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Chapter 24: Business law.

Law school is a three-year program to attain a Juris Doctorate degree. The most basic of business law courses in an undergraduate curriculum is usually a three credit hour course for a full semester. But we're going to cover the topic of business law in one brief chapter.

Obviously, this chapter will be very concise and, in effect, will be a glossary of key terms and concepts. The areas to be covered include

* contracts

* torts

* agency

* negotiable instruments

* professional liability

* fiduciary liability

* arbitration and mediation in alternative dispute resolution

CONTRACTS

A contract is an agreement among two or more parties (individuals or entities) consisting of a promise or promises for one or both parties to perform or refrain from performing an identified act or acts. Such agreement is enforceable by a court.

Basic Elements of a Contract

In order for there to be a contact, certain elements must exist.

1. Agreement--There must be mutual assent by the parties, evidenced by an offer by one party and some form of acceptance by the other. The mutuality may be manifested formally, in writing, or orally. The action of one party in response to an offer by another may result in an agreement, if the acts were in reliance of the offered promise.

The offer must be a clear, objective proposition that sets forth the material terms of the proposed contract. Such terms include identifying the parties, the subject matter of the agreement, the applicable quantities, and the consideration (price) to be paid for performance.

A valid offer must be distinguished from the following expressions which fall something short of an actual contractual offer

a) a statement of opinion

b) negotiations preceding an offer, including a mere solicitation to a possible agreement

c) a statement of mere intention or desire

d) broad-based advertising, price lists, circulars, etc.

e) offers made under true emotional stress

f) offers made in jest

g) a request for a bid or proposal

h) sham transactions

The material terms of an agreement must be clearly stated in the offer or by reference to a reasonably identifiable outside standard or third party. In addition, the offer must effectively communicate all material terms to the offeree.

An offer may be terminated by

a) actions of the parties, such as a revocation by the offeror or rejection by the offeree

b) the lapse of time, due to the expiration of a specific offer period or, absent a stated period, the passage of a reasonable time for acceptance by the offeree

c) by operation of law, resulting from, for example, death or incapacity of one of the parties, the subject matter of the agreement becoming illegal, or the destruction of the subject matter

An offer is accepted when the offeree clearly demonstrates his agreement to the proffered terms. In order for the acceptance to be effective, the offeree must

a) have knowledge of the terms of the offer

b) demonstrate the willingness and intent to be bound by the agreed terms

c) comply with the conditions of acceptance stated in the offer

Typically an offer is accepted by the offeree making a promise to perform (bilateral contract) or by the offeree performing the requisite acts of the offer (unilateral contract). Silence by the offeree will generally not be considered an acceptance unless

a) there was a similar, prior agreement indicating that such silence is continued acceptance

b) the offeree accepted the benefits provided by the offeror

c) the offeree exercised dominion over the subject matter of the agreement

Generally the acceptance becomes effective

a) in a unilateral contract, when the performance or intended restraint from acting is complete

b) in a bilateral contract, when the offeree provides the requisite promise, typically by delivering a signed contract

2. Consideration (the proverbial "quidpro quo")--Consideration is legally sufficient value received for value given. In a typical contract there is at least one promisor (the party who makes a promise to do or refrain from doing something) and at least one promisee (the party who receives a promise). In a unilateral contract there is only one promisor and one promisee. In a bilateral contract, the parties exchange promises, and are thus both promisors and promisees. In a bilateral contract, each promise is independently supported by consideration.

Legally adequate consideration exists when the promisor receives a legal benefit, the promisee experiences a legal detriment, or both. A legal benefit occurs if a promisor receives something (consideration) to which he is not entitled absent the existence of the contract.

A legal detriment occurs if the promisee

a) in a unilateral contract, actually gives up something to which he has a legal right or actually refrains from doing something that he has a legal right to do

b) in a bilateral contract, promises to give up something to which he has a legal right to retain or promises to refrain from doing something that he has a legal right to do

Consideration is provided so long as there is a surrender or receipt of a legal right. It is not necessary that an economic or material loss be incurred by the promisee or benefit received by the promisor.

Certain promises may be enforceable without adequate consideration. Such agreements include

a) charitable pledges and subscriptions

b) a new written promise or reaffirmation of a promise to pay debt otherwise discharged by bankruptcy

c) a new promise to pay debt barred by statute of limitations

d) promissory estoppel or detrimental reliance --applicable in most states--that requires the following:

i. A promise is made to induce a promise to perform a specific act.

ii. The promisor can foresee that promisee will justifiably rely on the promise.

iii. The promisee substantially changes his situation in the expected manner, incurring damage in reasonable reliance of the promise.

iv. It is grossly unfair not to enforce the promise.

3. Contractual capacity--The contracting parties must be able to enter into a legally binding agreement.

a) Minors--State statutes prescribe the age at which an individual is deemed old enough to enter into a legally binding contract. In most states that age is 18.

Minors may disaffirm a contract while still "under age" and for a reasonable period after attaining majority. However, a minor may be bound by a contract, in some states, if the contract is for life or medical insurance, medical care, educational loans, marriage, transportation by common carrier (bus, train, etc.), or enlistment in a branch of the armed forces.

Other special rules relating to minors and contracts include the following:

i. The transfer of real property cannot be disaffirmed until the minor reaches the age of majority.

ii. While a minor can void a contract, an adult party to the agreement cannot.

If the minor does void the contract, all parties must make restitution, returning the consideration received.

iii. Contracts for necessities, such as food, shelter, and clothing, not provided by a minor's parent or guardian may be disaffirmed by the minor. However, the provider of the necessities may use quasi contractual concepts to enforce payment for the goods or services.

iv. A contract becomes enforceable if the minor ratifies the agreement upon reaching majority. Such ratification may be expressed (in writing or orally) or implied by the conduct of the minor-turned-adult.

b) Intoxicated individuals--A contract is voidable if entered into by someone so intoxicated that he cannot understand the legal consequences of his actions. A contract may be voided while the person is still intoxicated or within a reasonable period thereafter. In such cases, restitution is required and the intoxicated person must pay for necessities that were conveyed. In addition the intoxicated person cannot void the contract if a third party would be injured as a result.

c) Mental incompetence--An individual is considered mentally incompetent to enter into a contract if the person's judgment is impaired and he cannot understand the consequences of the transaction. A contract is void if entered into by a person declared legally incompetent by the courts. If the individual has not been adjudicated to be mentally incompetent, the incompetent person may void the contract while he is in fact incompetent or within a reasonable period after regaining his sanity. In addition, a guardian or legal representative of a mentally incompetent person may void a contract entered into by the incompetent individual. Also, reasonable compensation for necessities actually provided to a mentally incompetent person must be paid, even if the contract is disaffirmed.

d) Certain convicts (primarily, in some states, those convicted of major felonies) are not considered to have the capacity to enter into contracts.

e) Individuals who are not U.S. citizens who are legally in the country are considered competent. However, illegal or enemy aliens have limited contractual capacity.

4. Legality--An agreement to perform an act which is illegal or against public policy generally does not constitute an enforceable contract.

5. Genuineness of assent--The consent to comply with the terms of the agreement must be genuine, real, and voluntary. Transactions that confront this issue include those involving

a) Mistake--A mistake is an error, forgetfulness, or unconscious ignorance of a present or past fact that is material, essential, or significant to the contract. A distinction should be made between a unilateral mistake and a mutual or bilateral mistake.

i. A unilateral mistake, involving a mistake by only one party to a contract, is generally not voidable by the mistaken party unless another party to the transaction caused the mistake, knew or should have known of the mistake, and did not rectify the error.

ii. A mutual or bilateral mistake generally concerns a material fact of which both contracting parties are unaware. Such a mistake would permit either party to void the contract.

b) Fraudulent misrepresentation may result from (i) fraud in the execution of a contract or (ii) fraud in the inducement to contract.

i. Fraud in the execution occurs when one party is led to believe that an act that he is performing is something other than the execution of a contract. Consequently, the parties' assent to the agreement is not real and there is no legal contract.

ii. Fraud in the inducement results when one party induces another to enter into a contractual relationship through a misrepresentation of a material fact.

Such contracts are voidable by the induced party.

Fraud may also result from silence or concealment. Although there is no duty to disclose known facts to the other party, there are several exceptions to this general rule. For instance, when there is a confidential or fiduciary relationship between the contracting parties, the party with knowledge must disclose that information to the other party and specific statutes, such as the Truth in Lending Act, require full disclosure of certain relevant facts.

c) Innocent misrepresentation occurs when a party makes a misrepresentation without knowing the information is false. In such circumstances, the relying party, if damaged by the misrepresentation, may void the contract.

d) Undue influence, which results when one party has control over the other because of a confidential relationship and takes unfair advantage, inducing the other party to enter into a contract. Such a contract would be voidable by the induced party.

e) Duress occurs when a party is coerced by wrongful force or threat of force to enter into a contract. The contract is voidable.

6. Form--The contractual agreement must be in a form that is prescribed and/or acceptable by law. For example, if transactions involving real estate, the Statute of Frauds requires the agreement be evidenced in writing.

The Statute of Frauds requires that certain contracts be made in written form in order for them to be enforceable. Contracts that must be in writing include

a) contracts for sale of real estate interests

b) contracts that cannot be performed within one year

c) collateral or secondary promises to perform in the event an identified primary contractor fails to meet his obligation (e.g., a guarantor)

A writing is deemed sufficient for purposes of the Statue of Frauds so long as it contains the basic, essential terms of the contract.

The parol evidence rule generally precludes the admission of oral or other written evidence to change, alter, or contradict a written contract which the parties have stated represents the complete and total terms of the agreement. Parol evidence may, however be admissible to substantiate

a) an acceptable, limited modification of the writing

b) that the contract was void or voidable

c) the meaning of vague or ambiguous terms

d) significant typographical or clerical errors

e) that the writing was incomplete

f) a prior continuing contractual relationship

g) a separate contract with different subject matter

Types of Contracts

There are several criteria that can used to distinguish one category of contract from another. These differentiators include:

1. Method of Assent

a) Express--The parties have stated the terms of the agreement to which they intend to be bound--typically in writing.

b) Implied--The terms of the agreement can reasonably be inferred by the acts of the parties, even if never stated in writing or orally.

In either case, the agreeing parties must objectively and independently desire to enter into the contract.

2. Nature of the Promise Made

a) Bilateral contract--Both (all) parties to the agreement exchange promises to perform --Mutual promises to do something in the future

b) Unilateral contract--One party makes a promise to another in anticipation of (in exchange for) the performance of some act (or refraining from acting)--no reciprocal promise, just the action

3. Expectation of Compliance with Statutorily Imposed Form

a) Formal contract--Some formal act or documentation required for contract to be enforceable

i. negotiable instruments

ii. letters of credit

iii. contacts under seal or notary

b) Informal contract--Agreement or contract for which no special form is required

4. Stage of Performance of the Contractual Promise

a) Executed contract--All parties have completed their contracted promises

b) Executory contract--Contract has been only partially performed or totally unperformed by all parties

5. Legal Validity and Enforcement

a) Valid and enforceable--All elements of a legal and binding contract are present

b) Void--So-called agreement is not really a contract and has no legal effect

c) Voidable--Some element of the contract is defective or otherwise enables one party to the agreement to avoid a contractual commitment

d) Unenforceable--Contractual promise(s) cannot be verified in a manner sufficient for legal enforcement, or contract fails to meet a formal or procedural requirement

Conditions, Performance and Discharge

A contract condition is an event, the occurrence or nonoccurrence of which limits, precludes, changes, causes or terminates a contractual obligation. Common types of conditions include:

1. Condition precedent--An even which must occur before performance by the promisor is required. Until all such conditions are met, the promisee cannot legal expect performance by the promisor.

2. Condition subsequent--An event which extinguishes an existing contractual commitment.

3. Concurrent condition--The performance of one party is conditioned on the parallel performance of the other party.

Conditions arise either (1) expressly (clearly stated by the parties), (2) implied in fact, or (3) implied in law (constructive)--imposed by courts to achieve justice or fairness.

Full, complete performance consistent with the terms of a contract will discharge a party from further obligation.

If the time for performance is not stated, a "reasonable time period" standard will be applied. If the parties agree that "time is of the essence," they must comply with the stated time. If the time for performance is stated, but not essential, compliance within a few days of the stated date will usually satisfy the contract.

If partial performance is accepted, than appropriate payment is due to the performing party. If the partial performance is substantial (only minor or insignificant incomplete aspects remain), and any deviation from the contract terms is not in bad faith, the performing party is discharged but is liable for the failure to fully complete the contract. If the partial performance is less than substantial, there will be a breach of contract, resulting in the discharge of the party entitled to receive performance but not the discharge of the party who failed to perform.

A total failure to comply will yield the same treatment to the failing party (no discharge) and the party who does not receive performance (full discharge).

A discharge may occur upon the agreement of the parties. The reasons for an agreement to discharge may be stated in the original contract or may be mutual consent after the contract period has commenced.

A discharge of contractual obligations may also occur by operation of law if

1. There is a material alteration of a written contract without consent.

2. The statue of limitations barring judicial remedies has run.

3. There is a decree of bankruptcy.

4. An unforeseen or intervening event makes performance impossible. Such events include

a) the subject matter of the contract becomes illegal

b) the death, incapacity or other serious illness of a party required to perform personal services

c) the destruction of the subject matter of the contract

d) anticipated economic results of performance are made impossible as a result of unforeseen, uncontrollable events

e) a serious and extreme change in conditions making performance impracticable without undue burden (financial or otherwise) on the intended performing party

Typical remedies for breach of contract include

1. Money damages--remedies at law

a) Compensatory damages--Compensation for the actual value of the loss or harm

b) Consequential or special damages--Compensation for unforeseeable, remote, indirect, or unexpected harm or loss which does not ordinarily result from such a breach of contract. Consequential damages are not recoverable unless the nonperforming party is made aware of such possible harm.

c) Punitive damages--An extraordinary award by a court granted in order to punish a party for willful or malicious harm caused by the contract breach

d) Nominal damages--an insignificant sum of money acknowledging that the nonperforming party did breach the contract, but that the harm or financial injury was minimal

e) Liquidated damages--Formula or amount of damages to be paid as agreed to by the parties and as established in the terms of the contract. Liquidating damages provisions are enforceable unless they are unreasonable, and in effect penalties.

2. Equitable remedies--usually consist of

a) requiring specific performance by a breaching party

b) recission--Cancellation or abrogation of the contract

c) restitution--requiring the return of property to it pre-contract condition or return of value

d) injunctive relief- An order preventing or restricting a person from doing something

e) reformation--Court order correcting an agreement so that it will conform to the intentions of the parties

These remedies are not available where

a) Monetary damages are adequate, determinable, and available.

b) The injured party has acted fraudulently or in bad faith.

c) laches--The injured party has unnecessarily delayed in bringing an action against the other party.

TORTS

A tort is a legal wrong by one person against another. It is a violation of a person's rights, usually due to negligence, but it may be the result of a deliberate act.

Tort law is a branch of civil law; the other main branches are property and contract law. Tort law is state law created through the judicial system (common law) or by legislation (statutory law). Many judges and states follow the Second Restatement of Torts as a primary guide to the creation and interpretation of tort law. The Restatement is a publication of the American Law Institute, an organization whose aim is to present an orderly statement of the general law of the United States.

A tort differs from a criminal act, which generally is an intentional violation of another's rights. A tort is subject to civil action and subsequent judgment for damages payable to the person who was wronged. In the case of a crime, the act is subject to criminal prosecution by governing authorities who impose penalties for a person found guilty of the criminal act. A wrongful act may be both a tort and a criminal act, in which case the wrongdoer would be subject to both civil action and criminal prosecution.

A plaintiff in a tort action is the alleged wronged party. A defendant is the alleged wrongdoer. The plaintiff may sue for monetary damages to compensate for the harm done. The plaintiff may also seek injunctive relief, restricting the defendant from continuing the actions which caused the harm.

Among the types of damages an injured party may recover (including both present and future expected losses) are

1. loss of earning capacity

2. reasonable medical expenses

3. pain and suffering

Among the many specific type of torts, the most common include

1. trespass

2. assault

3. battery

4. negligence

5. products liability

6. intentional infliction of emotional distress

Torts fall into three general categories:

1. Intentional torts--Wrongs which the defendant knew or should have known would occur through his actions or inactions (e.g., intentionally hitting a person)

2. Negligent torts--Occur when the defendant's actions were unreasonably unsafe (e.g., causing an accident by failing to obey traffic rules)

3. Strict liability torts--Wrongs which do not depend on the degree of carelessness by the defendant, but are established when a particular action causes damage (e.g., products liability--a liability for making and selling defective products)

Damages, for legal purposes, are the amount of money the law requires to be paid for the breach of some duty or the violation of some right. There are generally two types of damages: compensatory (or actual) and punitive.

Compensatory damages are intended to compensate the injured party for his loss or injury. Punitive damages are awarded to punish a wrongdoer. For certain types of injuries statutes provide that a successful party receive some multiple of their "actual damages", e.g. treble damages.

AGENCY

An agency relationship occurs when one person (a principal) uses another person (an agent) as a representative in certain transactions or business activities. An agent may bind his principal in a contract with a third party and usually has some degree of independence in his actions.

An agency relationship is distinguishable from an employer-employee relationship under which the employer controls, or has the right to control the employee's actions on his behalf. In addition, employees generally have little if any independent discretion. Employees are most often compensated for time (except commissioned employees) while agents are usually compensated based on results. Employers are required to withhold, remit and pay their share of employee payroll taxes, while principals are not required to do so for their agents.

An agent can also be differentiated from an independent contractor. An independent contractor is generally retained to perform a specific task and is paid upon its completion, while an agent often retains an ongoing relationship representing the principal for an identified function or functions, often for an extended period of time. The person who hires an independent contractor usually has very limited if any control over the contractor. In addition, unlike an agent, an independent contractor generally cannot bind the person retaining him to a contract with a third party.

Formation of Agency Relationship

An agency relationship may be formed for any legal purpose. It is a consensual relationship, which often but not always results in a contract. Consideration is not a necessary element of an agency.

General, no formalities are required to create an agency. Unless required by statute or by the Statute of Frauds, a written agency agreement is not necessary. A typical written agency document would be a power of attorney.

Since an agent generally represents his principal in contractual relationships, the principal must himself have the legal capacity to enter into contracts. Absent such capacity, the principal could void the contract, but the third party with whom the agent negotiated could not.

An agency agreement (although, as stated above, not always a contract) may be expressed in writing or orally, or implied by the actions of the parties. An agency can be created after the agent has acted for the principal if the principal expressly or by implication ratifies the agent's action on his behalf.

Agent's Duties to the Principal

1. Duty to perform--Carryout agreed to functions, etc.

2. Duty to notify--Inform the principal of material information relating to the subject of the agency.

3. Duty of loyalty--Agent cannot compete or use information obtained through the agency relationship for the benefit of others or his own benefit independent of his agency agreement. To put it simply, the agent cannot in any way act in a manner that creates a conflict of interest with the principal.

4. Duty to account--Report to the principal with the economic results and other consequences of his actions on behalf of the principal.

In the event an agent breaches his duties to the principal, the principal has the right to be indemnified by the agent. Thus, for example, if the principal is required to pay damages to an injured party caused by the agent's tortious act while representing the principal, the principal would be entitled to be recompensed by the agent.

A principal may void an action by an agent on his behalf if the act violates the agent's fiduciary duty to the principal.

Principal's Duties to the Agent

1. The principal must perform in accordance with his contract with an agent.

2. The principal has the duty to compensate, indemnify, and reimburse the agent for his efforts under the terms of the agreement. If no compensation is specified, the principal is obligated to pay expenses, losses and reasonable compensation for the agent's services.

3. The principal has an obligation to cooperate with the agent as the agent acts on his behalf.

The agent's remedies for breach by the principal include indemnification, sue for breach of contract, bring an action for an accounting, or withhold further performance.

Termination of Agency Relationship

An agency relationship may terminate by the parties or by operation of law. The parties may terminate the agency by providing for a specified expiration time in their agreement. Absent a stated time, a reasonableness standard will apply.

An agency will also terminate if the intended purpose is accomplished or if the parties mutually agree to end the relationship. Either party may terminate the agency unilaterally, but may be required to compensate the other who has acted in reliance of the terminating party. An agency relationship may also be terminated for cause.

By operation of law, an agency will terminate upon the death or incapacity of either the agent or principal. Knowledge of the death or incapacity is not required. Bankruptcy of the principal will also terminate the agency, although insolvency does not. Bankruptcy of the agent does not necessarily lead to termination. Impossibility of performance due, for example, to destruction of the subject property, or other unforeseen changes in circumstances will permit a termination of the agency.

If an agency is terminated by a party, notice must be given before the relationship is ended. Notice must also be provided to third parties with whom the agent is dealing on behalf of the principal.

NEGOTIABLE INSTRUMENTS

A negotiable instrument is typically a written document that either provides evidence of financial credit or acts as a substitute for money. If an instrument is negotiable, it would be considered commercial paper, governed by Article 3 of the Uniform Commercial Code (UCC). If it is not negotiable, ordinary contract law applies.

Types of Commercial Paper

1. A draft has three parties; the drawer (person with funds) who instructs the drawee (e.g., bank) to make a payment to a payee.

2. A check is a special kind of draft that is payable only by a bank as drawee and which is payable upon demand by the payee. The check writer is the drawer.

3. A promissory note is an instrument between two parties: the maker promises to pay a specific amount to a payee. A promissory note may be payable on demand or at a specific date. A certificate of deposit is a form of promissory note in which the bank is the maker and the depositor is the payee.

Negotiation

For an instrument to be negotiable, it must have all of the following elements on the face of the document:

1. must be in writing

2. must be signed by the drawer (draft) or maker (promissory note)

3. must contain an unconditional order or promise to pay

4. must state a set amount of money to be paid

5. must be payable upon demand or at a defined time

6. must be payable to the order of the payee or to the bearer (unless it is a check)

Commercial paper is typically transferred by either (1) negotiation or (2) assignment.

1. Negotiation--A person who holds a negotiable instrument is identified as a holder. If the holder meets the requirements of a "holder in due course," he can obtain rights greater than those of the transferor.

There are two basic methods of negotiating an instrument:

a) Commercial paper payable "to the order of" a specified person (order paper) is negotiated when endorsed by the transferor and the instrument is delivered to the holder.

b) "Bearer paper" is negotiated by the mere delivery to the holder. No endorsement is required.

2. Assignment--Occurs when a transfer does not meet all of the requirements of a negotiation. In this situation, the assignee can not be a holder in due course and cannot have rights any greater than those of the assignor.

There are several forms of endorsement of negotiable instruments:

1. A blank endorsement converts order paper into bearer paper by the endorsement signature of the payee/transferor, without identifying a specific transferee.

2. A special endorsement identifies a specific person to whom the endorser wants to endorse the instrument (endorsee).

3. A restrictive endorsement requires the endorsee to comply with certain requirements, such as "for deposit only."

4. A qualified endorsement disclaims the liability normally imposed on the endorser. For example, such a qualification would free the endorser from covering the amount due if the instrument is subsequently dishonored by the drawer/maker.

A Holder In Due Course is entitled to payment on a negotiable instrument in spite of defenses otherwise available to the maker or drawer of the instrument. Such enhanced rights are not available to an ordinary holder of a promissory note or an assignee.

In order to be a holder in due course, the holder of the instrument must

1. hold a properly negotiated negotiable instrument

2. give adequate value for the instrument

3. take the instrument in good faith

4. take the instrument without notice that it is already overdue, dishonored, or that a person has a claim to the instrument

The rights of a holder in due course include the following:

1. When a transfer of a negotiable instrument is made to someone who qualifies as a holder in due course, all personal defenses against the holder in due course are stopped. These personal defenses are available against ordinary holders and assignees. One key exception to this rule occurs when the holder in due course takes the instrument subject to the personal defenses applicable to the transferor. The usual Personal defenses include

a) breach of contract

b) lack or failure of consideration

c) prior payment

d) unauthorized completion

e) fraud in the inducement

f) non-delivery

g) undue influence or duress

h) mental incapacity

i) illegality

2. Certain defenses, referred to as real or universal defenses, may be asserted against any party, including a holder in due course. Such defenses include

a) forgery

b) bankruptcy

c) fraud in the execution

d) minority incapacity

e) material alteration of instrument

3. A person who is not himself a holder in due course, but who obtains a negotiable instrument from a holder in due course is called a holder through a holder in due course. Such a person obtains all the rights of a holder in due course. Exceptions apply to

a) a party who reacquires an instrument--His status remains as it was originally, and is not enhanced by the intervention of a holder in due course.

b) a person who was involved in a fraudulent or illegal act affecting the instrument--cannot become a holder through a holder in due course.

Warranties on negotiable instruments--There are two types of such warranties:

1. Contractual liability--Refers to a liability of any party who signs a negotiable instrument, whether as a maker, drawer, drawee, or endorser.

a) A maker has primary liability and is thus required to make payment on the note until it is paid or the statute of limitations has run.

b) No party of a draft or check initially has primary liability since the drawee has only been ordered by the drawer to make payment. However, the drawer has secondary liability and is liable only if the drawee fails to pay.

c) An endorser of a note or draft has secondary liability and is liable for payment to the holder only if the maker or other primary party fail to make payment.

d) A drawer or endorser can avoid secondary liability by signing or endorsing the instrument "without recourse."

e) If a certified check is issued, the bank, as drawee, accepts full responsibility for payment, thus relieving the drawer or prior endorsers from liability.

2. Warranty liability--Enables the holder to seek payment from secondary parties through a transfer warranty or presentment warranty.

To recover under a warranty liability, a party does not have to meet conditions of proper presentment, dishonor, or timely notice of dishonor that are required under contractual liability against endorsers.

A transfer warranty applies whenever a negotiable instrument is transferred, so long as

i. The transferor has good title.

ii. All signatures are genuine and authorized.

iii. The instrument has not been materially altered.

iv. No party has a good defense against the transferor.

v. The transferor has no notice of insolvency of the maker, drawer, or acceptor.

Transfer warranties place the loss of the transaction on the person who dealt face to face with the wrongdoer, who was thus in the best position to prevent the transfer of the forged, stolen, or altered instrument.

Banks and Checks--Banks are not obligated to pay on a check presented more than 6 months after the issue date. However they may, in good faith, make payment and charge the drawer (customer's) account, even if this creates an overdraft of the drawer's account.

Banks are liable to the drawer for damages resulting from the bank wrongfully dishonoring a check. Wrongful dishonor may occur if the bank erroneously believes there are insufficient funds to cover the check. Banks are also liable to the drawer for payment on forged or altered checks, unless the drawer's negligence contributed to the issuance of the bad check.

A written stop payment order on a check is good for six months and is renewable. An oral stop payment order is only good for 14 days. Any stop payment order must be given with sufficient time to provide the bank with reasonable time to act. The bank is liable to the drawer for payment after the effective date of the order, but only if the drawer can prove that the bank's failure to obey the order caused the drawer's loss. If the drawer of the check stops payment, he is still liable to the holder, unless the drawer has a valid defense.

PROFESSIONAL LIABILITY

The concept of professional liability is intended to impose a higher "standard of care" on so-called professionals for their acts which cause harm to others. It is intended to apply to those professions, such as law, medicine, accounting, engineering, architecture, requiring special licensing and a high level of special knowledge and training. In terms of negligence law, "a professional possesses a special form of competence which is not part of the ordinary equipment of the reasonable man, but which is the result of acquiring learning and aptitude developed by special training and experience."

Professional liability insurance is designed to provide insurance coverage for a professional's tangible performance of his duties and cover the "wrongful acts" of the insured, as defined in the insurance policy. This definition is typically narrowed by the requirement that the act be related to the conduct prescribed in the policy. Consequently the insured professional should take care that the policy language adequately describes what the insured is actually doing. Coverage is also limited by other provisions in the policy, such as a clause that sets out the term of the policy and any periods of extension. Most policies also include a "Special Reporting Clause" that requires the insured to report incidents which may give rise to a claim in the future.

Professional liability is recognized as being one of the most difficult kinds of insurance to obtain. The exposures are constantly evolving as a result of the courts' broadening the level of care expected of professionals, contributing to ever increasing defense cost. In addition, juries have continued to award extremely high awards for damages resulting from professional liability.

FIDUCIARY LIABILITY

A fiduciary is someone who agrees to act in the best interest of another person. It is essentially a financial or control relationship, characterized by discretionary control over assets, finances, or actions. Typical fiduciaries include

1. trustees of individual trusts (including irrevocable life insurance trusts)

2. trustees of pension and retirement fund trusts under the Employee Retirement Income Security Act of 1974 (ERISA)

3. corporate directors

4. corporate officers

As compared to a professional, who is held to a high standard of care with respect to the advice provided related to his area of expertise, a fiduciary is held to an even higher standard because of the responsibility and obligation to care for and handle the funds and affairs of the trust beneficiary, employees, shareholders, etc.

A professional, such as an attorney or an accountant, will be held to standards of both a professional and a fiduciary if he is acting as a fiduciary on behalf of his client. Errors in judgment and/or omissions in activity, including inaction, over-action, insufficient action, and wrongful action, may result in significant litigation. Awards can be accompanied by punitive damages and/ or more severe civil and criminal sanctions, approaching the dollar magnitude of recent manufacturing product liability awards.

Fiduciary and professional arrangements are governed by written, oral, and implied contracts. Written contracts specify the relationships, obligations, and the actions permitted between the parties. Oral and implied contracts may also contain many significant fiduciary obligations, which bind the parties to common law obligations. In addition, statutes may impose special fiduciary obligations, which can result in potential liabilities. For example, federal law requires that pension fund trustees have a definite fiduciary relationship to invest and protect the funds of employees to whom the funds belong.

With respect to the investment responsibilities of a fiduciary, The Restatement of the Law Third of Trusts (1990) and the Uniform Prudent Investor Act identify the following important principles of prudent investing:

1. Duty to diversify--If you decide to forgo the benefits of diversification, you need to have a good reason.

2. Duty to invest according to a suitable level of risk - You need to weigh risk and return in the context of the trust's objectives.

3. Duty to avoid unnecessary expenses--If you decide to pay higher costs than necessary, you need to have a good reason.

4. Duty to seek advice when necessary -You should recognize when you need help, and you must choose an adviser carefully and monitor the adviser's actions.

Liability under ERISA--The passage of the Employee Retirement Income Security Act of 1974 (ERISA) substantially increased the liabilities of fiduciaries in the United States. It also better defined some of the responsibilities and associated liabilities of fiduciaries.

ERISA was created to help protect the interests of pension and employee benefit plan beneficiaries. Under ERISA, an individual (or organization) is deemed a fiduciary if that person (or entity) exercises any discretionary authority or control over the management of any type of employee benefit plan. In particular, any person responsible for the investment, control, or disposition of assets held by the plan would be considered a fiduciary. ERISA broadly defines an "employee benefit plan" as:
  Any one plan, fund or program established or maintained
  for the purpose of providing to its participants
  or beneficiaries employee benefits.


Fiduciaries can also be held liable for the acts, errors, and omissions of outside entities that provide administrative and related services. Outside entities representing this exposure include those organizations that service pension and benefit plans: consulting and actuarial consulting firms, law firms, accounting firms, professional administration firms, investment advisers and investment management companies, and the trust departments of financial institutions.

Fiduciary liability insurance is a popular vehicle for the financial protection of fiduciaries, including those responsible for employee benefit plans, against legal liability arising out of their role as fiduciaries. Such insurance coverage can include the cost of defending against claims seeking to establish such liability.

At least two other types of "coverage" are related to fiduciary liability insurance. First, fidelity bonds are required by law (ERISA bonding). This is a form of insurance for dishonesty situations. When dishonest administrators or trustees have financially harmed an employee benefit plan, these bonds may be used, but only for the benefit of the plan and the plan's beneficiaries. This bonding insurance will not protect the trustees themselves from liability claims and is thus completely distinct from fiduciary liability insurance.

The second related coverage is employee benefit liability (EBL) insurance. EBL insurance policies cover many claims arising out of errors or omissions in the administration of a benefit plan, including the failure to enroll an employee in the plan as well as the administration of improper advice as to benefits.

EBL insurance does not cover all situations of fiduciary responsibility, especially those regarding imprudent investment of funds. Fiduciary liability insurance coverage may or may not encompass EBL insurance coverage; the insurer involved, the purchasing entity, and the specific type of fiduciary liability coverage being employed will ultimately determine what scope of coverage is available.

ARBITRATION AND MEDIATION IN ALTERNATIVE DISPUTE RESOLUTION

All the areas of business law discussed in this chapter identify a potential for dispute among parties--persons involved in contracts or other transactions, persons who have a degree of responsibility as fiduciaries for the benefit of others, and to persons who may intentionally engage in undesired activities (such as an automobile accident). Most of the disagreements are easily resolved by "reasonable people" acknowledging their responsibility or reconciling differences in opinion and perhaps negotiating a settlement on their own.

When the parties in conflict cannot resolve their difference by themselves, third-party intervention of some form is usually required. The typical forms of such third-party assisted dispute resolution include

1. litigation

2. mediation

3. arbitration

Litigation involves the use of the courts and civil justice system to resolve the legal controversies. It is inevitably expensive, protracted, and somewhat unpredictable. In a business situation, it should be the last resort considered.

In recent years mediation and arbitration have been so clearly identified as preferable to litigation, that the concept of Alternative Dispute Resolution (ADR) has become a watchword for their use in cost-effective and efficient resolving business conflicts.

Mediation is a voluntary process in which an impartial person (the mediator) assists with the communications between the parties, promoting reconciliation between the parties that will hopefully lead to a mutually acceptable resolution. The mediator manages the process and facilitates negotiations between the parties. The mediator does not force an agreement or make decisions. The parties participate and negotiate their own agreement, facilitated by the artful mediator.

Mediation can be used in most controversies, such as between merchants and customers, tenants and landlords, employees and employers, as well as complex business disputes.

Mediators are usually attorneys or other seasoned professionals or business persons, and are usually paid a fee for their services. In some cases a mediator knowledgeable in the specific area of dispute is agreed to by the parties, but this is not always necessary or helpful. The attorneys and other advisors of the disputing parties will usually participate in the process, assisting in the communication of their clients' positions.

Arbitration is the submission of a dispute to an impartial person or person (arbitrators) for decision. Like mediation, arbitration is an out-of-court method of dispute resolution. An arbitrator controls the process listens to both sides, but unlike a mediator, an arbitrator will make a decision. Like a trial, only one party will prevail. Unlike a trial, however, appeal right are limited.

"Binding arbitration" is often required under the terms of an agreement as the only means of resolving certain disputes between the parties. Such an agreement will usually identify the means for choosing the arbitrator or arbitration panel (usually three individuals), and the time frame for the arbitration process. Appeal rights are usually extremely limited in such agreed-to binding arbitrations. The arbitrator's award can be reduced to a judgment in a court making it enforceable.

In non-binding arbitration, a decision may become final if all the parties agree to accept it or it may serve to assist a party in evaluating the strength or weakness of his case if pursued in the courts or as a starting point for settlement negotiations.
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Title Annotation:FINANCIAL PLANNING
Publication:Tools & Techniques of Financial Planning, 9th ed.
Date:Jan 1, 2009
Words:7518
Previous Article:Chapter 23: Ownership of property.
Next Article:Chapter 25: Monetary settlement planning.

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