a promotion test if, for example, after administering the test, they find out from the professional testing service company that they committed an error in their sampling of minorities or in their calculations. This scenario would provide strong factual evidence that the discarding of the test results were necessary to avoid liability. • Sexual Harassment: Unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature are considered violations of Title VII if the conduct is (1) in the context of explicit or implicit conditions of an individual’s employment or as a basis for any employment decisions (quid pro quo), or (2) unreasonably interfering with an individual’s work performance or creating an offensive work environment (hostile work environment). o More recently, the U.S. Supreme Court has developed sexual harassment doctrines related to liability of an employer for harassment committed by the victim’s co-worker or supervisor, and has also made clear that sexual harassment prohibitions apply to same sex harassment (Faragher v. City of Boca Raton [P.376]; Oncale v. Sundowner Offshore Services, Inc. [P.376]). Self-Check: Theories of Discrimination: What is the best potential theory of discrimination for the plaintiff to pursue? [P. 377]. • Figure 13.1: Title VII Liability Analysis [P.378] • Remedies: Title VII provides for various remedies including injunctions, reinstatement, compensatory damages, retroactive promotions, and remedial actions by the employer (punitive damages are available only when a plaintiff proves that a private employer acted maliciously, in retaliation, or with reckless disregard to the employment discrimination laws). D. Age Discrimination in Employment Act [P.379] Points to emphasize: • The Age Discrimination Employment Act (ADEA) prohibits employers from discriminating against employees on the basis of their age if the employee is (1) 40-years-old or over; (2) satisfactory in job performance; (3) adversely affected by the job action; and (4) better treatment is given to someone substantially younger. • If the employee makes a prima facie case, then the employer must present a non-discriminatory reason for the adverse employment action, at which point it is up to the employee to convince the fact finder that the reason the employer gave is pretextual and the real reason is age discrimination. • Substantially Younger Requirement: Many courts follow the general rule that the age difference must be at least 10 years in order to qualify as substantially younger in asserting an age discrimination claim. o Disparate impact claims under the ADEA articulated in Smith v. City of Jackson, Miss. provide that the employer’s burden to show the reasonableness of the business practice at issue is minimal. E. Americans with Disabilities Act [P.380] Points to emphasize: • The Americans with Disabilities Act (ADA) passed in 1990 seeks to eliminate discriminatory employment practices against disabled persons by requiring that employers with 15 or more employees make reasonable accommodations that allow the disabled employee to perform essential job functions, so long as the accommodation does not cause the employer to suffer an undue hardship. • Documented Disability Requirement: The ADA defines disability in terms of individuals that have physical or mental impairments that substantially limit a person’s ability to participate in major life activities. o In a series of cases beginning in 1999, the Supreme Court narrowed the definition of what disabilities were covered under the ADA and ruled that any condition that could be corrected was not a disability covered by the act. • ADA Amendments Act of 2008: (effective on or after 1/1/09) The ADAAA Expanded the definition of disability with specific statutory definitions intended to urge courts to interpret the definition of disability “in favor of broad coverage of the individuals under this Act, to the maximum extent permitted by terms of the Act.” o Although the basic definition of a disability under the original ADA was left in place, the ADAAA expanded the statutory protections to specifically cover disabilities that had been excluded from coverage by virtue of the Supreme Court’s ADA case law. • Regarded as Test: Even if an individual does not meet the definitional requirements of a disability under the ADA, employees may still be protected by the ADA when the employee was regarded as having impairment by her employer (even if the impairment was not actually a disability). • Reasonable Accommodations: The ADA states that reasonable accommodations may include (1) making existing facilities readily available to individuals with disabilities; and (2) job restructuring, part-time or modified work schedules, reassignment to vacant positions, and the provision of readers or interpreters. o The statute does not require the employer to provide accommodations that constitute an undue hardship on the employer, defined as one that would result in significant difficulty or expense in the context of the overall resources of the employer, the number of persons employed, the effect on expenses or resources, or the impact of the accommodation upon the operation of the facility. Case 13.3 PGA Tour, Inc. v. Martin, 532 U.S. 661 (2001) [P.383] Facts: Martin was a professional golfer who is afflicted with an ADA recognized degenerative circulatory disability that causes severe pain due to an obstruction of blood flow between his legs and his heart. The PGA rules require players in tournaments to walk the course and they rejected Martin’s request for permission to use a golf cart on the grounds that it was not a reasonable accommodation. Though Martin was covered by the ADA, the PGA Tour asserted that walking was a fundamental part of golf and waiving it for any reason would fundamentally alter the nature of the competition. Martin countered by noting that even with the use of a cart he would be required to walk one mile during each round of golf and, because his disability causes him pain and fatigue, the use of the cart would not allow him an advantage over other players. Issue: Does Martin’s reasonable accommodations request constitute an undue hardship on the PGA? Ruling: No. The Court found that because nothing in the Official Rules of Golf expressly prohibits the use of carts, the PGA’s walking rule was not an essential part of the game, and further reasoned that the actual fatigue from walking four rounds of golf was insignificant. Answers to case questions: 1. Why was the PGA so reluctant to allow Martin to use a golf cart, especially considering carts are allowed in other tournaments? Answer: The PGA may have been reluctant to allow Martin to use a golf cart because of a fear that others would request similar waivers. Allowing an exception in this one instance could essentially alter the nature of the competition in future instances. 2. Do you agree with the Court’s reasoning that allowing Martin to use a golf cart during tournament does not give him an advantage? Why or why not? Are there any scenarios where it might, and as a result would alter the fundamental nature of the game? Answer: Generally, one could reasonably agree with the Court’s ruling that allowing Martin to use a golf cart during tournaments does not give him an advantage. Even with the use of a cart, Martin is still required to walk to a certain extent and if anything, he is disadvantaged because of the affects of his disability that other golfers are not subject to when walking. However, there are scenarios where it might give Martin an advantage and as a result alter the fundamental nature of the game. For example, on days where the elements are at play, whether it is on a rainy day or if the match is being played in extreme heat. In these instances, Martin’s use of a cart could be an advantage over other competitors that are subjected to the elements 3. Given the Court’s reasoning, would a request to double the size of the hole so that a partially blind competitor could see it when putting fundamentally alter the game? Explain your answer. Answer: Such a request would fundamentally alter the game because this scenario is distinguishable from the Martin case. In his case, walking was determined not to be an essential part of the game. Putting the ball into the hole however is the essential purpose of the game and therefore doubling the size of the hole would fundamentally alter the game. F. Equal Pay Act [P.382] Points to emphasize: • The Equal Pay Act (EPA) makes it illegal for employers to pay unequal wages to men and women who perform substantially equal work unless the difference is based on a factor other than gender. • Lilly Ledbetter Fair Pay Act of 2009: Effectively reversed the U.S. Supreme Court’s decision in Ledbetter v. Goodyear Tire & Rubber Co [P.382] and seeks to ensure that employees subject to discrimination have the opportunity to challenge every discriminatory pay check that they have received. Concept Summary: Federal Employment Discrimination Statutes [P.384] G. Procedures for Asserting a Claim [P.385] Points to emphasize: • First, an aggrieved employee must file a complaint against the employer with the local office of the EEOC (generally within 180 days of the adverse job action) at which point the EEOC commences a preliminary investigation. • During and immediately after the investigation, the EEOC is required by statute to engage in conciliation negotiations in an attempt to settle the case. • If efforts at conciliation fail, the EEOC may choose to file suit against the employer on the employee’s behalf or may decide not to take any action at all. • After 180 days have passed from the time of the complaint, the employee may demand that the EEOC issue a right to sue letter, entitling the employee to file a lawsuit in a federal court. H. Employer Defenses [P.386] Points to emphasize: • Though each antidiscrimination statute has its own set of legally recognized employer defenses, there is some level of commonality among these defenses. • Business Necessity: Broad defense to employment discrimination used when a business can justify discrimination on the basis that it is legitimately necessary to the business operations of the company (e.g. accounting degree for an accounting firm). • Bona Fide Occupation Qualification: Federal antidiscrimination statutes allow employers to hire and employ on the basis of religion, gender, or national origin in certain instance where the classification is a BFOQ that is reasonably necessary to the normal operation of that particular business or enterprise (e.g. employment of clergy). o On BFOQ cases that are unclear, the employer must prove that members of the excluded class cannot safely and effectively perform essential job duties. (Landmark) Case 13.4: Diaz v. Pan Am, 442 F.2d 385 (5th Cir. 1971) [P. 387] Facts: Diaz was denied a job as a flight attendant with Pan American Airlines because the airline had a policy that only a woman could be hired as a flight attendant. Diaz filed a complaint with EEOC alleging that Pan Am’s policy was a violation of Title VII because he faced hiring discrimination based on his gender. Pan Am argued that gender was a bona fide occupational qualification (BFOQ) for the position because expert studies had determined that women were better in non-technical aspects of the job such as reassuring anxious passengers. Issue: Is customer preference and non-technical aspects a legitimate part of Pan Am’s BFOQ defense? Ruling: No. The court rejected Pan Am’s arguments and ruled that the EEOC guidelines require that BFOQ defenses based on gender be interpreted narrowly. In this case, the court held that Pan Am’s assertion that women were better in non-technical aspects of the job may be important, but are not directly relevant in a BFOQ analysis. Similarly, the court also ruled that customer preference for a certain gender is not consistent with EEOC’s guidelines. Case Questions: 1. If customers truly overwhelmingly prefer one gender over another in certain jobs, is it fair or appropriate to force the public to be uncomfortable or unhappy in order to prevent sexual discrimination? Answer: There may be certain situations where preference could be legitimate (medical staff of a particular gender for patient modesty). But imagine using any other category (e.g., race). Would courts agree to preference for a particular race? 2. Why did the court decide that sex was not a BFOQ to qualify as a flight attendant? Answer: EEOC guidelines are very specific that refusal to hire cannot be based on preferences of customers. The primary function of Pan Am is transportation, so the gender preference has to be related to the essential function (operations of an airline). 3. Would the decision be the same if, instead of sex, the BFOQ was based on race, national origin, or religion? Why or why not? Answer: Yes. The court’s function was the primary function of the business. No one suggested that having male stewards would impede the operations of the airline and it is doubtful that any court would agree that other categories would impede airline operations. 4. Whether sex discrimination can be a BFOQ is interpreted narrowly by the EEOC, whose guidelines were adopted by the circuit court. Identify situations in which sex could be defended successfully as a BFOQ. Answer: Health care (patient privacy); Actor (primary function of job); Certain employee locker room situations (employee privacy). • Seniority: A defense for employers using a seniority system as the basis for certain job decisions if the seniority system is based on objective elements of seniority and the employment decisions are made in good faith and pursuant to that established objective system. • Employee Misconduct: When an employee commits an act of misconduct, so long as that act has been identified to the employee as misconduct, employers may discipline the employee in accordance with the company’s general practices without liability for discrimination. Legal/Ethical Reflection and Discussion: BFOQ and Reports in Locker room [P. 388] [Teaching tip: This feature ties directly to Diaz v. Pan Am P. 387]. I. Affirmative Action Programs [P.388] Points to emphasize: • Affirmative action as it is understood today includes, but goes beyond, outreach attempts to recruit minority applicants, special training programs, and the reevaluation of the effect of selection criteria. • Affirmative action plans may be adopted voluntarily by employers and may also be imposed on an employer by courts as a judicial remedy when finding that the employer acted in a pattern of egregious discrimination against employees. • Legality: Although federal antidiscrimination statues do not require employers to give preferential treatment to minority employees, the Supreme Court has upheld the constitutionality of Executive Order 11246 and has allowed certain affirmative action plans to apply to private employers as a condition to a contract with the federal government. J. State Antidiscrimination Statutes [P.389] Points to emphasize: • Each state has its own statutes that are often modeled after the federal statutes and have their own administrative agencies charged with enforcing and adjudicating discrimination cases. • State antidiscrimination statutes sometimes differ substantially from federal laws in two ways: (1) state statutes tend to cover more employers, with some statues imposing antidiscrimination statutes on small businesses with just one employee; and (2) some states have expanded protected class membership, most notably, to discrimination based on sexual orientation or gender transformation. Case 13.5 Enriquez v. West Jersey Health Systems, 342 N.J. Super. 501 (N.J. Super. Ct. App. Div. 2001) [P.390] Facts: Enriquez, a biological male, was hired as a medical director by Health Systems and subsequently began an external transformation from male to female as a result of his gender identity disorder. During the transformation, Enriquez’s co-workers and managers voiced discomfort with the transformation and a manager requested that Enriquez halt the transformation process and go back to her prior appearance. When her contract came up for renewal, Enriquez was told that her contract would not be renewed unless she ceased the transformation. Enriquez refused and she was terminated. Issue: Can Enriquez be a member of a protected class under state antidiscrimination statutes even though Title VII does not bar discrimination based on sexual orientation or gender identity disorders? Ruling: Yes. While Title VII does not bar discrimination based on sexual orientation or gender identity disorders, New Jersey’s Law Against Discrimination (LAD) does. Since the LAD makes it unlawful to discriminate against someone based upon sex and affectional or sexual orientation, individuals who were transsexual or affected by a gender identity disorder were also considered to be members of a protected class and were protected from discrimination. Answers to case questions: 1. Why couldn’t this case have been covered by Title VII on the basis of gender? Answer: This case could not have been covered by Title VII on the basis of gender because federal statutes are relatively conservative in exactly what constitutes a protected class and Title VII does not contain language barring discrimination based on one’s affectional or sexual orientation. 2. If Enriquez’s employment with Health Systems were not terminated would she still have a claim for discrimination? Would the conduct of her co-workers and managers have been sufficient to prevail on a discrimination suit? Why or why not? Answer: If Enriquez’s employment with Health Systems were not terminated she could still have a claim for discrimination under sexual harassment by contending that the conduct of her co-workers and managers created a hostile work environment. Sexual harassment claims are different than a typical discrimination case where the employer must have actually taken some adverse action for a violation to occur. Whether or not the conduct of her co-workers and managers would have been sufficient to prevail on a discrimination suit is variable because there is no formula for determining a hostile work environment and more details would be needed. END OF CHAPTER PROBLEMS, QUESTIONS AND CASES Theory to Practice [P. 392] 1. Curt’s claim against his employer would likely involve Cleaning, Inc.’s violation of Title VII of the Civil Right Acts of 1964. The employer is covered by the federal statute because there are more than 15 full time employees. Because this was essentially overt discrimination, the theory would likely be disparate treatment. [Ties to Title VII/ Theories of Discrimination]. 2. Curt’s burden is to prove several factors under the McDonnell Douglas standard: (1) Curt’s membership of a protected class, (2) that he was qualified for and applied for a job, (3) was rejected, and (4) the position was filled by a nonclass member—in this case a woman. [Ties to Disparate Treatment]. 3. Cleaning, Inc.’s best defense to any claim of discrimination is that being a woman is a bona fide occupational qualification (BFOQ) or that business necessity requires that a woman be hired. [Ties to Employer Defenses]. 4. Curt may not file suit immediately. He must use the EEOC procedure by notifying EEOC of the violation. After EEOC investigates, they may attempt to bring enforcement action against the employer or they may decline to pursue the case. If EEOC declines to pursue the case, Curt may obtain a “right to sue” letter from EEOC. This allows him to pursue the employer for discrimination in a federal court. [Ties to Procedures for Asserting a Claim]. 5. Curt would not be covered under Title VII for this type of discrimination because sexual orientation or transsexual operations are not protected classes under the federal statutes. [Ties to State Antidiscrimination Statutes]. 6. Some states, such as New Jersey, have broadened state anti-discrimination laws to include sexual orientation and transsexuals as protected classes [Ties to Enriquez case]. Manager’s Challenge [P. 392] A sample answer to all Manager’s Challenge questions is provided in the student and instructor versions of this textbook’s Web site. Case Summary 13.1: Title VII: Dumas v. Union Pacific Railroad Co. [P.392] 1. Does Dumas have a valid employment discrimination claim? Answer: Yes Dumas has a valid employment discrimination claim as long as he can establish that the audit was a pretextual reason for his termination. 2. If so, what theories would be best advanced by Dumas? Answer: A mixed motives theory would be best advanced by Dumas because it appears that legitimate motives (the falsified records) were mixed with illegitimate motives (retaliation for his testimony against the company). Case Summary 13.2: ADEA: Harding v. CareerBuilder, LLC. [P.393] 1. Does Harding have a claim for employment discrimination under ADEA? Why or why not? Answer: Most likely, Harding would not have a claim for employment discrimination. If MCC can show that Harding’s performance was lacking based on their legitimate expectations then he would not meet the second prong (satisfactory job performance) under the modified McDonnell Douglas standard applied to the ADEA. Additionally, Harding would likely fail to meet the fourth prong of this standard because the general rule is that the age difference must be at least 10 years in order to qualify as substantially younger. Here, Harding was replaced by Carey who is only 9 years younger. 2. Would your answer change if Carey was 24, 39, or 45? Explain. Answer: If Carey was 24 or 39 (45 would result in preceding analysis) then he may have a claim for employment discrimination under the ADEA if he can show that his job performance was satisfactory. Following the general rule, a 24 or 39 year old replacement would be substantially younger. Case Summary 13.3: ADA: U.S. Airways, Inc. v. Barnett [P.393] 1. Does Barnett have a cause of action under the ADA? Why or why not? Answer: Most likely, Grant would not have a cause of action under the ADA because USA’s reassignment to a luggage deliver would constitute a reasonable accommodation for his disability. 2. Has USA fulfilled their duty of reasonable accommodation? Answer: Yes, because a reasonable accommodation may include reassignments to vacant positions. The ADA does not require USA to assign Barnett to the mailroom position in violation of the established seniority system because doing so could constitute an undue hardship. Case Summary 13.4: State Antidiscrimination Protection: Hope v. California Youth Authority [P. 327] 1. Is Hope a member of a protected class under Title VII? Answer: Hope is not a member of a protected class under Title VII because federal statutes are relatively conservative in exactly what constitutes a protected class, and sexual orientation is not included. 2. Can he bring a federal claim for employment discrimination? Answer: Because Hope is not a member of a protected class under Title VII, he would be unsuccessful in bringing a federal claim for employment discrimination. 3. Suppose California has a state antidiscrimination statute that protects sexual orientation. Would Hope have a state claim for discrimination? Why or why not? Answer: If California has a state antidiscrimination statute that protects sexual orientation, Hope would have a state claim for discrimination because such a statute would expand protected class membership to cover Hope. 4. Had Hope not been terminated, would he have had a claim? Why or why not? Answer: If Hope had not been terminated, he may still have a claim under sexual harassment because in Oncale v. Sundowner Offshore Services, Inc the court recognized sexual harassment as a form of discrimination regardless of the gender of the victim or the harasser. Case Summary 13.5: Pretext: Schroer v. Billington [P. 394] 1. What should Preece have done after being informed by Schroer of her imminent sex change? Answer: Preece should have tried to verify that Schroer’s operation would have an impact on her clearance and contacts. He came to these conclusions without any evidence. 2. Were Preece’s reasons for rescinding the job offer defendable or a pretext for discrimination? Answer: On one hand, the CRS has an interest in the trustworthiness of its applicants and the fact that Schroer did not disclose the operation impacts that interest. On the other hand, Schroer’s experience and level of expertise were the only legitimate factors in the inquiry and the timing of her disqualification makes the decision subject to the notion of pretext. The court held that CRS’s reasons were pretextual. 3. Is stereotyping discrimination based on sex? Why or why not? Answer: This question is intended to spur debate on the stereotyping based on gender or based on the change in gender. If the rescission of the offer was based on Schroer’s gender, that is a Title VII violation. If it was made on the basis of transgender, Schroer is not protected under Title VII. Case Summary 13.6: Race Discrimination: Bradley v. Pizzaco [P. 394] 1. Is customer preference a persuasive argument for this policy? Why or why not? Answer: The court held that customer preference was not a persuasive argument in this case because the beard is not connected to the ordinary function of the business (making and delivering pizza) and no survey showed that customers would order less pizza in the absence of a strictly enforced no beard rule. 2. Is this a disparate treatment or disparate impact case? Answer: Disparate impact. The same rule is being applied to all employees, but the impact of the rule is on a protected class who suffered from PFB). No single employee is being singled out. 3. What would Domino’s have to have proved to successfully support a business necessity claim? Answer: They would have to prove that the policy had some business justification and that the business shad a compelling need for the strict n- beard policy as applied to those afflicted with PFB. 4. How could a manager allow an exception for an employee claiming PFB yet maintain the no-beard policy for other employees? Answer: this question is intended to spur discussion on the realities of managing a workforce when Title VII requires certain policies to have exceptions if the policies have a disparate impact on a protected class. UNIT THREE FLEXERCISE [P. 396] The nature of the flexercise is to stimulate debate and discussion. Many of the questions should be “Student answers will vary” the student is not wrong if they don’t state the “answers” provided below as long as the student’s reasoning is well thought out and defended. Unit Three Flexercise: 1. Are employees generally eligible for compensation for on-the-job injuries regardless of fault, and are there exceptions, such as disregarding safety rules? Answer: No. An employee is generally eligible for any on the job injuries regardless of fault or negligence. One exception is if the employee disregarded an employer’s safety rule. A sign on the machine warning of the danger is not an employer safety rule. 2. Would a written warning from the employer about safety rules serve as a valid defense if an employee violates those rules? Answer: Yes. Such a written warning, barring specific actions, would have put the employee on notice and the violation of the rule would be an employer defense. 3. How should a company formulate and communicate safety rules to ensure they are effectively implemented and enforceable? Answer: Student answers will vary. There is no correct answer and students can argue both sides. A company should develop clear, specific safety rules and communicate them through multiple channels, including written policies, signage in relevant areas, and regular training sessions. Ensuring that these rules are consistently enforced and reviewed will enhance their effectiveness and enforceability. 4. What steps should a company take to clearly formulate and prominently advertise workplace safety rules to employees? Answer: At minimum, specific clear rules must be formulated and advertised prominently. A company would need to place workplace rules not only on their website, but conspicuously in areas where safety rules will apply. Discussion of safety rules can also be prominent parts of employee meetings, individual contracts and union contracts (if any). Quick Assessment Questions (QAQs) 1. Which theory of discrimination involves overt and intentional discrimination? a. Disparate impact b. Disparate motives c. Pretextual motives d. Disparate treatment e. None of the above Answer: d 2. Which defense would be best advanced by an employer defending a lawsuit whereby a male contends discrimination when he is not hired to perform a female role in an upcoming theater production? a. Business Necessity b. Bona Fide Occupation Qualification c. Seniority d. Employee Misconduct e. Gender Necessity Answer: b 3. Which of the following is not a protected class under Title VII? a. National origin b. Pregnancy c. Religion d. Sexual orientation e. None of the above Answer: d 4. The ADAAA narrowed the definition of what disabilities were covered under the ADA. Answer: False 5. In order for an employee to file a sexual harassment claim, the employer must have actually taken some adverse action against the employee. Answer: False 6. Title VII only covers an employer’s discriminatory decision when it was based on the employee’s membership in a protected class. Answer: True Chapter 14: Choice of Business Entity, Sole Proprietorships, and Partnerships OVERVIEW This chapter begins a new unit that covers business entities, securities regulation, and corporate governance. Chapter 14 introduces the wider concept of choice of business entities, and then gives specific coverage to the law of sole proprietorships and partnerships. KEY LEARNING OUTCOMES Outcome Accreditation Category Articulate the factors that business owners should consider when selecting a business entity Knowledge, Analysis List the elements required to form a general partnership and the statutory requirements for forming a limited partnership and recognize the effect and role of the RUPA on general partnerships and the RULPA on limited partnerships. Knowledge, Analysis Identify methods through which sole proprietorships and partnerships may be capitalized (funded), and give examples of personal liability for general partners and limited partners. Knowledge, Critical thinking, Analysis Articulate the consequences of partner separation and dissolution and the difference depending on circumstances. Analysis TEACHING OUTLINE A. Choosing a Business Entity [P.409] Points to emphasize: • In choosing a business entity, principals should consider at least the following factors: formation, liability, capitalization, taxation of income, and management and operations. • Table 14.1: Common Forms of Business Entities [P.410] • Sole Proprietorships: The easiest single-person ownership entity to form and maintain with low start-up costs and minimal filing. o Typically capitalized using a proprietor’s personal assets or a bank loan secured by personal assets. o All income taxes of the business are paid at the proprietor’s individual tax rate and reported on the proprietor’s individual income tax return. o No restriction in terms of the number of employees or operating in as many locations as the principle desires. o The chief drawbacks to this form are that all debts and liabilities of the business are also personal debts and liabilities of the principle, and that the entity may not sell equity in the business in order to raise money to operate the proprietorship. Case 14.1: Vernon v. Schuster, 683 NE2d 1172 (Ill. 1997) [P. 412] Facts: James Schuster was a sole proprietor doing business as Diversey Heating and Plumbing (Diversey) and contracted with Vernon to install and maintain a boiler in his building. Schuster also promised Vernon a 10-year warranty. Schuster performed the services for a period three years, but died in October After Shuster died, his son Jerry Schuster began to operate Diversey and servicing Diversey customers. In February 1994, Vernon discovered that the boiler was broken beyond repair and needed to be replaced. Vernon brought a breach of warranty lawsuit against Jerry Schuster on the basis that he had continued the sole proprietorship that his father had started and therefore Jerry Schuster should honor the warranty given by James Schuster. Issue: Is Jerry Schuster liable for the obligations of his father’s sole proprietorship interest? Ruling: No. The Illinois Supreme Court found in favor of Schuster and held that a sole proprietor does not have a legal identity separate from that of the individual that owns it. Although the sole proprietor may do business under a fictitious name, the principal does not create an entity distinct from the person operating the business. Case Questions: 1. A dissenting opinion in this case argued that Jerry Schuster did carry on his father’s business and should be liable for obligations of the continued business. Does that strike you as reasonable? Shouldn’t a warranty be valid so long as the business that provided the warranty is still operating? Answer: On the one hand, it is an issue of fairness to the consumer. As far as Vernon knew, the business was still operating and providing service. On the other hand, a sole proprietorship is a non-transferrable entity and Schuster’s taking over his father’s customers is not the same as Schuster buying a business entity from his father and running it. 2. If Jerry Schuster changed the name of the business, but still used the tools and equipment he inherited from his father, how would that impact your analysis of this case? Answer: It would have been much clearer to the consumer that Diversey no longer existed and therefore Schuster would not honor any Diversey warranties. Chalk Talk: Forms of Entity If you have sufficient space on the board, I find that students benefit from use of a chart on the board that is filled in as I go along in my lecture. I put the types of entities on the top horizontal axis and the various factors to consider on the vertical side—then fill in as I cover each item. • Partnerships: Multiple-person business entity where the partners conduct an ongoing business relationship in which profits and losses are shared. o General Partnerships (designated as GP): A subcategory of a partnership whereby the law recognizes two or more principles or entities as being a general partnership if they have demonstrated an intent to carry on as co-owners of a business for profit. o In the absence of an agreement the Revised Uniform Partnership Act (RUPA) governs a general partnership. • Formation: No formal document or government filing is necessary to form a general partnership; in fact, the parties may not actually intend to be partners but the law still recognizes their relationship as an implied partnership. • Conversely, even if the parties label themselves as general partners and draft a partnership agreement, this does not, in and of itself, form a general partnership. • A joint venture is when the parties only wish to have a limited-in-time relationship instead of an ongoing business entity and is governed by the same legal principles as general partnerships. • Liability of the Principles: General partners’ personal assets are at risk for the full amount of the debts and liabilities of the partnership jointly (all partners together) and severally (each and every partner separately) regardless of their percentage of ownership interest in the partnership. • Capitalization: Generally funded through either debt or through selling of equity or some combination of the two (partnerships may not, however, sell ownership rights through the public markets). • Taxation of Partnership and Principals: All income tax of the business passes through the partnership, is distributed to the partners, and is paid at the individual tax rate of the receiving partner. The partnership entity itself does not file a tax return, but does file an information return for purposes of providing the government with documentation regarding how much, when, and to whom profits were paid. • Operation and Management of the Partnership: Absent and agreement by the parties, the RUPA governs certain internal operation of the general partnership. • Partners who provide labor to the partnership are not entitled to any compensation (other than a share of profits) for this work unless the principals have agreed ahead of time to certain compensation terms. • The default rule is that the partners share equally in profits and losses. • Fiduciary Obligations: General partners have the fiduciary duties of loyalty, care, and good faith that ensure they are acting in the best interest of the partnership. Case 14.2: Waddell v. Rustin, Tenn. Ct. App. (2011) [p. 414] Facts: Waddell and Rustin entered into a romantic relationship soon after meeting in 1999. Waddell maintained that their association started as personal and also grew into a business partnership. Rustin denied that they were ever express or implied business partners. Waddell claimed that she had management and oversight over Rustin’s business projects, access to the company checkbook, paid company bills, helped Rustin chose construction projects, and changed the store's name. When the personal relationship ended, Waddell brought suit claiming that she was entitled to a percentage of the profits as an implied partnership. Issue: Was an implied partnership was created? Ruling: No. The court ruled that because there was no written partnership agreement between Waddell and Rustin, Waddell bore the burden of proving the existence of a partnership by clear and convincing evidence. Waddell did not contribute equipment, experience, or capital. Case Questions: 1. Given the court’s ruling, what could Waddell have done differently to ensure that she would have had partner status? Answer: At the very least, the Waddell should have a written partnership agreement. Also, some type of state filing of a “Certificate of Partnership” etc. would be helpful in establishing a partnership existed. 2. At what point does a personal relationship rise to an implied partnership? Answer: An implied partnership has the same elements as any general partnership: Intent to carry on as co-workers of a business to share profits and losses. Once the parties demonstrate intent to carry on as co-owners and share profits of an ongoing business operation, a partnership is formed. o Limited Partnerships (designated as LP): An entity that exists by virtue of a state statute that recognizes one or more principals as managing the business enterprise, while other principals participate only in terms of contributing capital or property. • In the absence of an agreement, the Revised Uniform Limited Partnership Act (RULPA) governs a limited partnership. • Formation: Formed by the general partner filing a certificate of limited partnership with the state government authority (Figure 14.1: Sample Certificate of Limited Partnership for Redfern Catering, LP [P. 418]). • Personally Liability of Principals: Each general partner in a limited partnership is personally liable for all of the partnership’s debts and liabilities; however, the limited partner’s liability is limited to whatever the limited partner contributed to the partnership. • The primary exception to the liability rule whereby a limited partner can be personally liable is when a limited partner acts illegally or negligently within the scope of partnership duties. • Capitalization: Generally funded through either debt or through selling of equity, however limited partnerships may not sell ownership rights through the public markets. • Taxation of Partners and Partnership: All income tax of the business passes through the partnership, is distributed to the partners, and is paid at the individual tax rate of the receiving partner. The general partner is responsible for filing an information return with taxing authorities, but limited partnerships do not pay corporate taxes. • Management and Operation of the Partnership: General partners manage the business and are permitted to bind the partnership; however, limited partners may not participate in daily management of the business, do not have authority to bind the partnership, and remain primarily as investors. • Limited partners do have the right to access partnership information about the business and general information about the partnership’s information. • The partnership agreement may expand the limited partner’s role in management (though not to the point of day-to-day involvement) and may also expand her rights and prerogatives. • The default rule is that the partners share in profits and losses in proportion to “the value of contributions made by each partner to the extent they have been received by the partnership and have not been returned.” • Regardless of specific agreements and labels, courts employ a substance over form analysis focusing on the principal’s conduct in determining whether a partner maintains a limited partner status. • Family Limited Partnerships: A limited partnership that is used for estate planning for families of considerable wealth to allow wealthy members of one generation to distribute assets to heirs using a method that allows the distributing generation to claim a much lower market value than the actual market value of the gift. Case 14.3 United States v. Morton, 682 F. Supp. 999 (E.D. Mo 1988) [P.421] Facts: Dormilee Morton inherited the assets of her husband’s construction company and her son Steven Morton ran the day-to-day operations of the business as a limited partnership indicated by the business tax returns filed by Steven and by Mrs. Morton’s personal tax returns. During the 5 years of the partnership’s existence, Mrs. Morton signed for bank loans as “Dormillee Morton and Steven Morton d/b/a Morton Construction Company,” she provided additional capital for the business when needed, and her home phone number and address were listed as the principal place of business for Morton Construction. When the IRS assessed Morton Construction in back taxes and penalties, they pursued Mrs. Morton as a general partner because Steven and the business with without assets and Mrs. Morton defended on the basis that she had been nothing more than a limited partner and thus insulated from liabilities of the partnership. Issue: Is Morton Construction a limited partnership as labeled in both the business and individual tax returns? Ruling: No. The question is not how did they label themselves or how did they sign certain documents or what they called themselves; rather, the question is: did the principals operate as a limited partnership? Mrs. Morton participated in the business in the same way as a general partner would and, thus, has no limited liability status. Answers to case questions: 1. What could Dormilee Morton have done to strengthen her status as a limited partner? Answer: Dormilee Morton could have complied with the state statutory requirements for establishing a limited partnership and she could have conducted herself in a number of ways to limit her general involvement in the business to strengthen her status as a limited partner. She could have started by filing a certificate of limited partnership for Morton Construction with the state in which the business operates. Second, she could have listed the business phone number and address under Steven’s name to limit her involvement in the day-to-day operation of the business. Third, she could have had Steven take out debt or sell equity to provide for additional capital instead of contributing all capital assets herself. Lastly, she should not have taken a 50 percent business loss on pervious tax returns nor should she have granted the bank and security in interest in their equipment. Such conduct is indicative of a general partnership and weakens her status as a limited partner in a substance over form analysis. 2. Both Mortons testified that Mrs. Morton was only involved in a very small part of the business and that Steven had taken charge over all financial and tax affairs. Do you think it is fair to hold a widow responsible for the misdealing or ineptness of her son in this case? Answer: Though the result might not have been the most equitable, it is reasonable for one to conclude that Mrs. Morton cannot escape liability on the basis of her sons misdealing or ineptness. Mrs. Morton essentially contributed everything to the business and should therefore be held liable for the partnership because she jeopardized her limited partnership status and failed to structure the limited partnership appropriately. Though it can be argued that the result was unfair, her son’s ineptness is not a legally recognizable defense in this case and she could have taken measures to shield herself from liability. Concept Summary: Sole Proprietorships vs. Partnerships [P.422] • Partner Dissociation and Dissolution of the Partnership: When a partner no longer wishes to be a principal in the partnership, she may choose to leave the partnership through either dissociation (RUPA) or withdrawal (RULPA). o Dissociation under the RUPA: The RUPA lists a variety of events of dissociation that are termed rightful dissociations, including voluntary separation, expulsion, incapacity, and death. • In a rightful dissociation, the withdrawing partner is no longer liable for post-dissociation liabilities of the partnership. • A wrongful dissociation occurs if a partner’s withdrawal violates the partnership agreement of if a partner withdraws from a partnership before the expiration of a previously agreed upon time has elapsed and the wrongfully dissociated partner is liable for any damages the withdrawal caused. • When a partner dissociates herself from the partnership, the partnership does not automatically dissolve so long as the remaining partners wish to continue. • If the remaining principals wish to dissolve the partnership after dissociation, the process of winding up is triggered where the debts of the partnership are paid and remaining assets are liquidated/distributed before the partnership is officially terminated. o Withdrawal under RULPA: The RULPA plays a less significant role in a limited partnership context because so many limited partnerships operate under detailed agreements. • The default rule under RULPA for general partners is that they may withdraw at any time without causing dissolution of the partnership provided that (1) the partnership still has at least one remaining general partner, and (2) all of the partners agree in writing to continue the partnership. • If the partner’s withdraw does not result in dissolution of the partnership, the partnership must pay the departing partner the fair market value of her interest in the limited partnership within a reasonable time after withdrawal. • The default rule under RULPA for limited partners is that they may not withdraw from a partnership before the time that the partners have agreed that the partnership will terminate. Self-Check: Rules for Withdrawal: Is there a basis for rightful dissociation? [P.424] o Other Events of Dissolution: Partnerships may also be dissolved if the partnership has reached its agreed upon term, by court order, or by unanimous consent of the parties. Concept Summary: Partner Dissociation/Withdrawal and Dissolution of the Partnership [P.424] Franchises: A Method Rather than an Entity [P. 425] • Franchises are a method of conducting business and not a business entity, whereby franchisors enter into a contractual agreement with franchisees that allow the use of the franchisor’s business model, expertise, and trademarks in operating the business. o Franchise Agreements: Governs the relationship between the franchisee and the franchisor by covering (1) the term of the agreement; (2) the fees, payment terms, and ongoing investment or buying terms; (3) territory rights; (4) commitments from the franchisor for training, management support, and advertising; (5) commitments from the franchisee to follow operating protocol; (6) royalties and other fees that the franchisee must pay; and (7) franchisee termination/cancellation policies. • The FTC and Franchises: The FTC is the federal regulatory authority that oversees the regulation of franchisors to ensure full disclosure of all information relating to a franchise company prior to a franchisee investment. Franchises are a method of conducting business and not a business entity, whereby franchisors enter into a contractual agreement with franchisees that allow the use of the franchisor’s business model, expertise, and trademarks in operating the business. o Franchise Agreements: Governs the relationship between the franchisee and the franchisor by covering (1) the term of the agreement; (2) the fees, payment terms, and ongoing investment or buying terms; (3) territory rights; (4) commitments from the franchisor for training, management support, and advertising; (5) commitments from the franchisee to follow operating protocol; (6) royalties and other fees that the franchisee must pay; and (7) franchisee termination/cancellation policies. o The FTC and Franchises: The FTC is the federal regulatory authority that oversees the regulation of franchisors to ensure full disclosure of all information relating to a franchise company prior to a franchisee investment. o State Franchise Regulations: Most states have implemented their own individual franchise rules and minimum disclosure requirements to supplement the federal legislation, usually in the form of a registration statement filed with a state regulatory agency. END OF CHAPTER PROBLEMS, QUESTIONS AND CASES Theory to Practice [P. 427] 1. Although the parties never entered into an express partnership, their actions of carrying on the business demonstrate intent to conduct business together and share the profits and losses. This creates a general partnership. General partnerships are typically recognized under state statutes that are ordinarily adopted by state legislature based on the Revised Uniform Partnership Act. [Ties to Partnerships]. 2. If the venture runs out of money, Demuth, Warren, and Oakley will all have personal liability exposure for the debt owed to Strand. Demuth had the authority to bind the partnership and general partners have joint and several liability for all debts and liabilities of the partnership. The debt to Strand owed by the partnership is also owed by the partners individually. [Ties to General Partnerships]. 3. When one partner exercises an event of dissociation, the RUPA distinguishes between rightful or wrongful dissociation. If Oakley’s dissociation is wrongful (probable), she is liable to the partnership for existing liabilities of the venture, and to the other partners for damages caused by the dissociation. Thus, Oakley’s liability for the debt to Strand is not extinguished.[Ties to Partner Dissociation and Dissolution of the Partnership]. 4. If Oakley’s wrongful dissociation causes additional damages to the partnership’s interests, the RUPA imposes liability on the departing partner for any damages that were triggered by the partner’s dissociation. Here, Oakley would have liability to Demuth and Warren for any damages suffered by the partnership breaching the vendor contracts.[Ties to Partner Dissociation and Dissolution of the Partnership]. 5. The parties should consider at least the following factors when deciding on a business entity: formation issues, liability, capitalization, taxation, and management/operation of the venture. [Ties to Choosing a Business Entity]. Manager’s Challenge [P. 428] Sample answers to all Manager’s Challenge exercises are provided in the student and instructor’s versions of this textbook’s Web site.. Case Summary 14.1: Partnership Liability: Conklin v. Holland [P.428] 1. Was there a partnership? Answer: Yes a partnership was formed between Lewis and Holland because they were an association of two or more people, who were co-owners and co-managers of the property, and wished to share in the profits of the resale. 2. What was the partnership formed to do? Answer: This partnership was formed to purchase a rundown home, renovate the home, and sell the home for profit. If this was a limited-in-time relationship for just this one property then Lewis and Holland would be operating under a joint venture, governed by the same legal principles as a general partnership. 3. As a practical matter, why would the Conklins sue Holland instead of Lewis for partnership liability? Answer: Because Holland and Lewis are jointly and severally liable, as a practical matter the Conklins may sue Holland instead of Lewis for the entire judgment because Lewis may be without sufficient assets. Case Summary 14.2: Fiduciary Duty: Meinhard v. Salmon [P.429] 1. Who did the court side with? Answer: The court sided with Meinhard in that Salmon breached his fiduciary duty. 2. What duty did Meinhard claim was breached? Answer: Meinhard claimed that Salmon breached his fiduciary duty of loyalty because he used the partnership property for personal gain at the expense of the interests of the entity. 3. Does fiduciary duty end when the partnership expires? Answer: The fiduciary duty ends when a partner exercises a rightful dissociation of the partnership which is not found in the case at bar. Case Summary 14.3: Good Faith: Rahemtulla v. Hassam [P.429] 1. What duties did Hassam owe Rahemtulla? Answer: As a partnership, Hassam owed Rahemtulla the fiduciary duties of loyalty, care, and good faith. 2. Does it matter that Rahemtulla made foolish decisions when he trusted his friend? Answer: Despite foolish decisions in trusting his friend, Hassam still owes Rahemtulla a good faith obligation as the underlying duty for all actions taken by general partners in carrying out partnership interests. 3. What is the potential conflict when Hassam creates a partnership to lease from another partnership he is part of? Answer: When Hassam creates a partnership to lease from another partnership he is part of, this creates a conflict of interests between the fiduciary duties he owes to partners from each venture. Acting in good faith to the partner in which he owned the hotel with may require breaching his duty of good faith owed to Rahemtulla. Case Summary 14.4: Limited Partners: In re Spree.com Corp. [P.430] 1. Who prevails and why? Answer: Spree.com may prevail on the breach of duty claim because though limited partners do not generally owe fiduciary duties to the partnership or to other partners and exception may be made in this case because Testler was a member of the board of directors on Spree.com. 2. Does this case show potential problems with venture capital firms as limited partners? Answer: Yes, absent defined fiduciary duties owed to the partnership, limited partners can act inconsistently with the best interest of the business and this can have devastating effects as is seen in the Spree.com’s case. Venture capital firms often hold the purse strings as limited partners and as such, can make or break the business with their actions. 3. Was TCV in “control” of Spree.com because they held the purse strings? Answer: No, though they financially contributed to the company, “control” in the context of partnership law is the daily management of the business and the authority to bind the partnership. Case Summary 14.5 Clancy v. King [P.430] 1. Are there any circumstances under which there could be a good faith reason for Clancy to withdraw the right to use his name? Answer: There are circumstances under which there could be a good faith reason for Clancy to withdraw the right to use his name. For example, suppose the series using Clancy’s name replaced the original author or that author’s style of writing turned out to be substantially different than expected. Clancy agreed to lend his name because the author chosen was using a “Clancy-esque” writing style. Because Clancy is lending his name to the series, his reputation is at stake and an author writing in a style other than “Clancy-esque” could tarnish this reputation. Withdrawing the right to use his name in this circumstance would be a good faith reason to uphold the Clancy brand name. Similarly, if the series turned out to be financially unsuccessful, Clancy would be acting in good faith to remove his name and any resources of the partnership because the objective of the partnership is to generate profits. 2. Why didn’t the provision effectively waiving a breach of duty of care lawsuit by one partner against another govern this dispute? Answer: The provision effectively waiving a breach of duty of care lawsuit by one partner against another did not govern this dispute because good faith is an underlying duty for all actions taken by the general partners in carrying out partnership interests and cannot be bargained away. Quick Assessment Questions (QAQs) 1. What is the term used to describe when two or more parties only wish to have a limited-in-time relationship instead of an ongoing business entity? a. Sole Proprietorship b. General Partnership c. Joint Venture d. Venture Capitalist e. Limited Partnership Answer: c 2. Which of the following entities are pass-through entities for taxation purposes? a. Sole Proprietorship b. General Partnership c. Limited Partnership d. b and c e. All of the above Answer: e 3. Mitchell wants to start up a small landscaping company and projects relatively low annual revenues and expenses. Which of the following would be his best choice of business entity? a. Corporation b. General Partnership c. Sole Proprietorship d. Limited Partnership e. Joint Venture Answer: c 4. In a sole proprietorship, all debts and liabilities of the business are also personal debts and liabilities of the principal. Answer: True 5. Limited partners are jointly and severally liable for unpaid debts and liabilities of the partnership. Answer: False 6. The dissociation or withdrawal of a partnership results in automatic dissolution. Answer: False Chapter 15: Limited Liability Companies and Limited Liability Partnerships OVERVIEW This chapter continues the discussion of the forms of business entities by examining limited liability companies (LLCs) and limited liability partnerships (LLPs). These entities are first considered from a structural perspective, the coverage is then devoted to the law that governs their operations. KEY LEARNING OUTCOMES Outcome Accreditation Category Identify the sources and level of laws that govern LLP and LLC entities. Knowledge Provide examples of the legal protections from personal liability afforded of the principals in an LLC and LLP. Analysis, Critical thinking Explain the function of an operating agreement and the fundamental structure of an LLC. Knowledge, Application TEACHING OUTLINE A. Overview of LLCs and LLPs [P. 433] Points to emphasize: • A limited liability company (LLC) is a hybrid form of business entity that is designed to have characteristics of a partnership, while providing full protections afforded to the principals of a corporation. • A limited liability partnership (LLP) is a form of business entity that provides the limited liability for partners. • While LLCs and LLPs are similar in many ways to corporations and partnerships, the legal terminology for describing procedural and governance aspects of these entities is different. • Limited Liability Companies (designated as LLC): Entities whose primary characteristics are that it offers its principals the same amount of liability protection afforded to principals of a corporate form of entity, and it offers pass-through tax treatment for its principals without the restrictions on ownership and scope required for other pass-through entities. o Formation: Formed by filing articles of organization with the state public filing official in the secretary of state’s corporation bureau (Figure 15.1: Sample LLC Certificate of Organization [P.436]). • LLCs are frequently governed by agreement of the parties in the form of an operating agreement and if no operating agreement is executed, state LLC statute sets out default rules. • One of the primary benefits of the LLC is that it affords its members a great deal of flexibility in terms of the rights and responsibilities of each member including the structure of governance and responsibility of members, death, incapacity, and dissolution. o Liability: LLC members and managers are not personally liable for any debts or liabilities of the LLC so long as state law conditions are met. However, creditors often require LLC members to sign personal guarantees and, in cases of fundamental unfairness, a court my disregard the LLC protections. o Taxation: All though many LLCs are typically treated as a pass-through entity, the LLC’s members may elect to be taxed as a corporation if they consider the corporate tax structure more favorable. o Capitalization: Capitalized primarily through debt via private lenders or commercial lenders, or by selling equity ownership in the LLC itself. o Management and Operation: In a member-managed LLC, the LLC management structure is similar to a general partnership with all the members having the authority to bind the business; in a manager-managed LLC, LLC members name a manager (or managers) who generally has the day-to-day operational responsibilities while the nonmanaging members are typically investors with little input on the course of business taken by the entity except for major decisions. • Managing members and controlling members owe a fiduciary duty to other members. • Dissolution of LLCs and Dissociation of Members: LLC laws define dissolution of an LLC as a liquidation process triggered by an event that is specified in the operating agreement or the majority of membership interests deciding to dissolve the company. o Dissociation occurs when an individual member decides to exercise the right to withdraw from the partnership and the remaining members may either continue the LLC or decide to trigger dissolution. Case 15.1 Lieberman v. Wyoming.com, LLC, 82 P.3d 274 (Wyo. 2004) [P.440] Facts: Lieberman was a member and employee of Wyoming.com, LLC, with a $20,000 ownership stake, but was terminated as an employee following a dispute occurring four years after formation. Lieberman served the LLC with a “notice of withdrawal” and demanded that the LLC pay for Lieberman’s “share of the company” in the amount of $400,000. The LLC held a vote in which they accepted Lieberman’s withdrawal, but offered him only $20,000 because that was his initial ownership stake. Lieberman rejected the $20,000 offer and the LLC filed suit asking for a declaratory judgment of its rights against Lieberman because the operating agreement was silent on the issue of dissociation. Issue: Where an LLC’s operating agreement is silent on the issue of dissociation, does a dissociating member have the right to demand a buyout? Ruling: No. Absent a provision in the operating agreement, state LLC statute does not provide for a buyout in the case of dissociation nor may the LLC force him to sell his interest. Lieberman continues to keep his interest in the LLC until dissolution. Answers to case questions: 1. Based on the court’s decision, what specific rights did Lieberman lose when he withdrew as a member of the LLC? Answer: Based on the court’s decision, Lieberman is no longer a member of Wyoming.com. As such, he forfeited his right to manage any day-to-day operational responsibilities and the authority to bind the business. Essentially, Lieberman is now only an investor who maintains an equity interest in the LLC. He lost his right to negotiate terms of a buyout and in accordance with their operating agreement, which is silent on the issue, must keep his interest in the LLC until dissolution. 2. What kind of language and methodology could be included in an operating agreement that could have prevented this dispute? Answer: Wyoming.com’s operating agreement could have contractually provided for a buy-out in order to prevent this dispute. For example, they could have mentioned that in the event of dissociation, the dissociating member is entitled to “X” amount of his interest should the remaining members wish to continue the LLC. Any analogous provision in the operating agreement that provided a method for calculating a member’s interest in the case of dissociation would have prevented this dispute without the need for a declaratory judgment. • Limited Liability Partnership (designated as LLP): LLP statutes provide general partnerships with the right to convert their entity and gain the protective shield ordinarily only afforded to limited partners or corporate shareholders. o Formation: Formed when a general partnership files a statement of qualification with the appropriate public official after the conversion of the partnership is approved by a majority of ownership. o Liability: Partners are generally not liable for the debts of the partnership, nor the liabilities of the other partners (some states impose conditions on these limits); however, partners are personally liable for their own negligence. • Some states provide liability shields for partners only when the liability arises from some negligence by another partner, but not for other types of liabilities such as those resulting from a breach of contract. • An increasing number of states require that the LLP and individual partners carry and maintain a certain amount of liability insurance as a condition of LLP formation. o Taxation: Treated as pass-through entities and because it is not a taxable entity, an LLP files an information return that informs federal and state tax authorities of the profits and losses of the LLP. o Capitalization: Capitalized through debt via private or commercial lenders, by selling partnership equity for ownership in the LLP itself, or by personal financial contributions of partners as controlled by the partnership agreement. o Management and Operation: Managed through managing partner(s) and/or executive committee (no officers, directors, or shareholders), and although not required by statute, the partnership agreement typically sets out the management and operational structure, procedures, and powers. Case 15.2: Dillard Department Stores v. Chargois and Ernster, 602 F.3d 610 (5th Cir. 2010) [P. 441]. Facts: Chargois and Ernster (C&E) were individuals who formed and registered a limited liability partnership to operate their law practice in 2002. In an attempt to solicit business, C&E developed a Web site in June 2003 which included a link using Dillard Department Stores’s corporate name and trademarked logo. Dillard's sued C&E for trademark infringement, but during the litigation, Chargois and Ernster executed a separation agreement that provided for dissolution of the partnership. C&E ‘s registration as an LLP was not renewed with state authorities and their registration expired later that same year. The court entered a final judgment ordering "Chargois & Ernster, L.L.P." to pay Dillard's $143,500. Issue: Are Chargois and Ernster personally shielded from any partnership liability or debt by the state LLP statute? Ruling: No. Chargois and Ernster were personally liable for the judgment owed to Dillard’s. The court found that the debt was incurred when the judgment was entered on November 2, 2004, at which time the LLP had lost its liability-limiting attributes and no longer protected Chargois and Ernster. Case Questions: 1. Should two partners who have agreed to separate be forced to continue the LLP’s existence for a certain period of time? Answer: Some states require that an escrow account be set up in order to resolve post separation liabilities such as this one. No, partners in an LLP who have agreed to separate should not be forced to continue the LLP’s existence if they wish to dissolve it. Partnership agreements and relevant laws typically allow for the dissolution or restructuring of the LLP based on the partners' mutual agreement. 2. Could it be argued that the debt actually was incurred once C&E had notice of that they had infringed on Dillard’s trademark? Answer: Possibly. On one hand, a debt is incurred when a party takes some action resulting in liability. On the other hand, no liability actually occurs until a court has decided that the parties are liable Concept Summary: LLCs and LLPs [P.442] END OF CHAPTER PROBLEMS, QUESTIONS AND CASES Theory to Practice [P. 442] 1. The court will likely support BHA. BHA’s theory of the case will be that since Luciano was a nonmanaging member of a manager-managed LLC, he did not have the authority to negotiate the merger agreement. Here the operating agreement specified the type of LLC, so there is no confusion about management responsibilities. [Ties to LLC: Management and Operation]. 2. BHA is an LLC and therefore has the option of raising capital through debt (either private debt from a loan from a commercial lender such as a bank), or they may sell ownership interests in the LLC (equity) to current or additional members. The Operating Agreement may be used to restrict certain transactions (such as selling ownership to an outside party). [Ties to LLC: Capitalization]. 3. Under the facts presented in this question, BHA would be better off remaining an LLC. The LLC provides more protection for its members than an LLP would (protection from all liabilities including contract and tort), and the manager-managed structure provides maximum flexibility for business operations. Also, no per partner insurance is required in an LLC. [Ties to LLP]. 4. Luciano actions constitute self-dealing and are a breach of fiduciary duty and the Operating Agreement cannot limit liability for a breach of good faith. [Ties to LLC]. 5. Luciano’s dissociation would typically be governed by the LLC agreement. However, absent that agreement, the remaining members may choose to continue or dissolve. In any case, dissolution is not automatic. [Ties to LLC – Dissolution and Case 15.1 Liberman v. Wyoming.com on P. 440] Manager’s Challenge Sample answers to all Manager’s Challenge exercises are provided in the student and instructor’s versions of this textbook’s Web site.. Case Summary 15.1: Liability of LLC Member: Kaycee Land and Livestock v. Flahive [P.444] 1. Can the court disregard the LLC entity in this situation? Answer: Yes, the court may discard the protection in the case where a court finds that fairness demands that the LLC members should compensate any damaged party when the entity is without resources to recover the full amount owed. 2. Does fairness demand that Flahive be personally responsible for the LLC’s negligence? Answer: Whether or not fairness demands that Flahive be personally responsible for the LLC’s negligence is a factual determination governed by the special facts of the case. Though fraud is the typical example by which the veil of an LLC is pierced, it is not a prerequisite to such a result and a finding that Flahive caused the contamination of Kaycee’s property through a flawed process could reasonably result in personally liability. Case Summary 15.2: Personal Guarantees of LLC Members: Emprise v. Rumisek [P.445] 1. Does the bank have to wait until the litigation is complete to enforce the personal guarantees against the physicians? Why or why not? Answer: No, each physician had to make good on the guarantee made on behalf of the LLC before they can proceed with claims against each other because personal guarantees moderate the limited liability created in an LLC. 2. What is the impact of the departing physicians’ dissociation from the LLC? Answer: Though the departing physicians’ dissociated themselves from the LLC, they still must make good on their personal guarantee to Emprise because they pledged personal assets to guarantee payment obligations of the business venture, which are not dismissed upon dissociation. Case Summary 15.3: Involuntary Withdrawal: Lambrecht v. Jordan & Company [P. 445] 1. May the LLC members force Lambrecht to withdraw? Answer: Yes. The LLC Operating Agreement specified only that termination triggered the withdrawal and specified terms of payment. The RULLCA is gap filler and does not displace the agreement. 2. Is it fair to base the payment on the capital account balance (typically very small) rather than fair market value (typically a larger amount) when the withdrawal was forced? Answer: It may not be fair, but that is what the parties agreed to. The Operating Agreement is the controlling document. Case Summary 15.4: LLP Innocent Parties: First American Title v. Lawson [P. 445] 1. Does the LLP shield protect Snyder’s personal assets from negligence committed by other partners? Answer: Yes. Snyder was an innocent partner in an LLP and therefore has no liability for the negligent acts of his partners. 2. Should Snyder have been more active in being aware of his partners’ deeds? Did he have a duty to inquire? Answer: He does not have a duty to inquire into transaction where he has no knowledge or is suspicious of wrong-doing. As a practical matter, partners have liability and should be actively aware of dealing within the firm. Quick Assessment Questions (QAQs) 1. How are limited liability partnerships formed? a. The filing of a statement of qualification b. The filing of articles of organization c. The filing of certificates of organization d. The formation of an operating agreement e. None of the above Answer: a 2. Which of the following business entities have the option of being treated as a corporation or a pass-through entity for taxation purposes? a. Limited liability partnership b. General partnership c. Limited partnership d. Limited liability company e. Franchises Answer: d 3. _______ occurs when an individual member withdraws from an LLC. a. Dissociation b. Discard c. Termination d. Pass-through e. Ex Parte Answer: a 4. In cases of fundamental fairness, a court may disregard the LLC liability protections. Answer: True 5. Dissolution occurs when an individual member decides to exercise the right to withdraw from the partnership. Answer: False 6. In an LLC, managing members and controlling members owe a fiduciary duty to other members. Answer: True Solution Manual for The Legal Environment of Business: A Managerial Approach: Theory to Practice Sean P. Melvin, Michael A. Katz 9780078023804
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