This Document Contains Chapters 44 to 46 Chapter 44 ACCOUNTANT’S LEGAL LIABILITY ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Baldwin Corporation made a public offering of $25 million of convertible debentures and registered the offering with the SEC. The registration statement contained financial statements certified by Adams and Allen, Certified Public Accountants. The financial statements overstated Baldwin’s net income and assets by 20 percent and understated the company’s liability by 15 percent. Because Adams and Allen did not carefully follow Generally Accepted Accounting Standards, it failed to detect these inaccuracies, the discovery of which has caused the bond prices to drop from their original selling price of $1,000 per bond to $720. Can Conrad, who purchased $10,000 of the debentures, collect from Adams and Allen for his damages? Explain. Answer: Liability: Securities Act of 1933. Yes, decision for Conrad. Adams and Allen certified financial statements included in a registration statement, which were materially false. They are, therefore, liable to anyone who purchased the securities pursuant to that registration statement unless they can prove their due diligence defense. In that Adams and Allen failed to carefully follow GAAS, it is most probable that they will not be able to prove that they exercised due diligence. Therefore, they are jointly and severally liable to Conrad for the $280 depreciation in the bond price, for a total loss of $2,800. 2. Ingram is a Certified Public Accountant (CPA) employed by Jordan, Keller and Lane, CPAs, to audit Martin Enterprises, Inc., a fast-growing service firm that went public two years ago. The financial statements Ingram audited were included in a proxy statement proposing a merger with several other firms. The proxy statement was filed with the Securities and Exchange Commission and included several inaccuracies. First, approximately $1 million, or more than 20 percent, of the previous year’s “net sales originally reported” had proven nonexistent by the time the proxy statement was filed and had been written off on Martin’s own books. This was not disclosed in the proxy statement, in violation of Accounting Board Opinion Number 9. Second, Martin’s net sales for the current year were stated as $11.3 million when in fact they were less than $10.5 million. Third, Martin’s net profits for the current year were reported as $700,000, when the firm actually had no earnings at all. (a) What civil liability, if any, does Ingram have? (b) What criminal liability, if any, does Ingram have? Answer: Liability: Securities Exchange Act of 1934. (a) Ingram is civilly liable under Section 18 of the 1934 Act unless he can show that he acted in good faith and had no knowledge of the falsity. Section 18 imposes express civil liability upon an accountant if she makes or causes to be made any false or misleading statement with respect to any material fact in any application, report, document, or registration filed with the SEC under the 1934 Act. Liability extends to any person who purchased or sold a security in reliance upon that false or misleading statement and without knowing that it was false or misleading. An accountant is not liable, however, if she proves that she acted in good faith and had no knowledge that such statement was false or misleading. On these facts, it seems unlikely that this defense would be available. See part (b) below. (b) Ingram is probably criminally liable for a fine of up to $1 million (formerly $100,000) and/or imprisonment of not more than ten years. In U.S. v. Matelli, 527 F. 2d 311 (1975), upon which this problem is based, the U.S. Circuit Court upheld a conviction imposing a one year sentence with all but 60 days suspended and a $10,000 fine (which was the maximum fine at that time). The court found that these facts were sufficient for a jury to have found sufficient criminal intent. As the court stated: "Congress equally could not have intended that men holding themselves out as members of these ancient professions [law and accounting] should be able to escape criminal liability on a plea of ignorance when they have shut their eyes to what was plainly to be seen or have represented a knowledge they knew they did not possess." 3. Girard & Company, Certified Public Accountants, audited the financial statements included in the annual report submitted by PMG Enterprises, Inc., to the Securities and Exchange Commission (SEC). The audit failed to detect numerous false and misleading statements contained in the financial statements. (a) Investors who subsequently purchased PMG stock have brought suit against Girard under Section 18 of the 1934 Act. What defenses, if any, are available to Girard? (b) The SEC has initiated criminal proceedings under the 1934 Act against Girard. What must be proven for Girard to be held criminally liable? Answer: Liability: Securities Exchange Act of 1934. (a) Under Section 18 of the 1934 Act, Girard's defense would be that it acted in good faith and that it had no knowledge that the financial statement was false or misleading. Section 18 imposes express civil liability upon an accountant if she makes or causes to be made any false or misleading statement with respect to any material fact in any application, report, document, or registration filed with the SEC under the 1934 Act. Liability extends to any person who purchased or sold a security in reliance upon that false or misleading statement and without knowing that it was false or misleading. An accountant is not liable, however, if she proves that she acted in good faith and had no knowledge that such statement was false or misleading. (b) The SEC must prove that Girard willfully and knowingly made and caused to be made false and misleading statements with respect to material facts in the annual report filed with the SEC. 4. Dryden, a certified public accountant, audited the books of Elixir, Inc., and certified incorrect financial statements in a form that was filed with the Securities and Exchange Commission. Shortly thereafter, Elixer, Inc., went bankrupt. Investigation into the bankruptcy disclosed that through an intricate and clever embezzlement scheme Kraft, the president of Elixir, had siphoned off substantial sums of money that now support Kraft in a luxurious lifestyle in South America. Investors who purchased shares of Elixir have brought suit against Dryden under Rule 10b–5. At trial, Dryden produces evidence demonstrating that his failure to discover the embezzlement resulted merely from negligence on his part and that he had no knowledge of the fraudulent conduct. Is Dryden liable under the Securities Exchange Act of 1934? Why? Answer: Fraud Liability: Securities Exchange Act of 1934. No, Dryden is not liable. In Ernst & Ernst v. Hochfelder, the United States Supreme Court held that in an action for damages under Rule 10b-5, it must be shown that the violation was committed with scienter. Since Dryden did not know of the defalcations, he did not have scienter and it not liable under Rule 10b-5. 5. Johnson Enterprises, Inc., contracted with the accounting firm of P, A & E to perform an audit of Johnson. The accounting firm performed its duty in a nonnegligent, competent manner but failed to discover a novel embezzlement scheme perpetrated by Johnson’s treasurer. Shortly thereafter, Johnson’s treasurer disappeared with $75,000 of the company’s money. Johnson now refuses to pay P, A & E its $20,000 audit fee and is seeking to recover $75,000 from P, A & E. (a) What are the rights and liabilities of P, A & E and Johnson? Explain. (b) Would your answer to (a) differ if the scheme were a common embezzlement scheme that Generally Accepted Accounting Standards should have disclosed? Explain. Answer: Negligence Liability. (a) P, A & E will collect its $20,000 audit fee from Johnson and will not be liable to Johnson for the $75,000 embezzled by Johnson's treasurer. An auditor's duty to its client is limited to discovering fraud which can be detected by following GAAS audit procedures. The auditor must perform his duty in a non-negligent, competent manner, which P, A & E in fact did. There is no duty on an auditor to discover novel embezzlement schemes. (b) Yes, under the revised facts P, A & E would not be entitled to collect its audit fee and would be liable to Johnson for any harm P, A & E caused by not properly performing its audit duty. The accountant is obligated to perform its audit in a competent manner in accordance with GAAS procedures. 6. The accounting firm of T, W & S was engaged to perform an audit of Progate Manufacturing Company. During the course of its investigation, T, W & S discovered that the company had overvalued its inventory by carrying the inventory on the books at the previous year’s prices, which were significantly higher than current prices. When T, W & S approached Progate’s president, Lehman, about the improper valuation of inventory, Lehman became enraged and told T, W & S that unless the firm accepted the valuation, Progate would sue T, W & S. Although T, W & S knew that Progate’s suit was frivolous and unfounded, it wished to avoid the negative publicity that would arise from any suit brought against it. Therefore, on the assumption that the overvaluation would not harm anybody, T, W & S accepted Progate’s inflated valuation of inventory. Progate subsequently went bankrupt, and T, W & S is now being sued by (1) First National Bank, a bank that relied upon T, W & S’s statement to loan money to Progate, and (2) Thomas, an investor who purchased 20 percent of Progate’s stock after receiving T, W & S’s statement. What are the rights and liabilities of First National Bank, Thomas, and T, W & S? Answer: Tort Liability: Fraud. T, W & S was a party to the issuance of false statements which amounted to fraud. T, W & S's knowing acceptance of Progate's overvaluation of its inventory constituted a material misrepresentation of fact with knowledge of falsity upon which First National Bank and Thomas justifiably relied. Both First National and Thomas will prevail against T, W & S since a perpetrator of fraud is liable to all parties who justifiably rely upon the intentional misrepresentation. 7. J, B & J, Certified Public Accountants, has audited the Highcredit Corporation for the past five years. Recently, the Securities and Exchange Commission (SEC) has commenced an investigation of Highcredit for possible violations of Federal securities law. The SEC has subpoenaed all of J, B & J’s working papers pertinent to the audit of Highcredit. Highcredit insists that J, B & J not turn over the documents to the SEC. What action should J, B & J take? Why? Answer: Client Information: Working Papers. J, B & J must submit the papers to the SEC. Accountants' workpapers are not subject to the same protection afforded attorney-client work-product. The nature of the accountant's work as a public watchdog means that a duty is owed to the general investing public. Investors rely on the work of independent auditors in making investment decisions, and therefore, workpapers cannot be shielded from public scrutiny. 8. On February 1, the Gazette Corporation hired Susan Sharp to conduct an audit of its books and to prepare financial statements for the corporation’s annual meeting on July 1. Sharp made every reasonable attempt to comply with the deadline but could not finish the report on time due to delays in receiving needed information from Gazette. Gazette now refuses to pay Sharp for her audit and is threatening to bring a cause of action against Sharp. What course of action should Sharp pursue? Why? Answer: Contract Liability. Based on the contract of employment an accountant is obligated to perform her work in a reasonable, non-negligent manner within the stated deadline. Failure to complete work as prescribed will result in a material breach by the accountant for which she will be liable. In this case Sharp will not be liable since she attempted in good faith to complete the audit on time but was hampered by the intentional actions of her employer. Sharp can initiate a suit against Gazette seeking contract damages on the theory that Gazette was in breach by preventing a timely performance. 9. John P. Butler Accountancy Corporation agreed to audit the financial statements of Westside Mortgage, Inc., a mortgage company that arranged financing for real property, for the year ending December 31, 2015. On March 22, 2016, after completing the audit, Butler issued unqualified audited financial statements listing Westside’s corporate net worth as $175,036. The primary asset on the balance sheet was a $100,000 note receivable that had, in reality, been rendered worthless in August 2014 when the trust deed on real property securing the note was wiped out by a prior foreclosure of a superior deed of trust. The note constituted 57 percent of Westside’s net worth and was thus material to an accurate representation of Westside’s financial position. In October 2016, International Mortgage Company (IMC) approached Westside for the purpose of buying and selling loans on the secondary market. IMC signed an agreement with Westside in December after reviewing Westside’s audited financial statements. In June 2017, Westside issued a $475,293 promissory note to IMC, on which it ultimately defaulted. IMC brought an action against Westside, its owners, principals, and Butler. IMC alleged negligence and negligent misrepresentation against Butler in auditing and issuing without qualification the defective financial statements on which IMC relied in deciding to do business with Westside. Butler claimed that it owed no duty of care to IMC, a third party that was not specifically known to Butler as an intended recipient of the audited financial statements. Is Butler correct? Explain. Answer: Negligence. Judgment for IMC. The landmark opinion in applying the “duty” doctrine to the accounting profession is that of Justice Cardozo in Ultramares Corp. v. Touche, where the liability of a CPA in preparing and issuing unqualified audited financial statements was limited to those “in privity” with the accountant. The Restatement has rejected Ultramares’ requirement of privity but has limited liability to those “intended” recipients of the information. But the accountant’s role in modern society has changed from the time of Ultramares. Today, in contrast with the days when the auditor’s primary obligation was to the client, the accountant occupies a position of public trust. The auditor of a corporation’s financial statements is ultimately responsible to the creditors, stockholders, investors, and lenders who, he must realize, will rely upon the statements. Accountants should be held to the same foreseeability standard of negligence liability as other professionals. Therefore, since an independent auditor owes a duty of care to reasonably foreseeable third parties who rely upon negligently prepared and issued financial statements, the summary judgment must be reversed. International Mortgage Company v. John P. Butler Accountancy Corp., 177 Cal.App.3d 806 (4th Dist. 1986). 10. Equisure, Inc., was required to file audited financial statements when it applied to have its stock listed on the American Stock Exchange (AmEx). It retained an accounting firm, defendant Stirtz Bernards Boyden Surdel & Larter, P.A. (Stirtz). Stirtz issued a favorable interim audit report that Equisure used to gain listing on the stock exchange. Subsequently, Equisure retained Stirtz to audit the financial statements required for Equisure’s Form 10 filing with the U.S. Securities and Exchange Commission (SEC). Stirtz’s auditor knew that the audit was for the SEC reports. Stirtz issued a “clean” audit opinion, which, with the audited financial statements, was included in Equisure’s SEC filing and made available to the public. NorAm Investment Services, Inc., also known as Equity Securities Trading Company, Inc. (NorAm), a securities broker, began lending margin credit to purchasers of Equisure stock. These purchasers advanced only a portion of the purchase price; NorAm extended credit (a margin loan) for the balance and held the stock as collateral for the loan, charging interest on the balance. When NorAm had loaned approximately $900,000 in margin credit, its president, Nathan Newman, reviewed Stirtz’s audit report and the audited financial statements. Based on his review, NorAm extended more than $1.6 million of additional margin credit for the purchase of Equisure shares. When AmEx stopped trading Equisure stock due to allegations of insider trading and possible stock manipulation, the stock became worthless. NorAm was left without collateral for more than $2.5 million in margin loans. Stirtz resigned as auditor of Equisure and warned that its audit report might be misleading and should no longer be relied upon. NorAm sued Stirtz for negligent misrepresentation and negligence. Explain whether or not NorAm will prevail. Answer: Liability: NorAm should not prevail. The Restatement (Second) of Torts § 552 sets out the criteria for accountants’ liability to third parties who rely on the accountants’ negligent audits: An auditor may be held liable for negligent misrepresentations in an audit report to those persons who act in reliance upon those misrepresentations in a transaction which the auditor intended to influence. Also, an auditor may also be held liable to reasonably foreseeable third persons for intentional fraud in the preparation and dissemination of an audit report. It is not enough, however, that the maker merely knows of the ever-present possibility of repetition to anyone, and the possibility of action in reliance upon it, on the part of anyone to whom it may be repeated. In this case, NorAm argues that a “chain of reliance” links Stirtz, the SEC -- that Stirtz knew would rely on its work, and NorAm, which should be protected by the SEC’s reliance. The court disagreed. NorAm as a broker extending margin credit is not clearly in the class that should be protected by the SEC’s reliance. “If that liability is to be drawn somewhere short of foreseeability, it must be drawn on pragmatic grounds alone.” Noram Investment Services, Inc. V. Stirtz Bernards Boyden Surdel & Larter,P.A., 611 N.W.2d 372 11. Holtz Rubenstein Reminick, CPAs, audited year-end financial statements of Quality Food Brands, Inc. and related companies. Signature Bank, relying upon the audited financial reports prepared by Holtz Rubenstein Reminick, extended a term note to Quality in the principal sum of $10,000,000. Quality subsequently filed a petition under Chapter 7 of the United States Bankruptcy Code, and Signature Bank only then learned of various false and misleading statements contained in the audited financial reports. Explain whether Signature bank can recover damages for negligent misrepresentation. Answer: Liability for Negligence. Signature bank may not recover damages for negligent misrepresentation. In certain circumstances, accountants may be held liable for negligent misrepresentations made to third parties with whom they have no contractual relationship, but who have relied to their detriment on inaccurate financial statements prepared by the accountant. In order to establish such liability, the relationship between the accountant and the party must be found to approach privity, through a showing that the following prerequisites are satisfied: “(1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance.” Here, the allegations supporting the cause of action to recover damages for negligent misrepresentation do not satisfy the third Credit Alliance prong. Viewing the complaint in the light most favorable to the plaintiff, as amplified by the evidence submitted by the plaintiff in opposition to the defendant's motion, the complaint failed to allege some conduct by the defendant “linking” it to the plaintiff, which evinced the defendant's understanding of the plaintiff's reliance. Accordingly, the Supreme Court should have granted the subject branch of the defendant's motion. Signature Bank v. Holtz Rubenstein Reminick, 109 A.D.3d 465, 970 N.Y.S.2d 281 (Appellate Division of the Supreme Court of New York, Second Department, 2013). ANSWERS TO “TAKING SIDES” PROBLEMS Arthur Young & Co., a firm of certified public accountants, was the independent auditor for Amerada Hess Corporation. During its review of Amerada’s financial statements as required by federal securities laws, Young confirmed Amerada’s statement of its contingent tax liabilities and prepared tax accrual work papers. These work papers, which pertained to Young’s evaluation of Amerada’s reserves for contingent tax liabilities, included discussions of questionable positions Amerada might have taken on its tax returns. The Internal Revenue Service (IRS) initiated a criminal investigation of Amerada’s tax returns when, during a routine audit, it discovered questionable payments made by Amerada from a “special disbursement account.” The IRS summoned Young to make available all its information relating to Amerada, including the tax accrual work papers. Amerada instructed Young not to obey the summons. The IRS then brought an action against Young to enforce the administrative summons. (a) What are the arguments that Young must turn over the work papers? (b) What are the arguments that the work papers are protected from government summons? (c) Who should prevail? Explain. Answer: (a) The work papers of an accountant, like attorney work papers, should be protected from government subpoena. If not, clients will not be fully honest with their accountant in fear of information being divulged to government officials. (b) The work papers should not be protected because accountants serve a public role and need to be truly honest and protective of public interest. (c) Work papers are not protected by work-product immunity. The system of federal taxation demands forthright disclosure of all material information to the taxing authorities. Hence, the Internal Revenue Service (IRS) has been given extensive information-gathering authority by Congress. This authority should be curtailed only by congressional action. The argument comparing a work-product immunity for accountants’ tax accrual work papers to the attorney work-product doctrine is based upon a misunderstanding of the differing roles of the private attorney and the independent certified public accountant. The attorney is his client’s loyal and confidential advisor and advocate. The Certified Public Accountant, in certifying a corporation's financial statements, is a “public watchdog” who “assumes a public responsibility transcending any employment relationship with the client” and “owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public.” Moreover, in contrast with the view of the court of appeals, allowing the IRS access to tax accrual work papers poses no danger to the integrity of the securities markets. The court of appeals expressed the fear that, if tax accrual work papers were available to the IRS, a business might be tempted to withhold certain relevant and material information from its auditor. Such an action, however, could result in the auditor issuing a qualified opinion as to the accuracy of the financial statements, a possibility that responsible corporate management would be unwilling to risk. U.S. v. Arthur Young and Company, 465 U.S. 805. Chapter 45 ENVIRONMENTAL LAW ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Atlantic Cement operated a large cement plant. Neighboring landowners sued for damages and an injunction, claiming that their properties were injured by the dirt, smoke, and vibrations coming from the plant. The lower court found that the plant constituted a nuisance and granted temporary damages but refused to grant an injunction because the benefits of operating the plant outweighed the harm to the plaintiffs’ properties. The landowners appealed. Does the plant constitute a nuisance? Should it be shut down? Explain. Answer: Private Nuisance. This would be a private nuisance action because the alleged harm was suffered by the nearby landowners and not the general public. The defense asserted by Atlantic Cement will be upheld based upon their socially useful activity, and it should not be shut down. 2. Seindenberg and Hutchinson (the site owners) leased a four-acre tract of land (the Bluff Road site) to a chemical manufacturing corporation (COCC). While the lease initially was for the sole purpose of allowing COCC to store raw materials and finished products in a warehouse on the land, COCC later expanded its business to include the brokering and recycling of chemical waste generated by third parties. COCC’s owners subsequently formed a new corporation, South Carolina Recycling and Disposal, Inc. (SCRDI), for the purpose of taking over COCC’s waste-handling business. The site owners accepted rent from SCRDI. The waste stored at Bluff Road contained many chemical substances that federal law defines as hazardous. Subsequently, the Environmental Protection Agency concluded that the site was a major fire hazard. The Federal government contracted with a third party to perform a partial cleanup of the site. South Carolina completed the cleanup. The Federal government and South Carolina sued SCRDI, COCC, the site owners, and three third-party generators as responsible parties under Resource Conservation and Recovery Act and Comprehensive Environmental Response, Compensation and Liability Act. Explain whether the United States and South Carolina will prevail. Answer: Hazardous Substances. Judgment for the United States and South Carolina. Landowners are strictly liable regardless of their degree of participation. The Superfund was created to pay for removal and cleanup of hazardous wastes, but is not to be used when there are responsible parties. 3. The State of Y submits a plan under the Clean Air Act to attain national ambient air quality standards. Can the Environmental Protection Agency administrator deny approval of the State plan because it is (a) less stringent or (b) more stringent than the agency believes is feasible? Explain. Answer: Clean Air Act. The EPA Administrator may deny approval of a state plan because it is less stringent than the agency believes is feasible. A plan must provide for attainment and maintenance of national ambient air standards. The Administrator may not deny approval of a more stringent plan, in that the Act gives the “Agency no authority to question the wisdom of a state’s choices of emission limitations if they are part of a plan which satisfies the standards...” Train v. Natural Resources Def. Council, 42 U.S. 60 (1975). 4. Kennecott Copper Corp. brings this challenge to an Environmental Protection Agency (EPA) order that rejected a portion of the State of Nevada’s implementation plan dealing with the control of stationary sources of sulfur dioxide (SO2). All of the SO2 emissions come from a single source—the Kennecott copper smelter at McGill. The EPA based its decision on the belief that the Clean Air Act National Ambient Air Quality Standards (NAAQS) must be met by continuous emission limitations to the maximum extent possible and that the Act permits the intermittent use of emission controls only when continuous controls are not economically feasible. Kennecott contends that the EPA must approve any State implementation plan that will attain and maintain an NAAQS within the statutory time period. Who will prevail? Why? Answer: National Ambient Air Quality Standards. The EPA acted within its authority in refusing to accept intermittent controls as adequate compliance with the Act. That is, EPA correctly interpreted the Act as requiring that national air quality standards be met by continuous emission limitations to the maximum extent possible, and that intermittent controls and dispersion systems be used only when continuous emission controls are not economically feasible. The EPA order is upheld. Kennecott Copper Corp. v. Train, 526 F.2d 1149 (9th Cir. 1975). 5. The Environmental Protection Agency (EPA) administrator issued an order suspending the registration of the pesticides heptachlor and chlordane under the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA). Velsicol Chemical Corp., the sole manufacturer of these pesticides, brings this action, contending that the evidence does not support the administrator’s contention that the continued use of these chemicals poses an imminent hazard to human health. Velsicol and the U.S. Department of Agriculture (USDA) contend (a) that the EPA’s laboratory tests on mice and rats do not “conclusively” show that either chemical is carcinogenic; (b) that mice are too prone to tumors to be reliable test subjects; and (c) that human exposure to these chemicals is insufficient to create a risk. Nonetheless, human epidemiology studies on both chemicals provide no basis for concluding that either pesticide is safe. The administrator based part of his claim on residues of these chemicals found in soil, air, and the aquatic ecosystem over long periods of time and on the presence of these chemicals in the human diet and human tissue. Does FIFRA apply in this situation? Explain. Answer: FIFRA. The manufacturer’s voluntary cessation of production of heptachlor did not moot consideration of suspension order for heptachlor. The Administrator is not required to establish that the product is unsafe in order to suspend and the burden of proof as to the safety of the product rests on the applicant and the registrant. The substantial evidence, including experimental evidence establishing carcinogenicity of heptachlor and chlordane on laboratory animals, supported the suspension of registration and the Administrator properly found that the pesticides posed a carcinogenic risk to humans on the basis of the finding of risk to laboratory animals in view of evidence of widespread residues of heptachlor and chlordane present in the human diet and in human tissues. Environmental Defense Fund, Inc. v. Environmental Protection Agency, 548 F.2d 998 (D.C. 1976). 6. The U.S. Department of the Interior filed an environmental impact statement with regard to its proposal to lease approximately eighty tracts of submerged land, primarily located off the coast of Louisiana, for oil and gas exploration. Adjacent to the proposed area is the greatest estuarine coastal marsh in the United States. This marsh provides rich nutrients for the Gulf of Mexico, the most productive fishing region of the country. The environmental impact statement (EIS) focused primarily on oil pollution and its negative environmental effect. Three conservation groups contend that the EIS is insufficient in that it does not properly discuss alternatives. The government contends that (a) it need only provide a detailed statement of the alternatives, not a discussion of their environmental impact, and (b) the only alternatives the NEPA requires it to discuss are those that can be adopted and implemented by the agency issuing the impact statement. Is the government correct in its contentions? Why or why not? Answer: National Environmental Policy Act: Environmental Impact Statement. The National Environmental Policy Act requires both a detailed statement of alternative courses of action and also a presentation of environmental risks incident to them. Although this discussion is only required for those alternatives that are reasonably available, it should not be limited to measures which a particular agency or official can adopt. Natural Resources Defense Council, Inc. v. Morton, 458 F.2d 827 (D.C. 1972). 7. Chemical Manufacturers Association (CMA) and four companies that manufacture chemicals challenged a test rule promulgated by the Environmental Protection Agency under the Toxic Substances Control Act, (TSCA). The plaintiffs asserted that the EPA must find that the existence of an unreasonable risk of injury to health is more probable than not before it may issue a test rule under the act. In response, the EPA claimed that it may issue a test rule under the TSCA if the agency determines that there is a substantial probability of an unreasonable risk of injury to health. The test rule required toxicological testing to determine the health effects of the chemical, 2-ethylhexanoic acid, and imposed on exporters of this chemical a duty to file certain notices with the EPA. What standard should be applied? Why? Answer: Toxic Substances Control Act. The toxic substances control act establishes a two-tier structure: the EPA must find that a chemical substance “presents or will present an unreasonable risk of injury to health or the environment” in order to regulate that substance. In contrast, the EPA has the authority to require testing if the substance “may present an unreasonable risk to health or the environment.” The question here is whether the “unreasonable risk” must be more probable than not, as CMA contends, or must only be a probability that is more than merely theoretical or speculative, as the EPA contends. The court concluded that an “unreasonable risk” need not be established to a more-probable-than-not degree. If the EPA were required to find that a substance presents an unreasonable risk, then the EPA could regulate the substance and there would be no role for required testing. While Congress did not intend to authorize the EPA to issue test rules on the basis of mere hunches, the EPA’s reading of the TSCA is a reasonable accommodation of the congressional policies regarding the gathering of information about suspect chemicals. Chemical Manufacturer Association v. EPA 859 F.2d 977. 8. National-Southwire Aluminum Company (NSA) owns and operates a plant that emits fluoride. When its wet scrubbers were turned off as part of its regular maintenance program, NSA discovered no appreciable change in ambient fluoride levels. Because of the expense of operating the scrubbers and its belief that using the scrubbers did not significantly affect ambient fluoride levels, NSA desired to turn the scrubbers off permanently. Accordingly, NSA sought a determination from the EPA that turning off the scrubbers would not constitute a modification requiring the application of new source performance standards to the plant. Turning off the scrubbers would result in an increase of more than 1,100 tons per year of fluoride emissions with no decrease in the emission of any other pollutant. This increase was nearly 400 times the level the EPA had established as inconsequential. The EPA determined that turning off the scrubbers would constitute a “new source” modification. Accordingly, NSA was required either to leave the scrubbers on or to install new pollutant control equipment. Is the EPA correct in its assertion? Explain. Answer: New Source Standards: Stationary Sources. Determination of the EPA affirmed. The Clean Air Act defines “modification” as any physical change or change in operation of a “stationary source” that increases the emission of air pollutants. Under NSA’s argument, a “modification” depends on the amount of pollutant the pollution-generating equipment creates, without regard to the amount of pollution actually emitted into the atmosphere. The trial court disagreed. It is clear from EPA regulations that “modification” includes any change in operation that increases the emission of any air pollutant. The proposal to turn off the wet scrubbers does not suggest the addition or use of any device whose primary function is the reduction of air pollutants. Rather, the proposal involves the removal or replacement of a system, and in such a case the EPA can determine that such a change is a modification if it results in less environmentally beneficial operations. Here, it is clear that turning off the scrubbers is less environmentally beneficial, since it would increase the emission of fluorides without decreasing the emission of other pollutants. National-Southwire Aluminum Co v. EPA, 838 F.2d 835. 9. The city of Fayetteville, Arkansas, received a National Pollutant Discharge Elimination System permit from the Environmental Protection Agency (EPA) for the discharge of sewage into a stream that ultimately reaches the Illinois River, twenty-two miles upstream from the Oklahoma border. The EPA permit limited the effluent discharge to comply with Oklahoma water quality standards, but the EPA stated that those standards would be violated only if the discharge would cause an actual, detectable violation of Oklahoma standards. Oklahoma appealed the permit, arguing that the permit violated Oklahoma water quality standards, which allow no degradation of water quality. Explain whether the permit should be granted. Answer: National Pollutant Discharge Elimination System Yes. Affected states cannot block an EPA-issued permit, but instead, must seek to have the EPA administrator disapprove the permit on the grounds that the discharge will have an undue impact on the interstate waterway. In issuing the permit in this case, the EPA required that the discharge not violate Oklahoma’s water quality standards. This is a reasonable exercise of the EPA’s broad discretionary power under the Clean Water Act to establish conditions for issuing NPDES permits. Arkansas v. Oklahoma, 112 S. Ct. 1046. 10. On October 20, 1999, a group of nineteen private organizations filed a rulemaking petition asking the Environmental Protection Agency (EPA) to regulate greenhouse gas emissions from new motor vehicles under the Clean Air Act. Fifteen months after the petition’s submission, EPA requested public comment on all the issues raised in the petition, adding a “particular” request for comments on “any scientific, technical, legal, economic or other aspect of these issues that may be relevant to EPA’s consideration of this petition.” EPA received more than fifty thousand comments over the next five months. On September 8, 2003, EPA entered an order denying the rulemaking petition. The agency gave two reasons for its decision: (1) that contrary to the opinions of its former general counsels, the Clean Air Act does not authorize EPA to issue mandatory regulations to address global climate change; and (2) that even if the agency had the authority to set greenhouse gas emission standards, it would be unwise to do so at this time. In concluding that it lacked statutory authority over greenhouse gases, EPA observed that Congress “was well aware of the global climate change issue when it last comprehensively amended the [Clean Air Act] in 1990,” yet it declined to adopt a proposed amendment establishing binding emissions limitations. Calling global warming “the most pressing environmental challenge of our time,” twelve states, including Massachusetts, local governments, and private organizations, alleged that the EPA has abdicated its responsibility under the Clean Air Act to regulate the emissions of four greenhouse gases, including carbon dioxide, and challenged the decision. Explain whether the 12 States or the EPA are correct. Answer: Greenhouse Gases. The petitioners should prevail. The Clean Air Act’s sweeping definition of “air pollutant” includes “any air pollution agent or combination of such agents, including any physical, chemical . . . substance or matter which is emitted into or otherwise enters the ambient air.” Because greenhouse gases fit well within this definition of “air pollutant,” the EPA has statutory authority to regulate such gases from new motor vehicles The EPA’s reliance on subsequent congressional actions and deliberations it views as tantamount to a command to refrain from regulating greenhouse gas emissions is not persuasive. Even if postenactment legislative history could shed light on the meaning of an otherwise-unambiguous statute, EPA identifies nothing suggesting that Congress meant to curtail EPA’s power to treat greenhouse gases as air pollutants. Also unpersuasive is EPA’s argument that its regulation of motor-vehicle carbon dioxide emissions would require it to tighten mileage standards, a job the EPA felt Congress had assigned to the Department of Transportation. The fact that DOT’s mandate to promote energy efficiency by setting mileage standards may overlap with EPA’s environmental responsibilities in no way permits EPA to avoid its duty to protect the public “health” and “welfare.” EPA’s alternative basis for its decision—that even if it has statutory authority to regulate greenhouse gases, it would be unwise to do so at this time—rests on reasoning divorced from the statutory text. While the statute conditions EPA action on its formation of a “judgment,” that judgment must relate to whether an air pollutant “cause[s], or contribute[s] to, air pollution which may reasonably be anticipated to endanger public health or welfare.” Under the Act’s clear terms, EPA can avoid promulgating regulations only if it determines that greenhouse gases do not contribute to climate change or if it provides some reasonable explanation as to why it cannot or will not exercise its discretion to determine whether they do. It has not done so. Instead, EPA rejected the rulemaking petition based on arbitrary and capricious reasons. ANSWERS TO “TAKING SIDES” PROBLEMS When considering an application for a special use permit to develop and operate a ski resort at Sandy Butte, a mountain in Washington that is part of a national forest, the Forest Service prepared an environmental impact statement (EIS). The EIS recommended the issuance of a special use permit for what was to be a sixteen-lift ski area, and the forest service issued the permit as recommended. Four organizations sued, claiming that the EIS was inadequate. The lower court held that the EIS was adequate, but the Court of Appeals reversed, concluding that the National Environmental Policy Act required that actions be taken to mitigate the adverse effects of a major federal action and that the EIS contain a detailed mitigation plan. (a) What are the arguments that the EIS should only to take a hard look at the relevant environmental consequences? (b) What are the arguments that the EIS should propose actions that mitigate the relevant environmental consequences? (c) What should the EIS include in this situation? Answer: (a) The Act mandates that the relevant government agency review all environmental consequences but not propose ways to mitigate these consequences. Results are not mandated only the appropriate review. (b) An agency’s environmental impact statement (EIS) should include a fully developed plan detailing what steps will be taken to mitigate adverse environmental impacts. Otherwise, the law does not make any sense. (c) Decision of the Court of Appeals reversed and remanded. The National Environmental Policy Act (NEPA) ensures government commitment to protecting environmental quality by establishing important “action-forcing” procedures. Pursuant to these procedures, a federal agency must prepare an EIS, which forces the agency to take a “hard look” at the environmental consequences of proposed actions. It is implicit that through such procedures the NEPA requires that an EIS discuss which adverse effects are avoidable. The NEPA, however, only mandates certain procedures, not particular results. An agency that adequately identifies and evaluates the adverse environmental effects of a proposed action in its EIS is not constrained by the NEPA from deciding that other values outweigh the environmental costs. Thus, the NEPA requires neither that action be taken to mitigate the adverse effects of federal actions nor that an EIS include specific measures to mitigate the adverse impacts of the proposed action. NEPA only prohibits uninformed —rather than unwise— agency action and is procedural, not substantive, in nature. Robertson v. Methow Valley Citizens Council, 90 U.S. 332, 109 S.Ct. 1835, 104 L.Ed. 2d 351. Chapter 46 INTERNATIONAL BUSINESS LAW ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Three banks that are wholly owned by the Republic of Costa Rica had issued promissory notes, payable in U.S. dollars in New York City. The notes are now in default due solely to actions of the Costa Rican government, which had suspended all payments of external debt because of escalating economic problems. Efforts by Costa Rica to curb foreign debt payment difficulties conflicted with U.S. policy for debt resolution procedures as conducted under the auspices of the International Monetary Fund. A syndicate of U.S. banks brought suit to recover on the promissory notes. The three Costa Rican banks assert the act of state doctrine as a defense. Should the doctrine apply? Explain. Answer: Act of State. No. The act of state doctrine provides that the judicial branch of a nation should not question the validity of actions taken by a government within that foreign sovereign's own borders. In the United States, the doctrine is inapplicable to commercial activities of a foreign sovereign. Furthermore, the notes in question were to be paid in U.S. dollars in New York City --outside the border of Costa Rica. The act of state doctrine would be applicable to this dispute only if the situs of debt was Costa Rica. So the doctrine is not applicable. Allied Bank International et al. v. Banco Credito Agricola de Cartago (Costa Rica), 757 F.2d 516 (2d Cir. 1985). 2. Six U.S. manufacturers of broad-spectrum antibiotics derived a large percentage of their sales from overseas markets, including India, Iran, the Philippines, Spain, The Republic of Korea, Germany, Colombia, and Kuwait. The manufacturers agreed to a common plan of marketing, whereby territories were divided and prices for products were set. The plan members also agreed not to grant foreign producers licenses to the manufacturing technology of any of their “big money” drugs. May the above foreign countries recover treble damages for violation of the U.S. antitrust laws? Why? Answer: Application of Antitrust Laws. Yes, decision for the foreign nation plaintiffs. The foreign nations are entitled to prosecute civil claims in the courts of the United States on the same basis as domestic corporations or individuals. The treble damages provision of the Sherman Act has two purposes: (1) to deter violators; and (2) to deprive them of their illegality and to compensate victims of antitrust laws for their injuries. The Sherman Act provision granting "any person" an action for treble damages was intended to be broad and inclusive and thus includes foreign governments recognized by and at peace with the United States. Pfizer Inc. v. Government of India et al., 424 U.S. 306, 96 S.Ct. 584 (1978). 3. After reading attractive brochures advertising a package tour of the Dominican Republic, a U.S. family decided to purchase tickets for the family vacation plan. The tour was a product of four different business entities, two domestic (U.S.) and two foreign. Sheraton Hotels & Inns, World Corporation, was to provide food and lodging; Dominicana Airlines, wholly owned by the government of the Dominican Republic, which routinely flew into Miami International Airport and sold tickets within the United States, was to provide round-trip air transportation and “tourist cards” necessary for entry into the Dominican Republic; and two U.S. firms organized and sold the tour. Problems for the family began when their Dominicana flight landed in the Dominican Republic, and immigration officials denied them entry. Forced to leave, the family was shuttled first to Puerto Rico and then to Haiti, where they had to secure their own passage back to the United States at additional expense. The family brings suit for battery, false imprisonment, breach of warranty, and breach of contract against all four different business entities. The Dominicana Airlines asserts the act of state doctrine as a defense. Explain whether this defense applies in this situation. Answer: Act of State Doctrine/Foreign Sovereign Immunities Act. It applies to part of the claim, but not all of it. The act of state doctrine precludes judicial inquiry into the illegality, validity and propriety of the acts and motivations of foreign sovereigns acting in their governmental roles within their own boundaries. However, it does not preclude the judicial resolution of all commercial consequences stemming from the occurrence of public acts. Although the plaintiffs' battery and false imprisonment claims against the airline wholly owned by the government of the Dominican Republic were foreclosed under the act of state doctrine and the Foreign Sovereign Immunities Act and were therefore dismissed, the claims for breach of warranty and breach of contract are valid and do not lie within any exception to the Foreign Sovereign Immunities Act. There is no blanket grant of immunity to the government of the Dominican Republic to protect it from any breach of warranty or breach of contract. Arango v. Guzman Travel Advisors Corp., 621 F.2d 1371 (1980). 4. A privately owned business in a developing country determines that current computer technology could solve many of the problems faced by its country’s private and public sectors. This business, however, lacks the capital resources necessary for research and development to acquire such computer technology, even if trained personnel were available. Furthermore, despite a sense of patriotism, the business concludes that its national government could not efficiently or effectively handle such a development project. What business forms are available to this business for acquiring sophisticated computer technology? What are the advantages and problems inherent in the various options? Answer: Forms of Multinational Enterprises. The following business forms are available and should be considered. a. Foreign Agency–The business may become the foreign agent of a major international computer company. As an agent they would need to invest little or no capital, yet they could make the current state of the art technology available in their country. b. Distributorship– The business may become the foreign distributor of a major international computer company, with many of the same advantages of a foreign agency relationship. It may involve the investment of slightly more capital than would an agency relationship, but it would also give the company a little more control over the marketing of the product. c. Licensing Agreement–The company might seek to become a franchisee or licensee of a major computer corporation. Under this sort of arrangement the company would have to do its own manufacture of the computers. This would require a larger capital expenditure than an agency or distributorship relationship, but it would assure the availability of the technology and would also involve citizen employees in the developing country in the manufacturing process, thus providing jobs and assuring the technical training of local personnel. d. Joint Venture–The company might also seek to negotiate a joint venture agreement with a major computer corporation. Under such an arrangement the two companies would share profits and liabilities according to the negotiated agreement. This would involve a greater expenditure of capital than would either an agency or distributorship agreement, but less than a franchise or license agreement. At the same time it would allow the local company to actively participate in the manufacture and marketing of the computers. Of the options available, this might be the one that should be chosen by the local company, because it has the most potential for accomplishing the long term goals of the local company. 5. King Faisal II of Iraq was killed on July 14, 1958, in the midst of a revolution in that country that led to the establishment of a republic subsequently recognized by the U.S. government. On July 19, 1958, the new republic issued a decree that all property of the former ruling dynasty, regardless of location, should be confiscated. Subsequently, the Republic of Iraq brought suit in the United States to obtain possession of money and stocks deposited in the deceased king’s U.S. bank account in New York City. Explain whether Iraq will be able to collect the funds. Answer: Confiscation. Decision for the U.S. bank and against the Republic of Iraq. Under the traditional application of the act of state doctrine, the principle of judicial refusal of examination applies only to a taking by a foreign sovereign of property within its own territory. When the property in question is within the United States at the time of the attempted confiscation, the confiscation will be given effect only if consistent with the policy and law of both the United States and the country seeking to confiscate it. Republic of Iraq v. First National City Bank, 353 F.2d 47 (1965). 6. A business entity incorporated under the laws of one of the European Union (EU) member nations contracts with the government of a developing nation to form a joint venture for the mining and refining of a scarce raw material used by several industrial nations in the manufacture of highly sensitive weapons systems. The contract calls for the EU-based corporation to invest money and technology that will be used to build permanent refinery plants that will eventually revert to the developing nation. The developing nation also reserves the right to set quotas on sales of this scarce resource and to choose the destination of exports. Due to political conflicts, the developing nation refuses to allow any exports of the scarce material to the United States. This causes a sharp price increase in exports to the United States by other suppliers. The United States asserts antitrust violations against the EU-based corporation for the effects produced within the United States. Should the United States succeed? Explain. Answer: Application of Antitrust Laws. Yes. The United States courts have asserted the right to apply the Sherman Act to foreign commerce intended to or affecting the United States market. Even though the agreement was made outside of the United States between a business entity incorporated under the laws of an EU member nation and the government of a developing nation, it was intended to and did in fact affect the United States market. 7. A Panamanian corporation lends money to a Turkish enterprise, which issues a promissory note. The loan contract specifies that payment on the interest and principal shall be made to the Chemical Bank of New York City, where both parties maintain accounts. The loan contract contains no choice of law designation, but the Panamanian and Turkish companies have referred to the Chemical Bank in New York as their “legal address.” As a result of a contractual performance dispute, the Turkish company suspends payments on the loan. The Panamanian corporation then brings suit in the United States to recover the balance of the payments due. What possible options for choice of law apply? Answer: International Contracts. In the facts as stated in the problem, the law applied could be New York State law (the issues raised involve commercial paper, which is governed by Article 3 of the UCC.), Panamanian law, or Turkish law. In the actual case on which this problem is based, payment of the note was to be made in Swiss francs, and at the time this action was brought in New York State, another action was pending between the parties in Switzerland. Nevertheless, the New York State court entered judgment for the Panamanian corporation. Weston Bank v. Turkiye Garanti Bankasi, 446 N.Y.S. 2d 67 (App. Div. 1982). 8. New England Petroleum Corporation (NEPCO), a New York corporation, was in the business of selling fuel oil in the United States. PETCO, a refinery incorporated in the Bahamas, was a wholly owned subsidiary of NEPCO. In 1968, PETCO entered into a long-term contract to purchase crude oil from Chevron Oil Trading (COT), which held 50 percent of an oil concession in Libya. In 1973, Libya nationalized COT and several other foreign-owned oil concessions, thereby forcing COT to terminate its contract with PETCO. In order to secure needed oil supplies, PETCO entered into a new contract with National Oil Corporation (NOC), which was wholly owned by the Libyan government. This contract was at a substantially higher price than the original contract with COT. The following month, Libya declared an oil embargo on exports to the United States, the Netherlands, and the Bahamas. Accordingly, NOC canceled its contracts with PETCO. After oil prices rose dramatically, NOC accepted bids for new contracts to replace the ones inactivated by the embargo. NEPCO brought suit in a U.S. district court against the Libyan government and NOC, alleging breach of contract. Does the district court have jurisdiction? Explain. Answer: Sovereign Immunity. The district court does not have jurisdiction. Libya and NOC are immune from this suit in the courts of the U.S. The exception to sovereign immunity contained in the Foreign Sovereign Immunities Act of 1976 allows U.S. jurisdiction based on "an act outside of the territory of the U.S. in connection with a commercial activity of the foreign state elsewhere and that act causes a direct effect in the U.S." The actions of Libya in this case had a direct impact only upon the Bahamian company PETCO. Carey v. National Oil Corporation, 592 F. 2d 673 (2d Cir. 1979). 9. Nigeria, experiencing an economic boom due to exports of high-grade oil, embarked on an infrastructure development plan. Accordingly, Nigeria entered into at least 109 contracts with 68 suppliers for the purchase of cement at a price of almost $1 billion. Among the contracting suppliers were four US corporations, including Texas Trading & Milling Corporation. Nigeria misjudged the cement market (having anticipated only a 20 percent fulfillment rate) and was forced to repudiate most of the contracts. Texas Trading & Milling Corporation and three other U.S. companies brought suit, alleging anticipatory breach of contract. Nigeria claimed immunity under the Foreign Sovereign Immunities Act. Is Nigeria’s claim correct? Explain. Answer: Sovereign Immunity. No. The Foreign Sovereign Immunities Act denies immunity to foreign governments from suits arising from commercial, as opposed to public or governmental, activity. The commercial character of an activity is determined by the nature of the course of conduct or particular transaction rather than by its purpose. If a government enters into a contract to purchase goods and services, that is considered a commercial activity. Immunity cannot be claimed with respect to acts or transactions that are commercial in nature, regardless of their underlying purpose. If a government department goes into the marketplaces of the world and buys boots or cement as a commercial transaction, that government department should be subject to all the rules of the marketplace. Accordingly, Nigeria's cement contracts and letters of credit qualify as commercial activity for purposes of the Foreign Sovereign Immunities Act. Therefore, the defense of sovereign immunity is not available to Nigeria in this situation. Texas Trading & Milling Corp v. Federal Republic of Nigeria, 647 F.2d 300 (1981). 10. Prior to 1918, a Russian corporation had deposited sums of money with August Belmont, a private banker doing business in New York City. In 1918, the Soviet government nationalized the corporation and appropriated all of the corporation’s property and assets, including the deposit account with Belmont. The deposit became the property of the Soviet government until 1933, when it was released and assigned to the U.S. government as part of an international compact between the United States and the former Soviet Union. The purpose of this arrangement was to bring about a final settlement of the claims and counterclaims between the two countries. The United States brought an action to recover the deposit from Belmont. Belmont resists, arguing that the act of nationalization by the Soviets was a confiscation prohibited by the Fifth Amendment to the U.S. Constitution and was also a violation of New York public policy. Explain who will prevail. Answer: Act of State. Judgment for the United States. Governmental power over external affairs is vested exclusively in the national government, not the several states. Accordingly, the laws of New York cannot prevail against the international compact in this case. Principles of international courtesy and respect forbid the courts of one country to examine the validity of the acts of a foreign government done within its own territory. “What another country has done in the way of taking over property of its nationals, and especially of its corporations, is not a matter for judicial consideration.” The U.S. constitution, laws, and policies have no extraterritorial operation, except with respect to U.S. citizens. No U.S. interests were involved here, since August Belmont was merely a custodian for the deposit account. United States v. Belmont, 301 U.S. 324 (1937). 11. A Federal grand jury handed down an indictment naming as a defendant Nippon Paper Industries Co., Ltd. (NPI), a Japanese manufacturer of facsimile paper. The indictment alleged that five years earlier NPI and certain unnamed coconspirators held a number of meetings in Japan, which culminated in an agreement to fix the price of thermal fax paper throughout North America. NPI and other manufacturers who were involved in the scheme purportedly accomplished their objective by selling the paper in Japan to unaffiliated trading houses on the condition that the latter charge specified (inflated) prices for the paper when they resold it in North America. The trading houses then shipped and sold the paper to their subsidiaries in the United States, which in turn sold it to U.S. consumers at inflated prices. The indictment further states that, to ensure the success of the venture, NPI monitored the paper trail and confirmed that the prices charged to end users were those that it had arranged. The indictment maintains that these activities had a substantial adverse effect on commerce in the United States and unreasonably restrained trade in violation of the Sherman Act. Does the Sherman Act apply to this conduct? Explain. Answer: Sherman Act. Yes. In the United States Supreme Court's most recent exploration of the Sherman Act's extraterritorial reach the Justices permitted civil antitrust claims under Section One to go forward despite the fact that the actions which allegedly violated Section One occurred entirely on British soil. It is "well established by now that the Sherman Act applies to foreign conduct that was meant to produce and did in fact produce some substantial effect in the United States." United States v. Nippon Paper Industries Co., Ltd., 109 F.3d 1 (1997). 12. American Rice, Inc. ("ARI") is a Houston-based company that exports rice to foreign countries, including Haiti. Rice Corporation of Haiti ("RCH"), a wholly owned subsidiary of ARI, was incorporated in Haiti to represent ARI's interests and deal with third parties there. As an aspect of Haiti's standard importation procedure, its customs officials assess duties based on the quantity and value of rice imported into the country. Haiti also requires businesses that deliver rice there to remit an advance deposit against Haitian sales taxes, based on the value of that rice, for which deposit a credit is eventually allowed on Haitian sales tax returns when filed. The United States indicted David Kay and Douglas Murphy, both officers of ARI, for violation of the Foreign Corrupt Practices Act (FCPA). The indictment detailed how Kay and Murphy allegedly orchestrated the bribing of Haitian customs officials to accept false bills of lading and other documentation that intentionally understated by one-third the quantity of rice shipped to Haiti, thereby significantly reducing ARI's customs duties and sales taxes. The defendants argue that bribes paid to obtain favorable tax treatment are not payments made to "obtain or retain business" within the FCPA and thus are not within the scope of that statute's proscription of foreign bribery. Does the FCPA apply to this conduct? Explain. Answer: Foreign Corrupt Practices Act. Payments allegedly made to Haitian government officials for purpose of reducing corporation's customs duties and taxes were potentially within FCPA’s prohibition against payments to foreign officials to “obtain or retain” business. U.S. v. Kay, 359 F.3d 738 (U.S. Court of Appeals, Fifth Circuit, 2004). The Foreign Corrupt Practices Act (FCPA) did not criminalize every payment to foreign official, but only those payments intended to (1) influence foreign official to act or make decision in his official capacity, or (2) induce such official to perform or refrain from performing some act in violation of his duty, or (3) secure some wrongful advantage to payor, and Act criminalized such payments only if result they are intended to produce will assist, or is intended to assist, payor in efforts to get or keep some business. We hold that Congress intended for the FCPA to apply broadly to payments intended to assist the payor, either directly or indirectly, in obtaining or retaining business for some person, and that bribes paid to foreign tax officials to secure illegally reduced customs and tax liability constitute a type of payment that can fall within this broad coverage. In 1977, Congress was motivated to prohibit rampant foreign bribery by domestic business entities, but nevertheless understood the pragmatic need to exclude innocuous grease payments from the scope of its proposals. Congress was concerned about both the kind of bribery that leads to discrete contractual arrangements and the kind that more generally helps a domestic payor obtain or retain business for some person in a foreign country; and that Congress was aware that this type includes illicit payments made to officials to obtain favorable but unlawful tax treatment. Furthermore, by narrowly defining exceptions and affirmative defenses against a backdrop of broad applicability, Congress reaffirmed its intention for the statute to apply to payments that even indirectly assist in obtaining business or maintaining existing business operations in a foreign country. Finally, Congress's intention to implement the [OECD] Convention, a treaty that indisputably prohibits any bribes that give an advantage to which a business entity is not fully entitled, further supports our determination of the extent of the FCPA’s scope. *** [W]e conclude that bribes paid to foreign officials in consideration for unlawful evasion of customs duties and sales taxes could fall within the purview of the FCPA’s proscription. We hasten to add, however, that this conduct does not automatically constitute a violation of the FCPA: It still must be shown that the bribery was intended to produce an effect—here, through tax savings—that would "assist in obtaining or retaining business." *** Although we recognize that lowering tax and customs payments presumptively increases a company's profit margin by reducing its cost of doing business, it does not follow, ipso facto,—as the government contends—that such a result satisfies the statutory business nexus element. Even a modest imagination can hypothesize myriad ways that an unwarranted reduction in duties and taxes in a large-volume rice import operation could assist in obtaining or retaining business. For example, it could, as already indicated, so reduce the beneficiary's cost of doing business as to allow the beneficiary to underbid competitors for private commercial contracts, government allocations, and the like; or it could provide the margin of profit needed to fend off potential competition seeking to take business away from the beneficiary; or, it could make the difference between an operating loss and an operating profit, without which the beneficiary could not even stay in business; or it could free up funds to expend on legitimate lobbying or other influence-currying activities to favor the beneficiary's efforts to get, keep, or expand its share of the foreign business. Presumably, there are innumerable other hypothetical examples of how a significant diminution in duties and taxes could assist in getting or keeping particular business in Haiti; but that is not to say that such a diminution always assists in obtaining or retaining business. There are bound to be circumstances in which such a cost reduction does nothing other than increase the profitability of an already-profitable venture or ensure profitability of some start-up venture. *** *** *** We are satisfied that—for purposes of the statutory provisions criminalizing payments designed to induce foreign officials unlawfully to perform their official duties in administering the laws and regulations of their country to produce a result intended to assist in obtaining or retaining business in that country—an unjustified reduction in duties and taxes can, under appropriate circumstances, come within the scope of the statute. ANSWERS TO “TAKING SIDES” PROBLEMS The Commercial Office of Spain hired Enrique Segni to develop a market for Spanish wines in the U.S. Midwest. The Commercial Office is an arm of the Spanish government. Seven months later, Segni was fired, whereupon he filed a lawsuit in a U.S. district court charging that the Commercial Office had breached the contract and seeking payment for the remainder of the contract term as damages. The Commercial Office moved for dismissal, claiming immunity from suit under the terms of the Foreign Sovereign Immunities Act (FSIA). (a) What are the arguments that Spain is immune from suit under the FSIA? (b) What are the arguments that Spain is not immune from suit under the FSIA? (c) Explain which party should prevail. Answer: (a) The Commercial Office could argue that Segni had been hired to execute the policy of the Spanish government, that is, the fostering of exports of Spanish wines to the U.S. Midwest, and that his employment by the Commercial Office was a public act for which the Office, as an arm of the Spanish government, was entitled to sovereign immunity under the Foreign Sovereign Immunities Act (FSIA). (b) Segni could argue that his hiring is commercial in nature and therefore subject to the “commercial activity” exception to the FSIA. It could be argued that Segni’s employment was not governmental in any way and was merely to act as a commercial representative of Spanish wines. Segni should prevail. Segni v. Commercial Office of Spain, 835 F. 2d 160, Court of Appeals, 7th Circuit (1987). (c) The FSIA provides immunity to foreign states as a general matter, but subject to enumerated exceptions. The exception most frequently invoked, is the “commercial activity” exception: “A commercial activity means either a regular course of commercial conduct or a particular commercial transaction or act. The commercial character of an activity shall be determined by reference to the nature of the course of conduct or particular transaction or act, rather than by reference to its purpose.” The nature of a transaction for FSIA purposes may be determined by asking whether a similar agreement could have been entered into with a private party. For purposes of this case, Segni’s employment by the Commercial Office is best described as a contract under which he would provide services in the area of product marketing. This characterization reveals the nature of his activity without relying on its underlying government purpose. The hiring of a marketing agent is certainly an “activity . . . in which a private person could engage,” and many do, including individual businesses as well as associations of like business entities. Accordingly, we conclude that the district court correctly determined that the Commercial Office is not entitled to immunity from Segni’s breach-of-contract claim.Solution Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
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