Must read Chapters 5, 8, and 18 (three chapters attached word document) 

Must submit  news articles, or journal articles, that relate with the subject of the chapter 

Each chapter has a separate news article / journal. MUST BE CURRENT NEWS Fortune 500 companies. 

2 pages each chapter DUE WEDNESDAY  March 11, 2020

Chapter Five Constitutional Principles

The Constitution

The Constitution provides the legal framework for our nation. The articles of the Constitution set out the basic structure of our government and the respective roles of the state and federal governments. The Amendments to the Constitution, especially the first 10, were primarily designed to establish and protect individual rights.

Federalism

Underlying the system of government established by the Constitution is the principle of 

federalism

, which means that the authority to govern is divided between two sovereigns or supreme lawmakers. In the United States, these two sovereigns are the state and federal governments. Federalism allocates the power to control local matters to local governments. This allocation is embodied in the U.S. Constitution. Under the Constitution, all powers that are neither given exclusively to the federal government nor taken from the states are reserved to the states. The federal government has only those powers granted to it in the Constitution. Therefore, whenever federal legislation that affects business is passed, the question of the source of authority for that regulation always arises. The Commerce Clause is the predominant source of authority for the federal regulation of business, as we will see later.

federalism

A system of government in which power is divided between a central authority and constituent political units.

Critical Thinking About The Law

The Constitution secures numerous rights for U.S. citizens. If we did not have these rights, our lives would be very different. Furthermore, businesses would be forced to alter their practices because they would not enjoy the various constitutional protections. As you will soon learn, various components of the Constitution, such as the Commerce Clause and the Bill of Rights, offer guidance and protection for businesses. The following questions will help sharpen your critical thinking about the effects of the Constitution on business.

1. One of the basic elements in the Constitution is the separation of powers in the government. What ethical norm would guide the framers’ thinking in creating a system with a separation of powers and a system of checks and balances?

Clue:  Consider what might happen if one branch of government became too strong.

2. If the framers of the Constitution wanted to offer the protection of unrestricted speech to citizens and businesses, what ethical norm would they view as most important?

Clue:  Return to the list of ethical norms in 

Chapter 1

. Which ethical norm might the framers view as least important in protecting unrestricted speech?

3. Why should you, as a future business manager, be knowledgeable about the basic protections offered by the Constitution?

Clue:  If you were ignorant of the constitutional protections, how might your business suffer?

In some areas, the state and federal governments have concurrent authority; that is, both governments have the power to regulate the matter in question. This situation arises when authority to regulate in an area has been expressly given to the federal government by the Constitution. In such cases, a state may regulate in the area as long as its regulation does not conflict with any federal regulation of the same subject matter. A conflict arises when a regulated party cannot comply with both the state and the federal laws at the same time. When the state law is more restrictive, such that compliance with the state law is automatically compliance with the federal law, the state law will usually be valid. For example, as discussed in 

Chapter 22

, in many areas of environmental regulation, states may impose much more stringent pollution-control standards than those imposed by federal law.

Supremacy Clause

The outcome of conflicts between state and federal laws is dictated by the 

Supremacy Clause

. This clause, found in Article VI of the Constitution, provides that the Constitution, laws, and treaties of the United States constitute the supreme law of the land, “any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” This principle is known as the principle of 

federal supremacy

: Any state or local law that directly conflicts with the federal Constitution, laws, or treaties is void. Federal laws include rules promulgated by federal administrative agencies. 
Exhibit 5-1
 illustrates the application of the Supremacy Clause to state regulation.

Supremacy Clause

Provides that the U.S. Constitution and all laws and treaties of the United States constitute the supreme law of the land; found in Article VI.

federal supremacy

Principle declaring that any state or local law that directly conflicts with the federal Constitution, laws, or treaties is void.

Federal Preemption

The Supremacy Clause is also the basis for the doctrine of 

federal preemption

. This doctrine is used to strike down a state law that, although it does not directly conflict with a federal law, attempts to regulate an area in which federal legislation is so pervasive that it is evident that the U.S. Congress wanted only federal regulation in that general area. It is often said in these cases that federal law

Exhibit 5-1 Application of the Supremacy Clause to state Regulation

“preempts the field.” Cases of federal preemption are especially likely to arise in matters pertaining to interstate commerce, such as when a local regulation imposes a substantial burden on the flow of interstate commerce through a particular state. This situation is discussed in some detail in the section on the Commerce Clause.

federal preemption

Constitutional doctrine stating that in an area in which federal regulation is pervasive, state legislation cannot stand.

Separation of Powers

The U.S. Constitution, in its first three articles, establishes three independent branches of the federal government, each with its own predominant and independent power. These three are the legislative, executive, and judicial branches. Each branch was made independent of the others and was given a separate sphere of power to prevent any one source from obtaining too much power and consequently dominating the government.

The doctrine of 

separation of powers

 calls for Congress, the legislative branch, to enact legislation and appropriate funds. The president is commander-in-chief of the armed forces and is also charged with ensuring that the laws are faithfully executed. The judicial branch is charged with interpreting the laws in the course of applying them to particular disputes. No member of one branch owes his or her tenure in that position to a member of any other branch; no branch can encroach on the power of another. This system is often referred to as being a system of checks and balances; that is, the powers given to each branch operate to keep the other branches from being able to seize enough power to dominate the government. 

Exhibit 5-2

 provides a portrait of this system.

separation of powers

Constitutional doctrine whereby the legislative branch enacts laws and appropriates funds, the executive branch sees that the laws are faithfully executed, and the judicial branch interprets the laws.

Despite this delicate system of checks and balances, on numerous occasions a question has arisen as to whether one branch was attempting to encroach on the domain of another. This situation arose in an unusual context: a sexual harassment charge against President Bill Clinton.

 Case 5-1 William Jefferson Clinton v. Paula Corbin Jones

Supreme Court of the United States 520 U.S. 681 (1997)

Plaintiff Paula Jones filed a civil action against defendant (sitting) President Bill Clinton, alleging that he made “abhorrent” sexual advances. She sought $75,000 in actual damages and $100,000 in punitive damages.

Defendant Clinton sought to dismiss the claim on the ground of presidential immunity, or, alternatively, to delay the proceedings until his term of office had expired.

The district court denied the motion to dismiss and ordered discovery to proceed, but it also ordered that the trial be stayed until the end of Clinton’s term. The court of appeals affirmed the denial of the motion to dismiss and reversed the stay of the trial. President Clinton appealed to the U.S. Supreme Court.

Justice Stevens

Petitioner’s principal submission—that “in all but the most exceptional cases,” the Constitution affords the President temporary immunity from civil damages litigation arising out of events that occurred before he took office—cannot be sustained on the basis of precedent.

Only three sitting presidents have been defendants in civil litigation involving their actions prior to taking office. Complaints against Theodore Roosevelt and Harry Truman had been dismissed before they took office; the dismissals were affirmed after their respective inaugurations. Two companion cases arising out of an automobile accident were filed against John F. Kennedy in 1960 during the Presidential campaign. After taking office, he unsuccessfully argued that his status as Commander in Chief gave him a right to a stay. The motion for a stay was denied by the District Court, and the matter was settled out of court. Thus, none of those cases sheds any light on the constitutional issue before us.

The principal rationale for affording certain public servants immunity from suits for money damages arising out of their official acts is inapplicable to unofficial conduct. In cases involving prosecutors, legislators, and judges we have repeatedly explained that the immunity serves the public interest in enabling such officials to perform their designated functions effectively without fear that a particular decision may give rise to personal liability.

That rationale provided the principal basis for our holding that a former president of the United States was “entitled to absolute immunity from damages liability predicated on his official acts.” Our central concern was to avoid rendering the President “unduly cautious in the discharge of his official duties.”

This reasoning provides no support for an immunity for unofficial conduct. . . . “[T]he sphere of protected action must be related closely to the immunity’s justifying purposes.” But we have never suggested that the President, or any other official, has an immunity that extends beyond the scope of any action taken in an official capacity.

Moreover, when defining the scope of an immunity for acts clearly taken within an official capacity, we have applied a functional approach. “Frequently our decisions have held that an official’s absolute immunity should extend only to acts in performance of particular functions of his office.” Petitioner’s strongest argument supporting his immunity claim is based on the text and structure of the Constitution. The President argues for a postponement of the judicial proceedings that will determine whether he violated any law. His argument is grounded in the character of the office that was created by Article II of the Constitution and relies on separation-of-powers principles.

As a starting premise, petitioner contends that he occupies a unique office with powers and responsibilities so vast and important that the public interest demands that he devote his undivided time and attention to his public duties. He submits that—given the nature of the office—the doctrine of separation of powers places limits on the authority of the Federal Judiciary to interfere with the Executive Branch that would be transgressed by allowing this action to proceed.

We have no dispute with the initial premise of the argument. We have long recognized the “unique position in the constitutional scheme” that this office occupies.

It does not follow, however, that separation-of-powers principles would be violated by allowing this action to proceed. The doctrine of separation of powers is concerned with the allocation of official power among the three coequal branches of our Government. The Framers “built into the tripartite Federal Government . . . a self-executing safeguard against the encroachment or aggrandizement of one branch at the expense of the other.” Thus, for example, the Congress may not exercise the judicial power to revise final judgments, or the executive power to manage an airport.

. . . [I]n this case there is no suggestion that the Federal Judiciary is being asked to perform any function that might in some way be described as “executive.” Respondent is merely asking the courts to exercise their core Article III jurisdiction to decide cases and controversies. Whatever the outcome of this case, there is no possibility that the decision will curtail the scope of the official powers of the Executive Branch. The litigation of questions that relate entirely to the unofficial conduct of the individual who happens to be the President poses no perceptible risk of misallocation of either judicial power or executive power.

Rather than arguing that the decision of the case will produce either an aggrandizement of judicial power or a narrowing of executive power, petitioner contends that—as a by-product of an otherwise traditional exercise of judicial power—burdens will be placed on the President that will hamper the performance of his official duties. We have recognized that “[e]ven when a branch does not arrogate power to itself . . . the separation-of-powers doctrine requires that a branch not impair another in the performance of its constitutional duties.” As a factual matter, petitioner contends that this particular case—as well as the potential additional litigation that an affirmance of the Court of Appeals judgment might spawn—may impose an unacceptable burden on the President’s time and energy and thereby impair the effective performance of his office.

Petitioner’s predictive judgment finds little support in either history or the relatively narrow compass of the issues raised in this particular case. If the past is any indicator, it seems unlikely that a deluge of such litigation will ever engulf the presidency. As for the case at hand, if properly managed by the District Court, it appears to us highly unlikely to occupy any substantial amount of petitioner’s time.

Of greater significance, petitioner errs by presuming that interactions between the Judicial Branch and the Executive, even quite burdensome interactions, necessarily rise to the level of constitutionally forbidden impairment of the Executive’s ability to perform its constitutionally mandated functions. Separation of powers does not mean that the branches “ought to have no partial agency in, or no control over the acts of each other.” The fact that a federal court’s exercise of its traditional Article III jurisdiction may significantly burden the time and attention of the Chief Executive is not sufficient to establish a violation of the Constitution. Two long-settled propositions . . . support that conclusion.

First, we have long held that when the President takes official action, the Court has the authority to determine whether he has acted within the law. Perhaps the most dramatic example of such a case is our holding that President Truman exceeded his constitutional authority when he issued an order directing the Secretary of Commerce to take possession of and operate most of the Nation’s steel mills, in order to avert a national catastrophe.

1

1 

Youngstown Sheet & Tube Co. v. Sawyer, 343 U.S. 579 (1952).

Second, it is also settled that the President is subject to judicial process in appropriate circumstances. We . . . held that President Nixon was obligated to comply with a subpoena commanding him to produce certain tape recordings of his conversations with his aides. As we explained, “neither the doctrine of separation of powers, nor the need for confidentiality of high-level communications, without more, can sustain an absolute, unqualified presidential privilege of immunity from judicial process under all circumstances.”

Sitting Presidents have responded to court orders to provide testimony and other information with sufficient frequency that such interactions between the Judicial and Executive Branches can scarcely be thought a novelty. President Ford complied with an order to give a deposition in a criminal trial, and President Clinton has twice given videotaped testimony in criminal proceedings.

“[I]t is settled law that the separation-of-powers doctrine does not bar every exercise of jurisdiction over the President of the United States.” If the Judiciary may severely burden the Executive Branch by reviewing the legality of the President’s official conduct, and if it may direct appropriate process to the President himself, it must follow that the federal courts have power to determine the legality of his unofficial conduct. The burden on the President’s time and energy that is a mere by-product of such review surely cannot be considered as onerous as the direct burden imposed by judicial review and the occasional invalidation of his official actions. We therefore hold that the doctrine of separation of powers does not require federal courts to stay all private actions against the President until he leaves office.

*

* 

William Jefferson Clinton v. Paula Corbin Jones, Supreme Court of the United States 520 U.S. 681 (1997). https://www.law.cornell.edu/supct/html/95-1853.ZO.html.

Reversed in part. Affirmed in part in favor of Respondent, Jones.

Comment:

After this case was sent back for trial on the merits, the case was ultimately dismissed on April 1, 1998, on a motion for summary judgment on the ground that the plaintiff’s allegations, even if true, failed to state a claim of criminal sexual assault or sexual harassment. It is ironic that despite the high court’s claim that the case would be “highly unlikely to occupy any substantial amount of the petitioner’s time,” matters arising out of this case managed to occupy so much of the president’s time and become such a focus of a media frenzy that many people were calling for the media to reduce coverage of the issues so the president could do his job.

2

2 

Jones v. Clinton and Danny Ferguson, 12 F. Supp. 2d 931 (E.D. Ark. 1998).

Linking Law and Business Finance

The principle behind the separation of powers in government is also modeled in another realm of business. In your accounting class, you learned that internal controls are the policies and procedures used to create a greater assurance that the objectives of an organization will be met. One feature of internal controls is the separation of duties. This feature calls for the functions of authorization, recording, and custody to be exercised by different individuals. The likelihood of illegal acts by employees is reduced when the responsibility of completing a task is dependent on more than one person. If there are three people responsible for carrying out a particular task, then each person acts as a deterrent to the other two in regard to the possibility of embezzlement by one or more employees. Therefore, the chance of dishonest behavior is minimized when employees act as a check on the other employees involved in striving to meet organizational objectives

Exhibit 5-2 System of Checks and Balances

Cases like Jones v. Clinton are not common. The reason is not that each branch generally operates carefully within its own sphere of power. Rather, the explanation lies in the fact that because it is difficult to determine where one branch’s authority ends and another’s begins, each branch rarely challenges the power of its competing branches. The powers of each branch were established so that, although the branches are separate and independent, each branch still influences the actions of the others and there is still a substantial amount of interaction among them. You can review this system by examining 
Exhibit 5-2
.

The Impact of the Commerce Clause on Business

The Commerce Clause as a Source of Federal Authority

The primary powers of Congress are listed in Article I of the Constitution. It is important to remember that Congress has only limited legislative power. Congress possesses only that legislative power granted to it by the Constitution. Thus, all acts of Congress not specifically authorized by the Constitution or necessary to accomplish an authorized end are invalid.

The 

Commerce Clause

 provides the basis for most of the federal regulation of business today. This clause empowers the legislature to “regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” Early in our history, the Supreme Court was committed to a laissez-faire ideology, an ideology that was grounded in individualism. A narrow interpretation of the Commerce Clause means that only a limited amount of trade or exchange can be regulated by Congress.

Commerce Clause

Empowers Congress to regulate commerce with foreign nations, with Indian tribes, and among the states; found in Article I.

Under the Court’s initial narrow interpretation, the Commerce Clause was interpreted to apply only to the transportation of goods. Manufacturing of goods, even of goods that were going to be sold in another state, was not considered to have a direct effect on interstate commerce and, thus, was not subject to federal regulation. Businesses conducted solely in one state were similarly excluded from the authority of Congress. Under this restrictive interpretation, numerous federal regulations, such as laws attempting to regulate the use of child labor in manufacturing plants,3 were struck down.

3 

Hammer v. Dagenhart, 247 U.S. 251 (1918).

During the 1930s, the Supreme Court’s interpretation of the Commerce Clause was broadened to allow a greater scope for federal regulations. In NLRB v. Jones & Laughlin Steel Corp.,4 for example, the Court said that:

4 

301 U.S. 1 (1937).

Although activities may be intrastate in character when separately considered, if they have such a close and substantial relationship to interstate commerce that their control is essential or appropriate to protect that commerce from burdens or obstructions, Congress cannot be denied the power to exercise that control.
*

* 
NLRB v. Jones & Laughlin Steel Corp, 301 U.S. 1 (1937). https://supreme.justia.com/cases /federal/us/301/1/case.html.

Over the next several decades, the Supreme Court continued to expand Congress’s power under the Commerce Clause to regulate intrastate activities that affect interstate commerce. For example, in Perez v. United States,
5 loan-sharking, conducted on a local basis, was deemed to affect interstate commerce because of its connection to organized crime on a national scale, as the funds from loan-sharking help to pay for crime across the United States. According to the subsequent ruling in International House of Pancakes v. Theodore,

6

 a locally owned and operated franchise located near two interstates and three hotels qualifies the restaurant as related to interstate commerce and thus subject to the Americans with Disabilities Act. This expansive view continued with United States v. Lake,

7

 in which the court ruled that a locally operated coal mine that sells its coal locally and buys its supplies locally can still be subjected to federal regulations (Federal Mine Safety and Health Act) because the local activities of all coal mines help to influence the interstate market for coal.

5 

402 U.S. 146 (1971).

6 

844 F. Supp. 574 (S.D. Cal. 1993).

7 

985 F.2d 265 (6th Cir. 1995).

As these cases illustrate, during most of the twentieth century, almost any activity, even if purely intrastate, could be regulated by the federal government if it substantially affected interstate commerce. The effect may be direct or indirect, as the U.S. Supreme Court demonstrated in the classic 1942 case of Wickard v. Filburn,8 when it upheld federal regulation of the production of wheat on a farm in Ohio that produced only 239 bushels of wheat solely for consumption on the farm. The Court’s rationale was that even though one wheat farmer’s activities might not matter, the combination of a lot of small farmers’ activities could have a substantial impact on the national wheat market. This broad interpretation of the Commerce Clause has made possible much of the legislation covered in other sections of this book.

8 

317 U.S. 111 (1942).

Since the mid-1990s, however, the Supreme Court has appeared to be scrutinizing congressional attempts to regulate based on the Commerce Clause a little more closely. In the 1995 case of United States v. Lopez,9 the U.S. Supreme Court found that Congress had exceeded its authority under the Commerce Clause when it passed the Gun-Free School Zone Act, a law that banned the possession of guns within 1,000 feet of any school. The Court found the statute to be unconstitutional because Congress was attempting to regulate in an area that had “nothing to do with commerce, or any sort of economic enterprise.” At first, commentators did not see this case, decided in a 5–4 vote, as a major shift in the Supreme Court’s Commerce Clause interpretation. As the Court’s ruling in Brzonkala v. Morrison

10

 demonstrates, however, Lopez may indeed have indicated that the courts are going to look more closely at congressional attempts to regulate interstate commerce, an action that seems consistent with the high court’s increasing tendency to support greater power for states in conflicts between the state and federal governments. In Morrison, the Court ruled that the Violence Against Women Act, which Congress justified through its Commerce Clause power, was unconstitutional. Despite the rulings in Lopez and Morrison, however, the following case, Gonzales v. Raich, shows that the Court may not be categorically opposed to an expansion of congressional power through the Commerce Clause.

9 

514 U.S. 549 (1995).

10 

529 U.S. 598 (2000).

 Case 5-2 Gonzales v. Raich

Supreme Court of the United States 545 U.S. 1 (2005)

In 1996, California voters passed the Compassionate Use Act of 1996, which allowed seriously ill residents of the state to have access to marijuana for medical purposes. Angel Raich and Diane Monson are California residents who were using medical marijuana pursuant to their doctors’ recommendations for their serious medical conditions.

County deputy sheriffs and federal Drug Enforcement Administration (DEA) agents investigated Raich’s and Monson’s use of medical marijuana. Although Raich and Monson were found to be in compliance with the state law, the federal agents seized and destroyed their cannabis plants.

Raich and Monson brought suit against the attorney general of the United States and the head of the DEA, seeking injunctive and declaratory relief prohibiting the enforcement of the federal Controlled Substances Act (CSA) to the extent it prevents them from possessing, obtaining, or manufacturing cannabis for their personal medical use. The district court denied the respondents’ motion for a preliminary injunction. A divided panel of the court of appeals for the Ninth Circuit reversed and ordered the district court to enter a preliminary injunction. The United States appealed.

Justice Stevens

Respondents in this case do not dispute that passage of the CSA, as part of the Comprehensive Drug Abuse Prevention and Control Act, was well within Congress’ commerce power. Nor do they contend that any provision or section of the CSA amounts to an unconstitutional exercise of congressional authority. Rather, respondents’ challenge is actually quite limited; they argue that the CSA’s categorical prohibition of the manufacture and possession of marijuana as applied to the intrastate manufacture and possession of marijuana for medical purposes pursuant to California law exceeds Congress’ authority under the Commerce Clause.

[There are] three general categories of regulation in which Congress is authorized to engage under its commerce power. First, Congress can regulate the channels of interstate commerce. Second, Congress has authority to regulate and protect the instrumentalities of interstate commerce and persons or things in interstate commerce. Third, Congress has the power to regulate activities that substantially affect interstate commerce. Only the third category is implicated in the case at hand.

Our case law firmly establishes Congress’ power to regulate purely local activities that are part of an economic “class of activities” that have a substantial effect on interstate commerce. As we stated in Wickard v. Filburn, 317 U.S. 111 (1942), “even if appellee’s activity be local and though it may not be regarded as commerce, it may still, whatever its nature, be reached by Congress if it exerts a substantial economic effect on interstate commerce.” We have never required Congress to legislate with scientific exactitude. When Congress decides that the “total incidence” of a practice poses a threat to a national market, it may regulate the entire class.

Our decision in Wickard is of particular relevance. In Wickard, we upheld the application of regulations promulgated under the Agricultural Adjustment Act of 1938, which were designed to control the volume of wheat moving in interstate and foreign commerce in order to avoid surpluses and consequent abnormally low prices. The regulations established an allotment of 11.1 acres for Filburn’s 1941 wheat crop, but he sowed 23 acres, intending to use the excess by consuming it on his own farm. Filburn argued that even though we had sustained Congress’ power to regulate the production of goods for commerce, that power did not authorize “federal regulation [of] production not intended in any part for commerce but wholly for consumption on the farm.” Justice Jackson’s opinion for a unanimous Court rejected this submission. He wrote:

The effect of the statute before us is to restrict the amount which may be produced for market and the extent as well to which one may forestall resort to the market by producing to meet his own needs. That appellee’s own contribution to the demand for wheat may be trivial by itself is not enough to remove him from the scope of federal regulation where, as here, his contribution, taken together with that of many others similarly situated, is far from trivial.

Wickard thus establishes that Congress can regulate purely intrastate activity that is not itself “commercial,” in that it is not produced for sale, if it concludes that failure to regulate that class of activity would undercut the regulation of the interstate market in that commodity.

The similarities between this case and Wickard are striking. Like the farmer in Wickard, respondents are cultivating, for home consumption, a fungible commodity for which there is an established, albeit illegal, interstate market. Just as the Agricultural Adjustment Act was designed “to control the volume [of wheat] moving in interstate and foreign commerce in order to avoid surpluses . . .” and consequently control the market price, a primary purpose of the CSA is to control the supply and demand of controlled substances in both lawful and unlawful drug markets. In Wickard, we had no difficulty concluding that Congress had a rational basis for believing that, when viewed in the aggregate, leaving home-consumed wheat outside the regulatory scheme would have a substantial influence on price and market conditions. Here too, Congress had a rational basis for concluding that leaving home-consumed marijuana outside federal control would similarly affect price and market conditions.

More concretely, one concern prompting inclusion of wheat grown for home consumption in the 1938 Act was that rising market prices could draw such wheat into the interstate market, resulting in lower market prices. The parallel concern making it appropriate to include marijuana grown for home consumption in the CSA is the likelihood that the high demand in the interstate market will draw such marijuana into that market. While the diversion of homegrown wheat tended to frustrate the federal interest in stabilizing prices by regulating the volume of commercial transactions in the interstate market, the diversion of homegrown marijuana tends to frustrate the federal interest in eliminating commercial transactions in the interstate market in their entirety. In both cases, the regulation is squarely within Congress’ commerce power because production of the commodity meant for home consumption, be it wheat or marijuana, has a substantial effect on supply and demand in the national market for that commodity.

Nonetheless, respondents suggest that Wickard differs from this case in three respects: (1) the Agricultural Adjustment Act, unlike the CSA, exempted small farming operations; (2) Wickard involved a “quintessential economic activity”—a commercial farm—whereas respondents do not sell marijuana; and (3) the Wickard record made it clear that the aggregate production of wheat for use on farms had a significant impact on market prices. Those differences, though factually accurate, do not diminish the precedential force of this Court’s reasoning.

The fact that Wickard’s own impact on the market was “trivial by itself” was not a sufficient reason for removing him from the scope of federal regulation. That the Secretary of Agriculture elected to exempt even smaller farms from regulation does not speak to his power to regulate all those whose aggregated production was significant, nor did that fact play any role in the Court’s analysis. Moreover, even though Wickard was indeed a commercial farmer, the activity he was engaged in—the cultivation of wheat for home consumption—was not treated by the Court as part of his commercial farming operation.

In assessing the scope of Congress’ authority under the Commerce Clause, we stress that the task before us is a modest one. We need not determine whether respondents’ activities, taken in the aggregate, substantially affect interstate commerce in fact, but only whether a “rational basis” exists for so concluding. Given the enforcement difficulties that attend distinguishing between marijuana cultivated locally and marijuana grown elsewhere, and concerns about diversion into illicit channels, we have no difficulty concluding that Congress had a rational basis for believing that failure to regulate the intrastate manufacture and possession of marijuana would leave a gaping hole in the CSA. Thus, as in Wickard, when it enacted comprehensive legislation to regulate the interstate market in a fungible commodity, Congress was acting well within its authority to “make all Laws which shall be necessary and proper” to “regulate Commerce . . . among the several States.” That the regulation ensnares some purely intrastate activity is of no moment. As we have done many times before, we refuse to excise individual components of that larger scheme.
*

* 
Gonzales v. Raich, Supreme Court of the United States 545 U.S. 1 (2005). https://www.law .cornell.edu/supct/html/03-1454.ZO.html.

Reversed and remanded in favor of Attorney General Gonzalez.

Critical Thinking About The Law

Analogies are a standard method for creating a link between the case at hand and legal precedent.

Wickard v. Filburn is a long-established precedent. The court’s reasoning in 

Case 5-2

 is that the use of medical marijuana by the plaintiffs is sufficiently similar to the facts in Wickard to rely on this precedent.

1. What are the similarities between the case at hand and Wickard?

Clue: Try to make a large list of similarities. Later, after you have made a large list, think about the logic the analogy is trying to support. Eliminate those similarities that do not assist that logic because they are not relevant to an assessment of the quality of the analogy.

2. Are there significant differences that the Court ignores or downplays?

Clue: First think about the purpose this analogy is serving. Then think about the differences in the facts for this case and the facts for Wickard.

Although the current Supreme Court seems to prefer greater regulatory power for states, Gonzales v. Raich and another recent case stand as examples in which the Supreme Court upheld congressional acts on the basis of the Commerce Clause. In Pierce County v. Guillen,11 the Supreme Court held that the Hazard Elimination Program was a valid exercise of congressional authority under the Commerce Clause. This program provided funding to state and local governments to improve conditions of some of their most unsafe roads. To receive federal funding, however, state and local governments were required to regularly acquire information about potential road hazards. The state and local governments were reluctant to avail themselves of the program for fear that the information they acquired to receive funding would be used against them in lawsuits based on negligence. To alleviate these fears, Congress amended the program, allowing state and local governments to conduct engineering surveys without publicly disseminating the acquired information, even for discovery purposes in trials.

11 

537 U.S. 129 (2003).

Following his spouse’s death in an automobile accident, Ignacio Guillen sued Pierce County and sought information related to previous accidents at the intersection where his wife died. The county argued that such information was protected under the provisions of the Hazard Elimination Program. Reversing the appellate court’s holding that Congress exceeded its powers when amending the act, the Supreme Court concluded that the amended act was valid under the Commerce Clause. The Supreme Court reasoned that Congress had a significant interest in assisting local and state governments in improving safety in the channels of interstate commerce, the interstate highways. The Court validated Congress’s belief that state and local governments would be more likely to collect relevant and accurate information about potential road hazards if those governments would not be required to provide such information in discovery. Hence, the Supreme Court held that the amended act of Congress was valid on the basis of the Commerce Clause.

Despite the Court’s ruling in Pierce County v. Guillen, many Supreme Court commentators had thought that the Court’s turn toward a more restrictive interpretation of the Commerce Clause would lead the Court to rule that Congress cannot justify regulating states’ decisions regarding medical marijuana through the Commerce Clause. Instead, Justice Stevens distinguished Gonzales v. Raich from United States v. Lopez and Brzonkala v. Morrison, explaining that the federal regulations at issue in Lopez and Morrison were not related to economic activity, even understood broadly, and thus in both cases Congress had overstepped its bounds. Raich’s activities, however, did involve economic activity, even if it is the economic activity of an illegal, controlled substance. 

Exhibit 5-3

Exhibit 5-3 Modern Supreme Court Interpretations of the Commerce Clause

offers a summary of a number of Commerce Clause cases the Supreme Court has decided since Lopez. One inference a person could draw after examining the cases in 
Exhibit 5-3
 is that the Court is willing to limit congressional power but not necessarily in every instance where such restriction is possible.

The Commerce Clause as a Restriction on State Authority

Because the Commerce Clause grants authority to regulate commerce to the federal government, a conflict arises over the extent to which granting such authority to the federal government restricts the states’ authority to regulate commerce. The courts have attempted to resolve the conflict over the impact of the Commerce Clause on state regulation by distinguishing between regulations of commerce and regulations under the state police power. 

Police power

 means the residual powers retained by the state to enact legislation to safeguard the health and welfare of its citizenry. When the courts perceived state laws to be attempts to regulate interstate commerce, these laws would be struck down; however, when the courts found state laws to be based on the exercise of the state police power, the laws were upheld.

police power

The states’ retained authority to pass laws to protect the health, safety, and welfare of the community.

Since the mid-1930s, whenever states have enacted legislation that affects interstate commerce, the courts have applied a two-pronged test. First, they ask: Is the regulation rationally related to a legitimate state end? If it is, then they ask: Is the regulatory burden imposed on interstate commerce outweighed by the state interest in enforcing the legislation? If it is, the state’s regulation is upheld. 

Case 5-3

 is an example of a state statute that has been upheld by considering this two-pronged test.

 Case 5-3 Nat’l Ass’n of Optometrists & Opticians v. Brown

United States Court of Appeals for the Ninth District 682 F.3d 1144 (2012)

California had a regulation that prohibited licensed opticians from offering prescription eyewear in the same city or location where professional eye examinations are provided. The National Association of Optometrists and Opticians, LensCrafters, Inc., and EyeCare Centers of America, Inc. challenged this California statute, stating that it places a burden on interstate commerce that “excessively outweighs the local benefits of the law.” In this case, the district court granted the State’s motion for summary judgment. The plaintiff companies appealed.

Judge Hug

Plaintiffs challenge these laws to the extent they prohibit opticians and optical companies from offering prescription eyewear at the same location in which eye examinations are provided and from advertising that eyewear and eye examinations are available in the same location. The district court denied Plaintiffs’ motion for summary judgment and granted the State’s motion for summary judgment. The court effectively concluded that, based on the facts and the law, there were no genuine issues of material fact. Plaintiffs argued that the challenged laws impermissibly burdened interstate commerce because: (1) the challenged laws preclude an interstate company from offering one-stop shopping, which is the dominant form of eyewear retailing; and (2) interstate firms would incur a great financial loss as a result of the challenged laws. The district court concluded that it need not consider the evidence supporting these theories because both theories failed as a matter of law. In reaching this conclusion, the court reasoned that, because there was no cognizable burden on interstate commerce, it need not attempt to balance the “non-burden” against the putative local interests under the test derived from Plaintiffs timely appealed, and that appeal is now before us.

Modern dormant Commerce Clause jurisprudence primarily “is driven by concern about economic protectionism—that is, regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors.” “The principal objects of dormant Commerce Clause scrutiny are statutes that discriminate against interstate commerce.” “The central rationale for the rule against discrimination is to prohibit state or municipal laws whose object is local economic protectionism,” because these are the “laws that would excite those jealousies and retaliatory measures the Constitution was designed to prevent.”

Although dormant Commerce Clause jurisprudence protects against burdens on interstate commerce, it also respects federalism by protecting local autonomy. Thus, the Supreme Court has recognized that “under our constitutional scheme the States retain broad power to legislate protection for their citizens in matters of local concern such as public health” and has held that “not every exercise of local power is invalid merely because it affects in some way the flow of commerce between the States.”

In a long line of dormant Commerce Clause cases, the Supreme Court has sought to reconcile these competing interests of local autonomy and burdens on interstate commerce. In one of those cases, Pike v. Bruce Church, Inc., the Supreme Court set forth the following summary of dormant Commerce Clause law, stating:

Although the criteria for determining the validity of state statutes affecting interstate commerce have been variously stated, the general rule that emerges can be phrased as follows: Where the statute regulates even-handedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits. If a legitimate local purpose is found, then the question becomes one of degree. And the extent of the burden that will be tolerated will of course depend on the nature of the local interest involved, and on whether it could be promoted as well with a lesser impact on interstate activities.

Unfortunately, the Pike test has not turned out to be easy to apply. As the Supreme Court has acknowledged, there is “no clear line” in Supreme Court cases between cases involving discrimination and cases subject to Pike’s “clearly excessive” burden test.

Justice Scalia

has candidly observed that “once one gets beyond facial discrimination our negative-Commerce-Clause jurisprudence becomes (and long has been) a quag-mire.” According to the Supreme Court, only a small number of its cases invalidating laws under the dormant Commerce Clause have involved laws that were “genuinely nondiscriminatory, in the sense that they did not impose disparate treatment on similarly situated in-state and out-of-state interests.” The threshold issue in this appeal is whether Plaintiffs have produced sufficient evidence that the challenged laws, though non-discriminatory, impose a significant burden on interstate commerce. As discussed below, we hold that the Plaintiffs have not produced such evidence.

We conclude that Supreme Court precedent establishes that there is not a significant burden on interstate commerce merely because a non-discriminatory regulation precludes a preferred, more profitable method of operating in a retail market. Where such a regulation does not regulate activities that inherently require a uniform system of regulation and does not otherwise impair the free flow of materials and products across state borders, there is not a significant burden on interstate commerce.

We find no support in the law for Plaintiffs’ proposition that there is a significant burden on interstate commerce whenever, as a result of nondiscriminatory retailer regulations, there is an incidental shift in sales and profits to in-state entities from retailers that operate in-state but are owned by companies incorporated out-of-state. In light of this law, it is apparent that, in the case before us, there is no material issue of fact regarding whether the challenged laws place a significant burden on interstate commerce. Plaintiffs have not produced evidence that the challenged laws interfere with the flow of eyewear into California; any optician, optometrist, or ophthalmologist remains free to import eyewear originating anywhere into California and sell it there. In addition, we are not concerned here with activities that require a uniform system of regulation. Thus, Plaintiffs have failed to raise a material issue of fact concerning whether there is a significant burden on interstate commerce. Relying on Pike, Plaintiffs argue that, in determining whether a regulation violates the dormant Commerce Clause, courts are required to examine the actual benefits of nondiscriminatory regulations. However, [HN20] Pike discusses whether the burden on interstate commerce is “clearly excessive in relation to the putative local benefits.” See Pike, 397 U.S. at 142. It does not mention actual benefits as part of the test for determining when a regulation violates the dormant Commerce Clause.

Even if Pike’s “clearly excessive” burden test were concerned with weighing actual benefits rather than “putative benefits,” we need not examine the benefits of the challenged laws because, as discussed above, the challenged laws do not impose a significant burden on interstate commerce. If a regulation merely has an effect on interstate commerce, but does not impose a significant burden on interstate commerce, it follows that there cannot be a burden on interstate commerce that is “clearly excessive in relation to the putative local benefits” under Pike. Accordingly, where, as here, there is no discrimination and there is no significant burden on interstate commerce, we need not examine the actual or putative benefits of the challenged statutes. For the foregoing reasons, the district court’s order granting the State’s motion for summary judgment and denying Plaintiffs’ motion for summary judgment is affirmed.
*

* 
Nat’l Ass’n of Optometrists & Opticians v. Brown, United States Court of Appeals for the Ninth District 682 F.3d 1144 (2012). http://cdn.ca9.uscourts.gov/datastore/opinions/2012/06/13/10-16233 .

Affirmed.

Another example of a state statute that has been upheld is Chicago’s ban on the use of spray paint in the city. Paint retailers challenged the statute, arguing that it could have caused $55 million in lost sales over the next six years for spray paint retailers. The U.S. Court of Appeals eventually found the law to be constitutional. The state had a legitimate interest in trying to clean up graffiti, and it did not “discriminate against interstate commerce” nor violate the Commerce Clause. The appeals court reversed the previous ruling and allowed Chicago’s enactment of this ordinance to remain intact.

12

 Despite the rulings in the United Haulers and Chicago cases, it is not necessarily easy to craft a state statute that affects interstate commerce that will be upheld. Frequently, the courts will find that state legislation that impinges upon interstate commerce in some way is an unconstitutional interference with interstate commerce.

12 

National Paint & Coatings Association et al. v. City of Chicago, 45 F.3d 1124 (7th Cir. 1995).

The most recent illustration of the United States Supreme Court’s addressing a state’s attempt to evade the power of the dormant commerce clause occurred in 2015 in the case of Comptroller of the Treasury of Maryland v. Wynne et ux.

13

 Maryland’s personal income tax on state residents consisted of a “state” tax and a “county” tax. Maryland residents who earned money in other states received a “state” tax credit for the taxes they paid to the state where the income was earned, but not a “county” tax credit, resulting in double taxation of out-of-state income.

13
 135 S. Ct. 1787 (2015).

The law was challenged by the Wynnes, who claimed a tax credit for the taxes paid on their out-of-state earnings. The state comptroller denied their claim of a credit against their “county” tax and assessed them a deficiency. The appeals board of the comptroller’s office affirmed the assessment, as did the Maryland Tax Court, but the Court of Appeals for Howard County reversed on grounds that Maryland’s tax system violated the Constitution. The court applied the four-part test previously used by the Supreme Court in examing state tax systems, a test that asks whether a “tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.” The court found that the law failed the fair apportionment test because if every state had a law like Maryland’s, interstate commerce would be taxed at a higher rate than intrastate commerce and create a risk for multiple taxation. It also failed the nondiscrimination part because by denying residents tax credit on interstate commerce it made them pay a higher tax rate on income earned on interstate commerce.

Noting that a state “may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State,” the Supreme Court affirmed the decision of the appellate court. In striking down Maryland’s law, the court reiterated the point that when a tax system has the potential to result in the discriminatory double taxation of income earned out of state, it creates a powerful incentive to engage in intrastate rather than interstate economic activity, and thereby places an undue burden on interstate commerce in violation of the dormant Commerce Clause.

Take a look at the cases described in 

Table 5-1

. They further illustrate how the courts attempt to determine when a state statute that affects interstate commerce will be upheld.

Applying The Law To The Facts . . .

The Alabama legislature proposed an amendment to the state constitution that would require certain public works projects, such as highway construction and public transportation, to not be funded unless the company receiving the funds “is an Alabama based company or corporation employing only Alabama residents.” What is the potential constitutional problem with this proposed amendment?

Table 5-1 DORMANT COMMERCE CLAUSES CASES

Black Star Farms v. Oliver, 600 F.3d 1225 (9th Cir. 2010)

The state of Arizona developed a scheme of regulating wine sales whereby suppliers sell wine to wholesalers, who then sell the wine to retailers, who sell wine to the public. Exceptions to this distribution scheme were made for (1) small wineries that produce no more than 20,000 gallons of wine annually, who are allowed to sell directly to the public, and (2) direct shipments to consumers who visit a winery and request, in person, that purchased winery be shipped to their address. A winery that produces 35,000 bottles a year challenged the state scheme as unconstitutionally interfering with interstate commerce, thus violating the dormant Commerce Clause.

Because the law applied equally to wineries in all states, including Arizona, it did not unfairly burden interstate commerce. The appellate court thus upheld the District Court’s grant of a motion for summary judgment to the state of Arizona and denying the winery’s motion for summary judgment.

Family Winemakers of California, et al. v. Jenkins, 592 F.3d 1 (2010)

Massachusetts passed a statute allowing only “small” wineries, defined as those producing 30,000 gallons or less of grape wine a year, to obtain a “small winery shipping license” that allows them to sell their wines in Massachusetts in three ways: by shipping directly to consumers, through wholesaler distribution, and through retail distribution. All of Massachusetts’s wineries, and some out-of-state wineries, are “small” wineries.

“Large” wineries, those producing more than 30,000 gallons per year, and which are all located out of state, must choose between relying upon wholesalers to distribute their wines in-state or applying for a “large winery shipping license” to sell directly to Massachusetts consumers. They cannot, by law, use both methods to sell their wines in Massachusetts, and they cannot sell wines directly to retailers under either option.

The District Court granted the plaintiffs request for injunctive relief. The Court of Appeals upheld the order, finding that the statute afforded significant competitive advantages to “small” wineries for no nondiscriminatory purpose.

Florida Transportation Services, Inc. v. Miami-Dade County, 703 F.3d 1230 (11th Cir. 2012)

If a licensed stevedore wanted to operate at the Port of Miami, a Florida statute required that person to also have a permit issued by the Director of the Port of Miami. In practice, the Port Director automatically renewed permits of existing holders and repeatedly denied permits to new applicants. Florida Transportation Services brought suit against the County, alleging that the County’s stevedore permit regulation, as applied by the Port Director, violated the dormant Commerce Clause by placing an undue burden on interstate commerce.

On appeal, the court affirmed the judgment of the district court in favor of the plaintiffs. Because the ordinance effectively shut out new entrants, even if they could have provided better service, better equipment, or lower prices than incumbent stevedores, the ordinance of the County did place an unconstitutional burden on interstate commerce.

Rousso v. State, 170 Wn.2d 70 (2010)

Rousso brought suit against a Washington statute that criminalized the knowing transmission and reception of gambling information by means such as the Internet. The plaintiff claimed that this regulation violated the dormant Commerce Clause. The plaintiff asserted that this state regulation, which effectively bans Internet gambling, excessively burdens interstate commerce.

The court ruled that the interests of Washington were best served by banning Internet gambling, and that the burden on interstate commerce was not clearly excessive in light of the state’s interests. The Washington statute did not violate the dormant Commerce Clause.

The Taxing and Spending Powers of the Federal Government

Article I, Section 8, of the Constitution gives the federal government the “Power to lay and collect Taxes, Duties, Imports and Excises.” The taxes laid by Congress, however, must be uniform across the states. In other words, the U.S. government cannot impose higher taxes on residents of one state than another.

Although the collection of taxes is essential for the generation of revenue needed to provide essential government services, taxes can be used to serve additional functions. For example, the government may wish to encourage the development of certain industries and discourage the development of others, so it may provide tax credits for firms entering the favored industries. As long as the “motive of Congress and the effect of its legislative action are to secure revenue for the benefit of the general government,”

14

 the tax will be upheld as constitutional. The fact that it also has what might be described as a regulatory impact will not affect the validity of the tax.

14 

J. W. Hampton Co. v. United States, 276 U.S. 394 (1928).

While we may all think we know what a tax is, sometimes a tax is not easy to recognize. For example, in 2012, many commentators were surprised when the United States Supreme Court determined that the penalty imposed by the Affordable Care Act (ACA) on those who did not purchase health insurance was a tax.

15

 Chief Justice Roberts explained that even though the imposition of the tax payment was designed to encourage certain behavior, taxes may legitimately be used by the federal government to encourage behavior. Nothing in the ACA made the failure to purchase insurance a violation of any law; it simply imposed the payment of a tax, collected by the IRS like all other taxes, on those who opted to not purchase health care insurance. The fact that the ACA referred to the tax as a penalty did not change the fundamental nature of the payment as a tax.

15 

National Federation of Independent Business v. Sebelius, 132 S. Ct. 2566 (2012).

This finding that the payment was a tax was an important decision because it preserved the constitutionality of the ACA, which most commentators thought would have been upheld not as a tax, but rather as an exercise of the federal government’s authority to regulate interstate commerce under the Commerce Clause. In fact, the high court rejected the argument that the ACA constituted an exercise of congressional authority under the Commerce Clause.

Article I, Section 8, also gives Congress its spending power by authorizing it to “pay the Debts and provide for the common Defence and general Welfare of the United States.” Just as Congress can indirectly use its power to tax to achieve certain social welfare objectives, it can do the same with its spending power. For example, the U.S. Supreme Court in 1987 upheld the right of Congress to condition the states’ receipt of federal highway funds on their passing state legislation making 21 the legal drinking age.

Taxation of the Internet?

The rapid rise in Internet commerce has many states wondering how they will collect their fair share of sales taxes. According to the U.S. Department of Commerce, Internet retail sales have continued to increase. U.S. retail e-commerce sales reached almost $142 billion in 2008, up from a revised $137 billion in 2007—an annual gain of 3.3 percent. From 2002 to 2008, retail e-sales increased at an average annual growth rate of 21.0 percent, compared with 4.0 percent for total retail sales. Although Internet sales constituted only 3.7 percent of overall retail sales in the United States during 2009, advocates of taxes on Internet sales insist that states are losing a considerable amount of revenue each year.

16

16 

U.S. Census Bureau, E-Stats, May 27, 2010; access to these statistics is available at 

http://www .census.gov/econ/estats/2008/2008reportfinal

.

Currently, states are only allowed to require a business to submit sales tax payments if the business has a store or distribution center in the state. Otherwise, states are prohibited from collecting sales taxes, although residents are supposed to report the taxes on personal income tax returns. In addition to the e-commerce business, increased access to the Internet has some clamoring for a use tax on Internet access, in addition to a sales tax on Internet purchases.

In 1998, Congress approved the Internet Tax Freedom Act, which established a moratorium on Internet taxes until November 2001. The 1998 bill provided a grandfather clause that allowed several states to continue levying taxes on Internet access if those taxes were established before the Internet Tax Freedom Act was passed. In November 2001, Congress extended the moratorium for two more years to allow for more discussion and research on the effects of the ban on state governments.

In September 2003, the House of Representatives passed the Internet Tax Nondiscrimination Act (H.R. 49), a bill designed to replace the Internet Tax Freedom Act that would have expired in November 2003 with a permanent ban on taxes on Internet access and a permanent extension of the moratorium on multiple and discriminatory taxes on electronic commerce. On April 29, 2004, the Senate passed a different version of the Internet Tax Nondiscrimination Act (S. 150) that extended the moratorium on Internet taxes until November 2007. The Senate bill was a compromise between supporters of a permanent Internet tax ban and a group of senators who questioned how a permanent ban would affect state and local budgets.

The final version of the legislation, signed into law by President George W. Bush on December 3, 2004, had two different grandfather exemptions. States that taxed Internet service before October 1, 1998, were allowed to continue their taxes until November 1, 2007, whereas states that taxed Internet service before October 1, 2003, were allowed to continue their taxes until November 1, 2005. The law banned all other states from imposing Internet taxes from November 1, 2003 to November 1, 2007.

In 2007, Congress and the president extended the act until November 1, 2014, with the Internet Tax Nondiscrimination Act.

The Impact of the Amendments on Business

The first 10 amendments to the U.S. Constitution, known as the Bill of Rights, have a substantial impact on governmental regulation of the legal environment of business. These amendments prohibit the federal government from infringing on certain freedoms that are guaranteed to individuals living in our society. The 

Fourteenth Amendment

 extends most of the provisions in the Bill of Rights to the behavior of states, prohibiting their interference in the exercise of those rights. Many of the first 10 amendments have also been held to apply to corporations because corporations are treated, in most cases, as “artificial persons.” The activities protected by the Bill of Rights and the Fourteenth Amendment are not only those that occur in one’s private life, but also those that take place in a commercial setting. Several of these amendments have a significant impact on the regulatory environment of business, and they are discussed in the remainder of this chapter.

Fourteenth Amendment

Applies the entire Bill of Rights, excepting parts of the Fifth Amendment, to the states.

The First Amendment

The 

First Amendment

 guarantees freedom of speech and of the press. It also prohibits abridgment of the right to assemble peacefully and to petition for redress of grievances. Finally, it prohibits the government from aiding the establishment of a religion and from interfering with the free exercise of religion.

First Amendment

Guarantees freedom of speech, press, and religion and the right to peacefully assemble and to petition the government for redress of grievances.

Although we say these rights are guaranteed, they obviously cannot be absolute. Most people would agree that a person does not have the right to yell “Fire!” in a crowded theater. Nor does one’s right of free speech extend to making false statements about another that would be injurious to that person’s reputation. Because of the difficulty in determining the boundaries of individual rights, a large number of First Amendment cases have been decided by the courts.

Not surprisingly, student speech has given rise to a number of free speech cases. For example, in Tinker v. Des Moines Independent School District,

17

 the Court ruled that a school policy that prohibited students from wearing antiwar armbands was unconstitutional because the students’ message was political and was not disruptive to normal school activities. In Tinker, the Court famously stated that students do not “shed their constitutional rights . . . at the schoolhouse gate.”

18

 Subsequently, the Court ruled in Bethel School District No. 403 v. Fraser

19

 that speech that would otherwise be protected can be restricted within the school context. Fraser gave a speech at a school assembly that contained a graphic and extended sexual metaphor. The Court held that, although the speech would have been protected if given in the public forum, the fact that the speech was delivered at school allowed for administrators to censor the speech and restrict Fraser’s right to give the speech. Most recently, relying upon their rulings in Tinker and Fraser, the Court ruled in Morse v. Frederick

20

 that student speech advocating drug use during a school function can constitutionally be restricted. Morse v. Frederick is the much-discussed “Bong Hits 4 Jesus” case. The Court determined that the “Bong Hits 4 Jesus” banner clearly advocated drug use, and because the poster was displayed at a school function, the students responsible could be punished. Furthermore, the banner did not portray a political or religious message and thus was not protected speech.

17 

393 U.S. 503 (1969).

18 

Id. at 506.

19 

478 U.S. 675 (1986).

20 

127 S. Ct. 2618 (2007).

Attempts to regulate new technologies also raise First Amendment issues. For example, Congress passed the Communications Decency Act of 1996 (CDA) to protect minors from harmful material on the Internet; however, the U.S. Supreme Court found that provisions of the CDA that criminalized and prohibited the “knowing” transmission of “obscene or indecent” messages to any recipient under age 18 by means of telecommunications devices or through the use of interactive computer services were content-based blanket restrictions on freedom of speech. Because these provisions of the statute were too vague and overly broad, repressing speech that adults have the right to make, these provisions were found to be unconstitutional.

21

21 

Reno v. American Civil Liberties Union, 521 U.S. 844 (1997).

After the Supreme Court held that the CDA was unconstitutional, Congress responded by passing the Child Online Protection Act (COPA), which imposed a $50,000 fine and six months of imprisonment on individuals who posted material for commercial purposes that was harmful to minors. Websites that required individuals to submit a credit card number or some other form of age verification, however, were not in violation of the act. Nevertheless, the Supreme Court ruled that this act was also unconstitutional, as the provisions of the act likely violated the First Amendment.

22

 The Court reasoned that COPA was not narrowly tailored to meet a compelling governmental interest, and the regulations were not the least restrictive methods of regulating in this area, as filtering programs could more easily restrict minors’ access to obscene material than could criminal penalties.

22 

Ashcroft v. ACLU, 124 S. Ct. 2783 (2004).

Congress also passed the Child Internet Protection Act (CIPA), requiring libraries to implement filtering software to prevent minors from accessing pornography or other obscene and potentially harmful material. Libraries that did not comply with the provisions of CIPA would not receive federal funding for Internet access. In United States v. American Library Association,23 numerous libraries and website publishers brought suit, claiming that the CIPA was unconstitutional. Reversing the district court’s decision that the act was unconstitutional because it violated the First Amendment, the Supreme Court ruled in a split decision that the act was constitutional. Although six justices ruled that the act was not unconstitutional, there was greater disagreement about the Court’s opinion. The majority reasoned that the act did not violate an individual’s First Amendment rights, as libraries are afforded broad discretion about the kinds of materials they may include in their collections. In other words, a library is not a public forum in the traditional sense.

23 

539 U.S. 194 (2003).

An interesting issue that has arisen on many campuses is whether so-called hate speech—derogatory speech directed at members of another group, such as another race—is unprotected speech that can be banned. Thus far, hate-speech codes on campuses that were challenged as unconstitutional have been struck down by state courts or federal appeals courts, although the issue has not yet reached the Supreme Court. Hate speech is a serious issue that affects more than 1 million students every year, prompting 60 percent of universities to ban verbal abuse and verbal harassment and 28 percent of universities to ban advocacy of an offensive viewpoint.

24

 Because universities are often viewed as breeding grounds for ideas and citizen development, courts have not looked favorably on limits to speech on campuses.

24 

Timothy C. Shiell, Campus Hate Speech on Trial 2, 49 (Lawrence: University Press of Kansas, 1998).

The international community has been quicker than the United States to call hate speech unprotected, with a declaration from the United Nations and laws in several countries passed years ago.

25

 In October 22, 2009, however, the House and Senate passed the federal Matthew Shepard and James Byrd, Jr. Hate Crime Prevention Statute, and on October 28, 2009, President Obama signed the legislation.

26

 Under the law, a hate crime is defined as a crime of violence that is motivated by hatred of the group to which the victim belongs. Protected groups are those based on race, color, religion, national origin, gender, disability, sexual orientation, and gender identity.

25 

Id. at 32.

26 

Matthew Shepard and James Byrd, Jr. Hate Crimes Prevention Act. Accessed December 7, 2010 at http://www.hrc.org/laws_and_elections/5660.htm.

Corporate Commercial Speech

Numerous cases have arisen over the extent to which First Amendment guarantees are applicable to corporate commercial speech. The doctrine currently used to analyze commercial speech is discussed in the following case.

 Case 5-4 Central Hudson Gas & Electric Corp. v. Public Service Commission of New York

Supreme Court of the United States 447 U.S. 557 (1980)

Plaintiff Central Hudson Gas and Electric Corporation filed an action against Public Service Commission of New York to challenge the constitutionality of a regulation that completely banned promotional advertising by the utility but permitted “informational” ads—those designed to encourage shifting consumption from peak to nonpeak times. The regulation was upheld by the trial court. On appeal by the utility, the New York Court of Appeals sustained the regulation, concluding that governmental interests outweighed the limited constitutional value of the commercial speech at issue. The utility appealed.

Justice Powell

The Commission’s order [enforcing the regulation’s advertising ban] restricts only commercial speech, that is, expression related solely to the economic interests of the speaker and its audience. The First Amendment, as applied to the States through the Fourteenth Amendment, protects commercial speech from unwarranted governmental regulation. Commercial expression not only serves the economic interest of the speaker, but also assists consumers and furthers the societal interest in the fullest possible dissemination of information. In applying the First Amendment to this area, we have rejected the “highly paternalistic” view that government has complete power to suppress or regulate commercial speech. Even when advertising communicates only an incomplete version of the relevant facts, the First Amendment presumes that some accurate information is better than no information at all. Nevertheless, our decisions have recognized “the ‘common sense’ distinction between speech proposing a commercial transaction, which occurs in an area traditionally subject to government regulation, and other varieties of speech.”

The Constitution therefore accords a lesser protection to commercial speech than to other constitutionally guaranteed expression. The protection available for particular commercial expression turns on the nature both of the expression and of the governmental interests served by its regulation. Two features of commercial speech permit regulation of its content. First, commercial speakers have extensive knowledge of both the market and their products. Thus, they are well situated to evaluate the accuracy of their messages and the lawfulness of the underlying activity. In addition, commercial speech, the offspring of economic self-interest, is a hardy breed of expression that is not “particularly susceptible to being crushed by overbroad regulation.”

If the communication is neither misleading nor related to unlawful activity, the government’s power is more circumscribed. The State must assert a substantial interest to be achieved by restrictions on commercial speech. Moreover, the regulatory technique must be in proportion to that interest. The limitation on expression must be designed carefully to achieve the State’s goal. Compliance with this requirement may be measured by two criteria. First, the restriction must directly advance the state interest involved; the regulation may not be sustained if it provides only ineffective or remote support for the government’s purpose. Second, if the governmental interest could be served as well by a more limited restriction on commercial speech, the excessive restrictions cannot survive.

The second criterion recognizes that the First Amendment mandates that speech restrictions be “narrowly drawn.” The regulatory technique may extend only as far as the interest it serves. The State cannot regulate speech that poses no danger to the asserted state interest, nor can it completely suppress information when narrower restrictions on expression would serve its interest as well. In commercial speech cases, then, a four-part analysis has developed. At the outset, we must determine whether the expression is protected by the First Amendment. For commercial speech to come within that provision, it at least must concern lawful activity and not be misleading. Next, we ask whether the asserted governmental interest is substantial. If both inquiries yield positive answers, we must determine whether the regulation directly advances the governmental interest asserted and whether it is not more extensive than is necessary to serve that interest.

The Commission does not claim that the expression at issue is inaccurate or relates to unlawful activity. Yet the New York Court of Appeals questioned whether Central Hudson’s advertising is protected commercial speech. Because appellant holds a monopoly over the sale of electricity in its service area, the state court suggested that the Commission’s order restricts no commercial speech of any worth.

In the absence of factors that would distort the decision to advertise, we may assume that the willingness of a business to promote its products justifies belief that consumers are interested in the advertising. Since no such extraordinary conditions have been identified in this case, appellant’s monopoly position does not alter the First Amendment’s protection for its commercial speech.

The Commission offers two state interests as justifications for the ban on promotional advertising. The first concerns energy conservation. Any increase in demand for electricity—during peak or off-peak periods—means greater consumption of energy. The Commission argues that the State’s interest in conserving energy is sufficient to support suppression of advertising designed to increase consumption of electricity. In view of our country’s dependence on energy resources beyond our control, no one can doubt the importance of energy conservation. Plainly, therefore, the state interest asserted is substantial.

We come finally to the critical inquiry in this case: whether the Commission’s complete suppression of speech ordinarily protected by the First Amendment is no more extensive than necessary to further the State’s interest in energy conservation. The Commission’s order reaches all promotional advertising, regardless of the impact of the touted service on overall energy use. But the energy conservation rationale, as important as it is, cannot justify suppressing information about electric devices or services that would cause no net increase in total energy use. In addition, no showing has been made that a more limited restriction on the content of promotional advertising would not serve adequately the State’s interests.

Appellant insists that but for the ban, it would advertise products and services that use energy efficiently. These include the “heat pump,” which both parties acknowledge to be a major improvement in electric heating, and the use of electric heat as a “backup” to solar and other heat sources. Although the Commission has questioned the efficiency of electric heating before this Court, neither the Commission’s Policy Statement nor its order denying rehearing made findings on this issue. The Commission’s order prevents appellant from promoting electric services that would reduce energy use by diverting demand from less-efficient sources, or that would consume roughly the same amount of energy as do alternative sources. In neither situation would the utility’s advertising endanger conservation or mislead the public. To the extent that the Commission’s order suppresses speech that in no way impairs the State’s interest in energy conservation, the Commission’s order violates the First and Fourteenth Amendments and must be invalidated.

The Commission also has not demonstrated that its interest in conservation cannot be protected adequately by more limited regulation of appellant’s commercial expression. To further its policy of conservation, the Commission could attempt to restrict the format and content of Central Hudson’s advertising. It might, for example, require that the advertisements include information about the relative efficiency and expense of the offered service, both under current conditions and for the foreseeable future.
*

* 
Central Hudson Gas & Electric Corp. v. Public Service Commission of New York, Supreme Court of the United States 447 U.S. 557 (1980).

Reversed in favor of Plaintiff, Central Hudson.

Critical Thinking About The Law

In Case 5-4, the Court had to balance government interests in energy efficiency, as well as fair and efficient pricing, with the conflicting constitutional value of Central Hudson’s right to free commercial speech. Having affirmed the validity of the government’s substantial interests in regulating the utility company, the Court sought to determine whether these interests could have been sufficiently served with more limited restrictions. Because this determination is of central importance to the Court’s reversal of the earlier court’s judgment, it will be the focus of the questions that follow.

1. What primary ethical norm is implicit in the legal requirement that regulations on commercial speech be of the most limited nature possible in carrying out the desired end of advancing the state’s substantial interest?

Clue: Review the four primary ethical norms. You want to focus not on the government regulation but on the rationale for limits on that regulation.

2. What information missing from the Court’s opinion must you, as a critical thinker, know before being entirely satisfied with the decision?

Clue: You want to focus on the issue about which the Public Service Commission and Central Hudson have conflicting viewpoints. What information would you want to know before accepting the soundness of the Court’s judgment in resolving this conflict?

The test set forth in Central Hudson was reaffirmed by the U.S. Supreme Court in two decisions handed down in the summer of 1995, when it applied the test in Rubin v. Coors Brewing Co.

27

 and Florida Bar v. Went for It and John T. Blakely.

28

 In the first case, Coors challenged a regulation of the Federal Alcohol Administration Act that prohibited beer producers from disclosing the beer’s alcohol content. The Court found that the government’s interest in suppressing “strength wars” among beer producers was “substantial” under the Central Hudson test, but held that the ban failed to meet the asserted government interest and be no more extensive than necessary to serve that interest.

27 

514 U.S. 476, 115 S. Ct. 1585 (1995).

28 

515 U.S. 618, 115 S. Ct. 2371 (1995).

A restriction that passed the Central Hudson test was the Florida ethics rule upheld in the Went for It case. The rule requires lawyers to wait 30 days before sending targeted direct-mail solicitation letters to victims of accidents or disasters. The high court found a substantial interest both in protecting the privacy and tranquility of victims and their loved ones against invasive and unsolicited contact by lawyers and in preventing the erosion of confidence in the profession that such repeated invasions have caused. The bar association had established, by unrebutted survey data, that Floridians considered immediate postaccident direct-mail solicitation to be an invasion of victims’ privacy that reflects poorly on lawyers. The Court also found that the ban’s scope was reasonably well tailored to meet the stated objectives. It was limited in duration, and there were other ways for injured Floridians to learn about the availability of legal services during the time period set by the ban. Thus, the ban was upheld as directly advancing the asserted legitimate interest in a manner no more extensive than necessary to serve that interest.

The U.S. Supreme Court once again reaffirmed and applied the four-part test of Central Hudson in the case of Lorillard Tobacco Co. et al. v. Thomas F. Reilly,29 a case challenging Massachusetts’s comprehensive set of regulations regarding cigarette, cigar, and smokeless tobacco advertising and distribution. The high court found that Massachusetts’s outdoor-advertising regulations that prohibited smokeless tobacco or cigar advertising within 1,000 feet of a school or playground violated the First Amendment because they failed the fourth part of the Central Hudson test. The Court reasoned as follows:

29 

533 U.S. 525 (2001).

Their broad sweep indicates that the Attorney General did not “carefully calculat[e] the costs and benefits associated with the burden on speech imposed.” The record indicates that the regulations prohibit advertising in a substantial portion of Massachusetts’ major metropolitan areas; in some areas, they would constitute nearly a complete ban on the communication of truthful information. This substantial geographical reach is compounded by other factors. “Outdoor” advertising includes not only advertising located outside an establishment, but also advertising inside a store if visible from outside. Moreover, the regulations restrict advertisements of any size, and the term advertisement also includes oral statements. The uniformly broad sweep of the geographical limitation and the range of communications restricted demonstrate a lack of tailoring. The governmental interest in preventing underage tobacco use is substantial, and even compelling, but it is no less true that the sale and use of tobacco products by adults is a legal activity. A speech regulation cannot unduly impinge on the speaker’s ability to propose a commercial transaction and the adult listener’s opportunity to obtain information about products. The Attorney General has failed to show that the regulations at issue are not more extensive than necessary.

30 

*

30 

Id.

* 
Lorillard Tobacco Co. et al., v. Thomas F. Reilly, 533 U.S. 525 (2001).

In that same case, the high court also struck down regulations prohibiting placement of indoor, point-of-sale advertising of smokeless tobacco and cigars lower than five feet from the floor of a retail establishment located within 1,000 feet of a school or playground because they failed both the third and fourth steps of the Central Hudson analysis. The Court found that the five-foot rule did not seem to advance the goals of preventing minors from using tobacco products and curbing demand for that activity by limiting youth exposure to advertising, because not all children are less than five feet tall, and those who are can look up and take in their surroundings. In the case, the Court overruled the circuit court’s finding that the regulations met the four-part test of Central Hudson, so it clearly is not always easy to know how the test is going to be applied.

31

31 

Id.

Corporate Political Speech

Not all corporate speech is considered commercial speech. Sometimes, for example, corporations might spend funds to support political candidates or referenda. At one time, states restricted the total amount of money corporations could spend on advertising because of a fear that, with their huge assets, corporations’ speech on behalf of a particular candidate or issue would drown out other voices. In the 1978 case of First National Bank of Boston v. Bellotti,

32

 however, the U.S. Supreme Court struck down a state law that prohibited certain corporations from making contributions or expenditures influencing voters on any issues that would not materially affect the corporate assets or business. Stating that “the concept that the government may restrict speech of some elements of our society in order to enhance the relative voice of others is wholly foreign to the First Amendment,” the high court ruled that corporate political speech should be protected to the same extent as the ordinary citizen’s political speech.

32 

435 U.S. 765 (1978).

The ability of the government to regulate corporate political speech was further restricted in 2010 by the landmark decision in Citizens United v. Federal Election Commission.

33

 By a 5–4 vote, the majority ruled that the corporate funding of independent political broadcasts in candidate elections cannot be limited under the First Amendment, thus finding political spending to be a form of protected speech. The decision struck down a provision of a 2002 campaign financing law that prohibited all corporations, both for-profit and not-for-profit, and unions from broadcasting “electioneering communications,” which were defined as “a broadcast, cable, or satellite communication that mentioned a candidate within 60 days of a general election or 30 days of a primary.” Arguably, this decision paved the way for the 2010 midterm election setting a record for midterm election spending, with an estimated $3.8 billion being spent.

34

33 

130 S. Ct. 876 (2010).

34 

US Mid-Term Elections Most Expensive: 3.98 Billion Dollars (Extra), M&C News. Accessed December 7, 2010 at http://www.monstersandcritics.com/news/usa/news/article_1596039.php /US-mid-term-elections-most-expensive-3-98-billion-dollars-Extra.

Our discussion of the First Amendment has focused on its effect on people’s ability to speak, but just as the First Amendment may also prevent the government from prohibiting speech, the Amendment may also prevent the government from compelling individuals to express certain views or from compelling certain individuals to pay subsidies for speech to which they object. This protection is illustrated by the 2001 case of United States Department of Agriculture v. United Foods, Inc.,35 in which the Court struck down a governmental assessment against mushroom growers that was used primarily for generic advertising to promote mushroom sales. The mushroom producer who challenged the assessment wanted to be able to promote his mushrooms as different from other producers’ mushrooms and, hence, did not want to be forced to help fund generic advertising that promoted the idea that all mushrooms were good. The Supreme Court agreed, stating that “First Amendment values are at serious risk if the government can compel a citizen or group of citizens to subsidize speech on the side that it favors.”

36

35 

533 U.S. 405, 121 S. Ct. 2334 (2001).

36 

Id. at 411.

Comparative Law Corner Corporate Speech in Canada

As the limits on political speech made by corporations in the United States have been expanded, Canada has been tightening its regulations. The recent Federal Accountability Act in Canada bans contributions by corporations, trade unions, and associations. This act signals a change in policy by eliminating the exception that allowed annual contributions of $1,000 to various political entities.

The law also tightens the limits on individual contributions, but not to the extent of a total ban. This reveals a difference in the treatment of corporations and people in Canada, despite the fact that corporations are considered juristic persons under Canadian law, just as they are in the United States. Although there are differences in the restrictions on individual and corporate speech in the United States, the recent trend in Supreme Court rulings has been to eliminate the differences between individual and corporate speech. Canada’s conservative government seems to be taking the opposite approach and restricting political speech for corporations.

The Fourth Amendment

The 

Fourth Amendment

 protects the right of individuals to be secure in their persons, their homes, and their personal property. It prohibits the government from conducting unreasonable searches of individuals and seizing their property to use as evidence against them. If such an unreasonable search and seizure occurs, the evidence obtained from it cannot be used in a trial.

Fourth Amendment

Protects the right of individuals to be secure in their persons, homes, and personal property by prohibiting the government from conducting unreasonable searches of individuals and seizing their property.

An unreasonable search and seizure is basically one conducted without the government official’s having first obtained a warrant from the court. The warrant must specify the items sought, and this requirement is strictly enforced, as the Supreme Court case from 2004 illustrates. In Groh v. Ramirez,

37

 the high court ruled that a search warrant was invalid on its face when it utterly failed to describe the persons or things to be seized, despite the fact that the requisite particularized description was contained in the search warrant application. The residential search that was conducted pursuant to this facially invalid warrant was therefore unreasonable, despite the fact that the officers conducting the search exercised restraint in limiting the scope of the search to materials listed in the application.

38

37 

450 U.S. 551, 124 S. Ct. 1284 (2004).

38 

Id.

Government officials are able to obtain such a warrant only when they can show probable cause to believe that the search will turn up the specified evidence of criminal activity. Supreme Court decisions, however, have narrowed the protection of the Fourth Amendment by providing for circumstances in which no search warrant is needed. For example, warrantless searches of automobiles, under certain circumstances, are allowed. Moreover, the Supreme Court even held in one case that an out-of-car arrest and subsequent warrantless search of the individual’s car did not violate the individual’s Fourth Amendment rights.

39

 The Supreme Court decided in another case that police highway checkpoints, where police officers questioned drivers on a particular highway for information about a recent incident, did not violate drivers’ Fourth Amendment rights, even though the police arrested one of the passing drivers for drunk driving.

40

39 

Thornton v. United States, 124 S. Ct. 2127 (2004).

40 

Illinois v. Lidster, 124 S. Ct. 885 (2004).

Improvements in technology have also caused problems in application of the Fourth Amendment, because it is now simpler to eavesdrop on people and to engage in other covert activities. One such case was decided by the U.S. Supreme Court in mid-2001.

41

 In that case, the police had information from informants that led them to believe that Danny Kyllo was growing marijuana in his home. Kyllo also had unusually high electricity bills (common when one is using heat lamps to grow the plants indoors). The police used a thermal imager, an instrument that can detect unusually high levels of heat emissions and translate them into an image, to provide them with the evidence necessary to get a warrant to physically search his house. The question the Court had to address was whether the use of the thermal imaging instrument on the property constituted a “search.” Or, if we think of the case the way judges do, by comparing it to past precedents, it is a question of whether thermal imaging is more like going through someone’s garbage or more like using a high-powered telescope to look through someone’s window. If the former situation is more analogous, then the behavior does not constitute a search; however, if the case is more analogous to the latter scenario, then using thermal imaging on a home is a search that requires a warrant. The Ninth Circuit, in a case of first impression (the first time an issue is ruled on by the court), found that using thermal imaging was not a search that was prohibited by the Fourth Amendment in the absence of a warrant.

41 

Kyllo v. United States, 533 U.S. 27, 121 S. Ct. 2038 (2001).

The U.S. Supreme Court, however, in a 5–4 decision, ruled that police use of a thermal imaging device to detect patterns of heat coming from a private home is a search that requires a warrant. The Court said further that the warrant requirement would apply not only to the relatively crude device at issue, but also to any “more sophisticated systems” in use or in development that let the police gain knowledge that in the past would have been impossible without a physical entry into the home. In explaining the decision, Justice Scalia wrote that in the home, “all details are intimate details, because the entire area is held safe from prying government eyes.” He went on to add that the Court’s precedents “draw a firm line at the entrance to one’s house.”

42

42 

Id.

Although many were happy with the Supreme Court’s decision in this case, some were quick to point out that this case is not necessarily the final word when it comes to the use of technology. They noted that Scalia seemed to rely heavily on the fact that the thermal imaging was used to see inside a home. It is, therefore, not clear whether thermal imaging of some other locale would be upheld.

As the U.S. Supreme Court continued to refine the definition of unreasonable searches in 2013, canine searches were the focus of two important cases. In the first case, Florida v. Harris,43 the court found that that the police had reasonable cause to search the defendant’s truck based on the reaction of a dog trained in drug detection during a routine traffic stop. When the policeman pulled Harris over for a routine traffic stop, he saw an open beer can in the truck and noted nervousness of the driver, so he asked permission to search the truck. When it was refused, he had the dog do a sniff test and the dog alerted at the driver’s side handle, leading the officer to conclude that he had reasonable cause for a search. The U.S. Supreme Court agreed, noting that, “All we have required is the kind of ‘fair probability’ on which ‘reasonable and prudent [people,]’ not legal technicians, act.” The court went on to say that as long as the State has produced proof from controlled settings that a dog performs reliably in detecting drugs, and the defendant has not contested that showing, then there is probable cause for the search.

43 

568 U.S. 133 S. Ct. 1050 (2013).

The second case, which follows, led to a contrary outcome. As you read the following case, think about the similarities and differences between the two to help you better understand how the court analyzes Fourth Amendment challenges.

 Case 5-5 Florida v. Jardines

United States Supreme Court 133 S. Ct. 1409 (2013)

Adetective received an unverified tip that marijuana was being grown in Jardines’ home. A month later, the Police Department and the Drug Enforcement Administration sent a joint surveillance team to Jardines’ home. The detective approached Jardines’ home accompanied by a trained canine handler who had just arrived at the scene with his drug-sniffing dog. The dog was trained to detect the scent of marijuana, cocaine, heroin, and several other drugs, indicating the presence of any of these substances through particular behavior recognizable by his handler.

As the dog approached Jardines’ front porch, he apparently sensed one of the odors he had been trained to detect, and began energetically exploring the area for the strongest point source of that odor. After sniffing the base of the front door, the dog sat, which is the trained behavior upon discovering the odor’s strongest point, which the handler described as a positive indicator of narcotics.

On the basis of what he had learned from the dog, the detective applied for and received a warrant to search the home. A later search revealed marijuana plants, and Jardine was charged with trafficking in cannabis.

At trial, Jardines moved to suppress the marijuana plants on the ground that the canine investigation was an unreasonable search. The trial court granted the motion, and the Florida Third District Court of Appeal reversed. On a petition for discretionary review, the Florida Supreme Court quashed the decision of the Third District Court of Appeal and approved the trial court’s decision to suppress, holding (as relevant here) that the use of the trained narcotics dog to investigate Jardines’ home was a Fourth Amendment search unsupported by probable cause, rendering invalid the warrant based upon information gathered in that search. The police department appealed.

Justice Scalia

We granted certiorari, limited to the question of whether the officers’ behavior was a search within the meaning of the Fourth Amendment.

The Fourth Amendment provides in relevant part that the “right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated.” The Amendment establishes a simple baseline, one that for much of our history formed the exclusive basis for its protections: When “the Government obtains information by physically intruding” on persons, houses, papers, or effects, “a ‘search’ within the original meaning of the Fourth Amendment” has “undoubtedly occurred” . . .

That principle renders this case a straightforward one. The officers were gathering information in an area belonging to Jardines and immediately surrounding his house—in the curtilage of the house, which we have held enjoys protection as part of the home itself. And they gathered that information by physically entering and occupying the area to engage in conduct not explicitly or implicitly permitted by the homeowner.

The Fourth Amendment “indicates with some precision the places and things encompassed by its protections”: persons, houses, papers, and effects . . . The Fourth Amendment does not, therefore, prevent all investigations conducted on private property; for example, an officer may gather information in what we have called “open fields”—even if those fields are privately owned—because such fields are not enumerated in the Amendment’s text . . .

But when it comes to the Fourth Amendment, the home is first among equals. At the Amendment’s “very core” stands “the right of a man to retreat into his own home and there be free from unreasonable governmental intrusion.” . . . This right would be of little practical value if the State’s agents could stand in a home’s porch or side garden and trawl for evidence with impunity; the right to retreat would be significantly diminished if the police could enter a man’s property to observe his repose from just outside the front window.

We therefore regard the area “immediately surrounding and associated with the home”—what our cases call the curtilage—as “part of the home itself for Fourth Amendment purposes” . . . This area around the home is “intimately linked to the home, both physically and psychologically,” and is where “privacy expectations are most heightened” . . .

Here there is no doubt that the officers entered [the cutilege]: The front porch is the classic exemplar of an area adjacent to the home and “to which the activity of home life extends.”

Since the officers’ investigation took place in a constitutionally protected area, we turn to the question of whether it was accomplished through an unlicensed physical intrusion . . . As it is undisputed that the detectives had all four of their feet and all four of their companion’s firmly planted on the constitutionally protected extension of Jardines’ home, the only question is whether he had given his leave (even implicitly) for them to do so. He had not.

“A license may be implied from the habits of the country,” . . . This implicit license typically permits the visitor to approach the home by the front path, knock promptly, wait briefly to be received, and then leave. Complying with the terms of that traditional invitation does not require fine-grained legal knowledge; it is generally managed without incident by the Nation’s Girl Scouts and trick-or-treaters. Thus, a police officer not armed with a warrant may approach a home and knock, precisely because that is “no more than any private citizen might do.”

But introducing a trained police dog to explore the area around the home in hopes of discovering incriminating evidence is something else. There is no customary invitation to do that. An invitation to engage in canine forensic investigation assuredly does not inhere in the very act of hanging a knocker. To find a visitor knocking on the door is routine (even if sometimes unwelcome); to spot that same visitor exploring the front path with a metal detector, or marching his bloodhound into the garden before saying hello and asking permission, would inspire most of us to—well, call the police. The scope of a license—express or implied—is limited not only to a particular area but also to a specific purpose. Consent at a traffic stop to an officer’s checking out an anonymous tip that there is a body in the trunk does not permit the officer to rummage through the trunk for narcotics. Here, the background social norms that invite a visitor to the front door do not invite him there to conduct a search . . . That the officers learned what they learned only by physically intruding on Jardines’ property to gather evidence is enough to establish that a search occurred . . .

The government’s use of trained police dogs to investigate the home and its immediate surroundings is a “search” within the meaning of the Fourth Amendment.

Judgment of the Florida Supreme Court affirmed, in favor of the Defendant.

During the second term of 2013, the high court handed down another important Fourth Amendment case, but that decision was not quite as clear as the holding in Jardines, and some lawyers thought it created as many questions as it answered. In Maryland v. King,44 the high court upheld a Maryland law allowing the warrantless collection of DNA samples from suspects accused of certain serious crimes. Writing the majority opinion in the 5–4 decision,

Justice Kennedy

said that the collection of DNA via a cheek swab was clearly a search, but the government’s substantial interest in using DNA evidence to identify arrestees and connect them to other crimes outweighs suspects’ privacy interests given the nonintrusive nature of the search. Kennedy observed that DNA testing was analogous to fingerprinting except more accurate. More than two dozen other states also have laws allowing the warrantless collection of DNA, some of which are broader than the Maryland statute, so some of those may still be challenged by defense lawyers.
*

44 

133 S. Ct. 1958 (2013).

* 
Florida v. Jardines, United States Supreme Court 133 S. Ct. 1409, 2013.

Another important Fourth Amendment case was handed down in 2014. In Riley v. California,
45 the high court ruled that the police generally may not, without a warrant, search digital information on a cell phone seized from an individual who has been arrested. While the officers may examine the phones’ physical aspects to ensure that the phones would not be used as weapons, digital data stored on the phones could not itself be used as a weapon to harm the arresting officers or to effectuate the defendants’ escape, so police have no justification for examining it. Further, the potential for destruction of evidence by remote wiping or data encryption was not shown to be prevalent and could be countered by disabling the phones. Moreover, the immense storage capacity of modern cell phones implicated privacy concerns with regard to the extent of information which could be accessed.

45 

134 S. Ct. 2473 (2014).

The Fourth Amendment protects corporations as well as individuals. This protection is generally applicable, as noted earlier, in criminal cases. Fourth Amendment issues also arise, however, when government regulations authorize, or even require, warrantless searches by administrative agencies.

Although administrative searches are presumed to require a search warrant, an exception has been carved out. If an industry has been subject to pervasive regulation, a warrantless search is considered reasonable under the Fourth Amendment. In such industries, warrantless searches are required to ensure that regulations are being upheld, and a warrantless search would not be unreasonable because the owner has a reduced expectation of privacy. When a warrantless search is challenged, and the state argues that the “pervasively regulated” exception should apply, before the court will find that the search was reasonable, the agency will have to demonstrate that:

1. there is “a substantial government interest that informs the regulatory scheme pursuant to which the inspection is made”

46

46 

New York v. Burger, 482 U.S. 691, 107 S. Ct. 2636 (1987).

2. the warrantless inspections must be “necessary to further the regulatory scheme”

47

47 

Id.

3. “the statute’s inspection program, in terms of the certainty and regularity of its application, must provide a constitutionally adequate substitute for a warrant”;

48

 that is, it advises the business owner that “the search is being made pursuant to the law and has a properly defined scope,” and limits the discretion of the inspecting officers.

49

48 

Id.

49 

Id.

As the Fourth Amendment is currently interpreted, a warrantless search authorized by the Gun Control Act or the Federal Mine Safety and Health Act would be legal. A warrantless search under the Occupational Safety and Health Act, however, would violate the Fourth Amendment because there is no history of pervasive legislation on working conditions before passage of that act.

Applying The Law To The Facts . . .

One of a store’s employees asked the mall security guards to stop a man that she thought had shoplifted some merchandise. They stopped him, handcuffed him, and searched his pockets while waiting for police to arrive. In his pocket they found a small pill bottle that contained bags of cocaine. They gave the bottles to the police when the police arrived. In his subsequent trial, the suspect argued that that the bottles of cocaine should not be used as evidence against him because the mall security guards searched him in violation of his Fourth Amendment rights. Do you think he has a good argument? Why or why not?

The Fifth Amendment

The 

Fifth Amendment

 provides many significant protections to individuals. For instance, it protects against self-incrimination and double jeopardy (that is, being tried twice for the same crime). Of more importance to businesspersons, however, is the 

Due Process Clause

 of the Fifth Amendment. This provision provides that one cannot be deprived of life, liberty, or property without due process of law.

Fifth Amendment

Protects individuals against self-incrimination and double jeopardy and guarantees them the right to trial by jury; protects both individuals and businesses through the Due Process Clause and the Takings Clause.

Due Process Clause

Provides that no one can be deprived of life, liberty, or property without “due process of law”; found in the Fifth Amendment.

There are two types of due process: procedural and substantive. Originally, due process was interpreted only procedurally. 

Procedural due process

 requires that a criminal whose life, liberty, or property would be taken by a

Technology and the Legal Environment

In 2010, in the case of United States v. Warshak,

50

 the Sixth Circuit Court of Appeals became the first appellate court to rule that the people who use email have a reasonable expectation of privacy in its contents, and that the government, therefore, must obtain a warrant under probable cause to have an ISP turn over the communications to it. The court analyzed the expectation of privacy regarding the various forms of communication, finding that email is the direct descendant of telephone and letters, because email has replaced those forms of communication. The same privacy considerations, therefore, apply to email and trigger the Fourth Amendment warrant requirement. Consequently, the court held that a subscriber enjoys a reasonable expectation of privacy in the contents of emails “that are stored with, or sent or received through, a commercial ISP.” However, despite ruling that the Stored Communications Act under which the warrantless search was unconstitutional, and finding that because they did not obtain a warrant, the government agents violated the Fourth Amendment when they obtained the contents of Warshak’s emails, the court in Warshak still allowed the government to use the email evidence it had acquired because the agents had relied in good faith on the Stored Communications Act, under which the ex parte order to the company to turn over the emails had been issued.

50 

United States v. Warshak, 631 F.3d 266 (6th Cir. 2010).

conviction be given a fair trial; that is, he or she is entitled to notice of the alleged criminal action and the opportunity to confront his or her accusers before an impartial tribunal. The application of procedural due process soon spread beyond criminal matters, especially after passage of the Fourteenth Amendment, discussed in the next section, which made the requirement of due process applicable to state governments.

procedural due process

Procedural steps to which individuals are entitled before losing their life, liberty, or property.

Today, the Due Process Clause has been applied to such diverse situations as the termination of welfare benefits,51 the discharge of a public employee from his or her job, and the suspension of a student from school. It should be noted, however, that the types of takings to which the Due Process Clause applies are not being continually increased. In fact, after a broad expansion of the takings to which this clause applied, the courts began restricting the application of this clause during the 1970s and have continued to do so since then. The courts restrict application of the clause by narrowing the interpretation of property and liberty. This narrowing is especially common in interpreting the Due Process Clause as it applies to state governments under the Fourteenth Amendment.

51 

Goldberg v. Kelly, 90 U.S. 101 (1970). In this case, the Supreme Court stated that the termination of a welfare recipient’s welfare benefits by a state agency without affording him or her opportunity for an evidentiary hearing before termination violates the recipient’s procedural due process rights.

What procedural safeguards does procedural due process require? The question is not easily answered. The procedures that the government must follow when there may be a taking of an individual’s life, liberty, or property vary according to the nature of the taking. In general, as the magnitude of the potential deprivation increases, the extent of the procedures required also increases.

The second type of due process is 

substantive due process

. The concept of substantive due process refers to the basic fairness of laws that may deprive an individual of his or her liberty or property. In other words, when a law is passed that will restrict individuals’ liberty or their use of their property, the government must have a proper purpose for the restriction, or it violates substantive due process.

substantive due process

Requirement that laws depriving individuals of liberty or property be fair.

During the late nineteenth and early twentieth centuries, this concept was referred to as economic substantive due process and was used to strike down a number of pieces of social legislation, including laws that established minimum wages and hours. Business managers successfully argued that such laws interfered with the liberty of employer and employee to enter into whatever type of employment contract they might choose. Analogous arguments were used to defeat many laws that would allegedly have helped the less fortunate at the expense of business interests. Economic substantive due process flourished only until the late 1930s. Today, many pieces of social legislation are in force that would have been held unconstitutional under the old concept of economic substantive due process.

The concept of substantive due process is not dead. Its use today, however, protects not economic interests, but personal rights, such as the still-evolving right to privacy. The right to privacy is a liberty now deemed to be protected under the Constitution. In order for a law restricting one’s right to privacy to conform to substantive due process, the restriction in question must bear a substantial relationship to a compelling governmental purpose.

And most recently, in the following case, we saw the Due Process Clause used to strike down the Defense of Marriage Act (DOMA).

 Case 5-6 United States v. Windsor

United States Supreme Court 133 S. Ct. 2675 (2013)

Edith Windsor and Thea Spyer were legally married in Canada, and moved to New York, which recognizes same sex marriage. When Spyer died in 2009, she left her entire estate to Windsor, who sought to claim the federal estate tax exemption for surviving spouses, but was barred from doing so by § 3 of the federal Defense of Marriage Act (DOMA), which amended the federal law that provides rules of construction for over 1,000 federal laws and all federal regulations—to define “marriage” and “spouse” as excluding same-sex partners. Windsor paid $363,053 in estate taxes and applied for a refund. When the Internal Revenue Service refused to give her the refund, Windsor filed suit, arguing that DOMA violates the principles of equal protection incorporated in the Fifth Amendment.

The District Court found that DOMA unconstitutionally violated principles of due process and equal protection enshrined in the Constitution. The Second Circuit Court of Appeals upheld the decision, saying the courts should apply strict scrutiny to classifications based on sexual orientation. (In an unrelated case, the United States Court of Appeals for the First Circuit also found § 3 of DOMA unconstitutional.) The United States then appealed the case to the U.S. Supreme Court.

Justice Kennedy

III

 . . . [S]ome States concluded that same-sex marriage ought to be given recognition and validity in the law for those same-sex couples who wish to define themselves by their commitment to each other. The limitation of lawful marriage to heterosexual couples, which for centuries had been deemed both necessary and fundamental, came to be seen in New York and certain other States as an unjust exclusion.

Against this background of lawful same-sex marriage in some States, the design, purpose, and effect of DOMA should be considered as the beginning point in deciding whether it is valid under the Constitution. By history and tradition the definition and regulation of marriage, . . . has been treated as being within the authority and realm of the separate States. Yet it is further established that Congress, in enacting discrete statutes, can make determinations that bear on marital rights and privileges. . . . Congress has the power both to ensure efficiency in the administration of its programs and to choose what larger goals and policies to pursue.

Though these discrete examples establish the constitutionality of limited federal laws that regulate the meaning of marriage in order to further federal policy, DOMA has a far greater reach; for it enacts a directive applicable to over 1,000 federal statutes and the whole realm of federal regulations. And its operation is directed to a class of persons that the laws of New York, and of 11 other States, have sought to protect. . . .

In order to assess the validity of that intervention it is necessary to discuss the extent of the state power and authority over marriage as a matter of history and tradition. . . . State laws defining and regulating marriage, of course, must respect the constitutional rights of persons, . . . but, subject to those guarantees, “regulation of domestic relations” is “an area that has long been regarded as a virtually exclusive province of the States.”

 . . . DOMA rejects the long-established precept that the incidents, benefits, and obligations of marriage are uniform for all married couples within each State, though they may vary, subject to constitutional guarantees, from one State to the next. . . . Here the State’s decision to give this class of persons the right to marry conferred upon them a dignity and status of immense import. When the State used its historic and essential authority to define the marital relation in this way, its role and its power in making the decision enhanced the recognition, dignity, and protection of the class in their own community. . . .

The Federal Government uses this state-defined class for the opposite purpose—to impose restrictions and disabilities. That result requires this Court now to address whether the resulting injury and indignity is a deprivation of an essential part of the liberty protected by the Fifth Amendment. What the State of New York treats as alike the federal law deems unlike by a law designed to injure the same class the State seeks to protect.

In acting first to recognize and then to allow same-sex marriages, New York was responding “to the initiative of those who [sought] a voice in shaping the destiny of their own times.” . . . These actions were without doubt a proper exercise of its sovereign authority within our federal system, all in the way that the Framers of the Constitution intended. The dynamics of state government in the federal system are to allow the formation of consensus respecting the way the members of a discrete community treat each other in their daily contact and constant interaction with each other.

The States’ interest in defining and regulating the marital relation, subject to constitutional guarantees, stems from the understanding that marriage is more than a routine classification for purposes of certain statutory benefits. Private, consensual sexual intimacy between two adult persons of the same sex may not be punished by the State, and it can form “but one element in a personal bond that is more enduring.” By its recognition of the validity of same-sex marriages performed in other jurisdictions and then by authorizing same-sex unions and same-sex marriages, New York sought to give further protection and dignity to that bond. For same-sex couples who wished to be married, the State acted to give their lawful conduct a lawful status. This status is a far-reaching legal acknowledgment of the intimate relationship between two people, a relationship deemed by the State worthy of dignity in the community equal with all other marriages. It reflects both the community’s considered perspective on the historical roots of the institution of marriage and its evolving understanding of the meaning of equality.

IV

DOMA seeks to injure the very class New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government. . . . The Constitution’s guarantee of equality “must at the very least mean that a bare congressional desire to harm a politically unpopular group cannot” justify disparate treatment of that group. . . . In determining whether a law is motived by an improper animus or purpose, “‘[d]iscriminations of an unusual character’” especially require careful consideration. . . . DOMA cannot survive under these principles. The responsibility of the States for the regulation of domestic relations is an important indicator of the substantial societal impact the State’s classifications have in the daily lives and customs of its people. DOMA’s unusual deviation from the usual tradition of recognizing and accepting state definitions of marriage here operates to deprive same-sex couples of the benefits and responsibilities that come with the federal recognition of their marriages. This is strong evidence of a law having the purpose and effect of disapproval of that class. The avowed purpose and practical effect of the law here in question are to impose a disadvantage, a separate status, and so a stigma upon all who enter into same-sex marriages made lawful by the unquestioned authority of the States.

The history of DOMA’s enactment and its own text demonstrate that interference with the equal dignity of same-sex marriages, a dignity conferred by the States in the exercise of their sovereign power, was more than an incidental effect of the federal statute. It was its essence. . . .

As the title and dynamics of the bill indicate, its purpose is to discourage enactment of state same-sex marriage laws and to restrict the freedom and choice of couples married under those laws if they are enacted. The congressional goal was “to put a thumb on the scales and influence a state’s decision as to how to shape its own marriage laws.” . . . The Act’s demonstrated purpose is to ensure that if any State decides to recognize same-sex marriages, those unions will be treated as second-class marriages for purposes of federal law. This raises a most serious question under the Constitution’s Fifth Amendment.

DOMA’s operation in practice confirms this purpose. When New York adopted a law to permit same-sex marriage, it sought to eliminate inequality; but DOMA frustrates that objective through a system-wide enactment with no identified connection to any particular area of federal law. DOMA writes inequality into the entire United States Code. The particular case at hand concerns the estate tax, but DOMA is more than a simple determination of what should or should not be allowed as an estate tax refund. Among the over 1,000 statutes and numerous federal regulations that DOMA controls are laws pertaining to Social Security, housing, taxes, criminal sanctions, copyright, and veterans’ benefits.

DOMA’s principal effect is to identify a subset of state-sanctioned marriages and make them unequal. The principal purpose is to impose inequality, not for other reasons like governmental efficiency. Responsibilities, as well as rights, enhance the dignity and integrity of the person. And DOMA contrives to deprive some couples married under the laws of their State, but not other couples, of both rights and responsibilities. By creating two contradictory marriage regimes within the same State, DOMA forces same-sex couples to live as married for the purpose of state law but unmarried for the purpose of federal law, thus diminishing the stability and predictability of basic personal relations the State has found it proper to acknowledge and protect. By this dynamic DOMA undermines both the public and private significance of state-sanctioned same-sex marriages; for it tells those couples, and all the world, that their otherwise valid marriages are unworthy of federal recognition. This places same-sex couples in an unstable position of being in a second-tier marriage. The differentiation demeans the couple, whose moral and sexual choices the Constitution protects, and whose relationship the State has sought to dignify. And it humiliates tens of thousands of children now being raised by same-sex couples. The law in question makes it even more difficult for the children to understand the integrity and closeness of their own family and its concord with other families in their community and in their daily lives.

Under DOMA, same-sex married couples have their lives burdened, by reason of government decree, in visible and public ways. By its great reach, DOMA touches many aspects of married and family life, from the mundane to the profound. It prevents same-sex married couples from obtaining government healthcare benefits they would otherwise receive. It deprives them of the Bankruptcy Code’s special protections for domestic-support obligations. It forces them to follow a complicated procedure to file their state and federal taxes jointly. It prohibits them from being buried together in veterans’ cemeteries.

The power the Constitution grants it also restrains. And though Congress has great authority to design laws to fit its own conception of sound national policy, it cannot deny the liberty protected by the Due Process Clause of the Fifth Amendment.

What has been explained to this point should more than suffice to establish that the principal purpose and the necessary effect of this law are to demean those persons who are in a lawful same-sex marriage. This requires the Court to hold, as it now does, that DOMA is unconstitutional as a deprivation of the liberty of the person protected by the Fifth Amendment of the Constitution.

The liberty protected by the Fifth Amendment’s Due Process Clause contains within it the prohibition against denying to any person the equal protection of the laws. . . . While the Fifth Amendment itself withdraws from Government the power to degrade or demean in the way this law does, the equal protection guarantee of the Fourteenth Amendment makes that Fifth Amendment right all the more specific and all the better understood and preserved.

The class to which DOMA directs its restrictions and restraints are those persons who are joined in same-sex marriages made lawful by the State. DOMA singles out a class of persons deemed by a State entitled to recognition and protection to enhance their own liberty. It imposes a disability on the class by refusing to acknowledge a status the State finds to be dignified and proper. DOMA instructs all federal officials, and indeed all persons with whom same-sex couples interact, including their own children, that their marriage is less worthy than the marriages of others. The federal statute is invalid, for no legitimate purpose overcomes the purpose and effect to disparage and to injure those whom the State, by its marriage laws, sought to protect in personhood and dignity. By seeking to displace this protection and treating those persons as living in marriages less respected than others, the federal statute is in violation of the Fifth Amendment.
*

* 
United States v. Windsor, Supreme Court of the United States, 133.S. Ct. 2675.

Affirmed, in favor of Respondents.

The complete ramifications of this holding were not immediately clear at the time of the decision. Twelve states and the District of Columbia recognized same-sex marriage at that time, and employers at that time were scrambling to find out what their obligations would be under the new law. Over 1,000 federal regulations are affected by the ruling, many of those directly or indirectly affecting employers. Employers in states recognizing same-sex marriage were being forced to look carefully for policy changes they would need to make in three areas: health benefits, retirement plans, and family and medical leave policies. For example, the Family Medical Leave Act (discussed in greater detail in 

Chapter 19

), now covers same-sex marriage partners, whereas before it did not. There are also benefits from this ruling for many employers.

In 2015, however, the impact of this decision became even more extensive, as the recognition of same-sex marriages spread from those 12 states and the District of Columbia to every state in the Union, as the result of the ruling by the U.S. Supreme Court in the case of Obergefell et al. v. Hodges et al.

52

 In that case, the high court held that the Fourteenth Amendment requires a State to license a marriage between two people of the same sex and to recognize a marriage between two people of the same sex when their marriage was lawfully licensed and performed out-of-State.

53

52 

135 S. Ct. 2584 (2015).

53 

Ibid.

The Fifth Amendment further provides that if the government takes private property for public use, it must pay the owner just compensation. This provision is referred to as the 

Takings Clause

. Unlike the protection against self-incrimination, which does not apply to corporations, both the Due Process Clause and the provision for just compensation are applicable to corporations. This provision for just compensation has been the basis of considerable litigation. One significant issue that has arisen is the question of what constitutes a “public use” for which the government can take property. This issue is discussed in greater detail in 

Chapter 13

.

Takings Clause

Provides that if the government takes private property for public use, it must pay the owner just compensation; found in the Fifth Amendment.

A second issue under this takings provision is the question of when a government regulation can become so onerous as to constitute a taking for which just compensation is required. These takings, which do not involve a physical taking of the property, are called regulatory takings. Environmental regulations, because they often have an impact on the way landowners may use their property, have been increasingly challenged as unconstitutional regulatory takings.

Perhaps one of the most important takings cases was Lucas v. South Carolina Coastal Commission,54 which was decided in 1992. The case arose out of a dispute between a beachfront property owner and the state of South Carolina, after the state passed a regulation prohibiting permanent construction on any eroding beach. Lucas had bought two beachfront lots for $975,000 a few years before the law was passed, and planned to build a couple of condominiums on the land. He challenged the law as constituting an unlawful taking because it prohibited him from building the condominiums or really doing anything with the property. The state court agreed with Lucas that the regulation denied him the economic value of his land and thus constituted an unconstitutional taking without compensation. It ordered the state to pay him $1.2 million in compensation. The South Carolina Supreme Court, however, citing U.S. Supreme Court precedents, overturned the lower court’s decision.

54 

505 U.S. 1003 (1992).

Lucas appealed the decision to the U.S. Supreme Court, which reversed the state supreme court ruling in a 6–3 decision. The Court held that a state regulation that deprives a private property owner of all economically beneficial uses of property, except those that would not have been permitted under background principles of state property and nuisance law, constitutes a taking of private property for which the Fifth Amendment requires compensation. The highest court in the land said that the state court had erred in applying the principle that the Takings Clause does not require compensation when the regulation at issue is designed to prevent “harmful or noxious uses” of property.

One of the factors that many commentators believed was critical to the Court’s ruling in Lucas was the fact that the law that led to his inability to develop his land had been enacted after Lucas had acquired his property. In the 2001 case of Palazzolo v. Rhode Island,

55

 however, the Supreme Court held by a 5–4 vote that someone who bought property after restrictions on development were in place could still challenge the restrictions as an unconstitutional “taking” of private property.

55 

533 U.S. 606 (2001).

Many advocates of private property rights now believe that the Takings Clause has taken on new importance because of cases such as Lucas and Whitney Benefits, Inc. v. United States,

56

 wherein a federal court found that the federal Surface Mining and Reclamation Act constituted a taking with respect to one mining company whose land became completely useless as a result of the act. Whether the “Property Firsters,” as they call themselves, will be successful in the future remains to be seen, but they have clearly brought back attention to an argument against regulation that had been fairly dormant for the past 50 years. Moreover, they are using their arguments primarily to challenge a broad range of environmental laws involving matters from forcing cleanups of hazardous waste sites to restricting grazing and rationing water, as well as land use planning statutes.

56 

926 F.2d 1169 (Fed. Cir. 1991).

For example, in Dolan v. Tigard,

57

 the owner of a store in the city’s business district sued when her receipt of a permit to double the size of her store and pave its gravel parking lot was made contingent on the condition that she dedicate a sixth of her land to the city. She was to make part of the land, which was in a floodplain, a public recreational greenway and part of a bike trail that could help reduce the increased congestion in the area that might result from the expansion of her store. The U.S. Supreme Court found that there was no evidence of a reasonable relationship between the floodplain easement required of Dolan and the impact of the new building. They held that the city had the right to take the easement for the greenway, but it had to provide just compensation for the regulatory taking.

57 

512 U.S. 374, 114 S. Ct. 2309 (1994).

Using the Fifth Amendment to bring individual challenges to land use regulations and zoning laws is a very time-consuming process, so many property rights organizations have instead focused on trying to pass state laws that would make it easier for property owners to get compensation when their property values fall because of new regulations. In 2004, such groups achieved their greatest success with the passage of Ballot Measure 37

58

 in the state of Oregon. The measure, which was initially struck down by the state court, but was subsequently upheld by the Oregon State Supreme Court, provides that any property owners who can prove that environmental or zoning laws have hurt their investments can force the government to compensate them for their losses or get an exemption from the rules. Other states that have laws providing compensation for aggrieved property owners are Florida, Texas, Louisiana, and Mississippi, but these laws provide compensation only after a particular loss threshold has been reached, usually a 25 percent reduction in the property’s value. Those laws also allow compensation only for losses caused by new land use laws. Whether the passage of the legislation in Oregon indicates the beginning of a new wave of legislation remains to be seen.

58 

Subsequently codified as Oregon Revised Statutes (ORS) 195.305.

Another factor that many who studied the Lucas case saw as important was the fact that the regulation really deprived its owner of any possible economically viable use for the land. Challenges based on the idea of a regulatory taking have not been quite as successful when there is just arguably a diminishment of the value of the property, as property rights advocates have found when attempting to use the law to challenge smoking bans as constituting a regulatory taking in violation of the Fifth Amendment. For example, operators of bars and restaurants in Toledo, Ohio were unsuccessful in challenging a citywide smoking ban as a violation of the Fifth Amendment, as applied to the states by the Fourteenth Amendment. They unsuccessfully argued that the statute denied them any “economically viable” use of their land because they would have to either spend huge amounts of money to establish smoking lounges in their establishments or lose all of their customers who smoked.

A final problem that often causes confusion among businesspersons is the question of the extent of Fifth Amendment protections for corporations. The Fifth Amendment protection against self-incrimination has not been held to apply to corporations. Some decisions, however, have raised questions about this long-standing interpretation. In United States v. Doe,

59

 the U.S. Supreme Court determined that even though the contents of documents may not be protected under the Fifth Amendment, a sole proprietor should have the right to show that the act of producing the documents would entail testimonial self-incrimination as to admissions that the records existed. Therefore, the sole proprietor could not be compelled to produce the sole proprietorship’s records.

59 

465 U.S. 605 (1984).

In the subsequent case of Braswell v. United States,60 however, the Court clearly distinguished between the role of a custodian of corporate records and a sole proprietor. In Braswell, the defendant operated his business as a corporation, with himself as the sole shareholder. When a grand jury issued a subpoena requiring him to produce corporate books and records, Braswell argued that to do so would violate his Fifth Amendment privilege against self-incrimination. The U.S. Supreme Court denied Braswell’s claim and said that, clearly, subpoenaed business records are not privileged, and, because Braswell was a custodian for the records, his act of producing the records would be in a representative capacity, not a personal one, so the records must be produced. The Court stated that, had the business been a sole proprietorship, Braswell would have had the opportunity to show that the act of production would have been self-incriminating. Because his business was a corporation, he was acting as a representative of a corporation, and regardless of how small the corporation, he could not claim a privilege. In 2003, the Court of Appeals for the Eighth Circuit applied the Supreme Court’s decision in the Braswell case, as the appellate court ordered a woman to produce corporate documents even though the corporation’s charter had been revoked.

61

 The appellate court reasoned that the subpoena of documents from an inactive corporation does not constitute a violation of the corporate custodian’s Fifth Amendment rights.

60 

487 U.S. 99 (1988).

61 

In re Grand Jury Subpoena, 75 Fed. Appx. 562 (2003).

The Fourteenth Amendment

The Fourteenth Amendment is important because it applies the Due Process Clause to the state governments. It has been interpreted to apply almost the entire Bill of Rights to the states, with the exceptions of the Fifth Amendment right to indictment by a grand jury for certain types of crimes and the right to trial by jury.

The Fourteenth Amendment is also important because it contains the Equal Protection Clause, which prevents the states from denying “the equal protection of the laws” to any citizen. This clause, discussed in more detail in 

Chapter 21

, has been a useful tool for people attempting to reduce discrimination in this country.

The most recent significant use of the Fourteenth Amendment to fight discrimination was the previously mentioned case of Obergefell et al. v. Hodges et al.

62

 In that case, the court demonstrated that the right to marry is a fundamental right inherent in the liberty of the person, and under the Due Process and Equal Protection Clauses of the Fourteenth Amendment couples of the same sex may not be deprived of that right and that liberty.

63

62 

Supra, note 53.

63 

Ibid.

Standard of Review

The Equal Protection Clause prohibits “invidious” discrimination, that is, discrimination not based on a sufficient justification. To determine whether a specific classification system being used by the government has sufficient justification, the Supreme Court has established standards of review based upon the nature of the classification. The standards are: strict scrutiny, intermediate scrutiny, and the rational basis test.

Strict scrutiny is used when a government activity classifies people based on their belonging to a suspect class (race, color, national origin). For the court to uphold such a classification, the government must have a compelling reason for the classification and the regulation must be narrowly drawn so that it goes no further than necessary to meet the compelling government interest. This is the same level of scrutiny applied when the government is attempting to deprive a person of their fundamental rights, as in the Obergefell case.

Intermediate scrutiny is applied when the classification is based on a protected class other than race, color, or national origin, such as sex, age, or religion. In such a case the government must have an important reason for treating those in the classification differently, and the regulation must be “reasonably related” to furthering that reason.

If the classification does not involve a suspect classification, then the court will simply apply a rational basis test, meaning that there has to be some legitimate reason why the government would treat members of that class differently. The regulation at issue must simply be reasonably related to furthering that reasonable government interest. For example, in 2008, the Iowa Supreme Court ruled that a law that taxed apartment buildings at a higher commercial rate rather than at the lower residential rate charged to owners of owner-occupied condominiums did not violate the Equal Protection Clause.

64

64 

State v. DeAngelo, 2009 WL 291169 (N.J. 2009).

SUMMARY

The framework of our nation is embodied in the U.S. Constitution, which established a system of government based on the concept of federalism. Under this system, the power to regulate local matters is given to the states; the federal government is granted limited powers to regulate activities that substantially affect interstate commerce. All powers not specifically given to the federal government are reserved to the states.

The Commerce Clause is the primary source of the federal government’s authority to regulate business. The same clause restricts states from passing regulations that would interfere with interstate commerce. The state and federal governments are limited in their regulations by the amendments to the Constitution, especially the Bill of Rights. The First Amendment, for example, protects our individual right to free expression; commercial speech is also entitled to a significant amount of protection in this area.

Other important amendments for the businessperson are the Fourth Amendment, which protects one’s right to be free from unwarranted searches and seizures, and the Fifth Amendment, which establishes one’s right to due process. A final amendment that has a significant impact on the legal environment is the Fourteenth Amendment, which applies most of the Bill of Rights to the states and also contains the Equal Protection Clause.

Assignment On The Internet

This chapter introduces you to the many constitutional principles that govern business activities. One such principle is free speech and the extent to which it applies to commercial speech. For example, should advertisements for pharmaceuticals be subject to Federal Drug Administration regulations and limitations?

Read the summary from a Supreme Court decision about the advertising of pharmaceuticals from the pharmaceutical industry, found at 

www.oyez.org

 (type in “advertisement of pharmaceutical” in the search bar and click on the first link, titled “Bolger vs. Youngs Drug Products Corp.). Can you determine from the summary whether the Central Hudson test was applied to the case? If so, how?

Chapter Eight The International Legal Environment of Business

At the outset of 

Chapter 2

, we noted that U.S. managers can no longer afford to view their firms as doing business on a huge island between the Pacific and the Atlantic Oceans. Existing and pending multilateral trade agreements open vast opportunities to do business in Europe and Asia, throughout the Americas, and indeed throughout the world. If present and future U.S. managers do not become aware of these opportunities, as well as the attendant risks, they and their firms will be at a competitive disadvantage vis-à-vis foreign competitors from all over the world.

Critical Thinking About The Law

This chapter (1) introduces the international environment of business; (2) sets forth the methods by which companies may engage in international business; (3) indicates the risks involved in such engagement; (4) describes organizations that work to bring down tariff barriers, and thus encourage companies of all nations to engage in international business; and (5) identifies the means by which disputes between companies doing business in the international arena are settled. Please note carefully that when we use the word companies in an international context, we are referring not only to private-sector firms, but also to nation-state subsidized entities and government agencies that act like private-sector companies.

Because of today’s widespread international opportunities and advances in communication, business managers must be aware of the global legal environment of business. As you will soon learn, the political, economic, cultural, and legal dimensions are all important international business considerations. The following questions will help sharpen your critical thinking about the international legal environment of business.

1. Consider the number of countries that might participate in an international business agreement. Why might ambiguity be a particularly important concern in international business?

Clue: Consider the variety of cultures as well as the differences in languages. How might these factors affect business agreements?

2. Why might the critical thinking questions about ethical norms and missing information be important for international businesses?

Clue: Again, consider the variety of cultures involved in international business. Why might identifying the primary ethical norms of a culture be helpful?

3. What ethical norm might influence an entity’s willingness to enter into agreements with foreign companies?

Clue: How might international agreements differ from agreements between two U.S. companies?

Dimensions of the International Environment of Business

Doing international business has political, economic, cultural, and legal dimensions. Although this chapter emphasizes the legal dimensions of international business transactions, business managers need to be aware of those other important dimensions as well. (Ethical dimensions were examined in 

Chapter 7

.)

Political Dimensions

Managers of firms doing international business must deal with different types of governments, ranging from democracies to totalitarian states. They are concerned with the stability of these governments and with whether economic decisions are centralized or decentralized. In the Marxist form of government, such as that which existed in the former Soviet Union and in Eastern Europe until the 1990s, economic decisions were centralized, and there was political stability. This would seem to be an ideal environment in which to do business from a multinational business manager’s perspective. But it was not ideal, because a centralized economy limits the supply of goods coming from outside a country, the price that can be charged for goods inside the country, and the amount of currency that can be taken out of the country by multinational businesses.

Despite the collapse of communism and the development of new political systems professing support of free enterprise in Eastern Europe and throughout the former Soviet Union, companies in the industrialized nations have delayed investing in some of these areas because they are uncertain of these areas’ political stability and willingness to adhere to economic agreements. In the People’s Republic of

China

(PRC or China), an early rush to invest was slowed by foreign companies’ experiences with a seemingly capricious government. For example, McDonald’s leased a prime location in Beijing from the centralized government but found itself ousted a few years later when the government revoked the lease to allow a department store to be built on that site. Moreover, doubts about the Chinese government’s intention to honor its agreement with the British government—that

Hong Kong

would retain its separate political and economic status for 50 years after the 98-year British lease expired in 1997—led one long-time Hong Kong trading company, Jardine, to move its headquarters to the Bahamas. In 2010, China’s monitoring of Google users’ Internet communications prompted Google initially to move most of its activities to Hong Kong, a district now belonging to China. Three months later, China rejected the scheme. Google, instead of continuing to reroute queries to its Hong Kong engine, started sending visitors to a new “landing page” that linked to the Hong Kong website where users could perform searches beyond the reach of Chinese censors. Later in 2010, a compromise was reached. China allowed Google to operate in China if it tweaked its mainland search box to ask users if they still wanted to have communications sent to the Hong Kong site. Chinese users of Google thus had a choice, and both the Chinese government and Google saved face. Despite these political problems, China’s growth rate in 2007–2009 proceeded at an annual gross domestic product (GDP) of 10–12 percent. Further, China has brought investment capital to Latin American, Asian, and African nations. It is searching for minerals and energy to develop its infrastructure. As this search continues, China’s political influence spreads worldwide.

Economic Dimensions

Every business manager should do a country analysis before deciding to do business in another nation-state. Such an analysis not only examines political variables, but also dissects a nation’s economic performance as demonstrated by its rate of economic growth, inflation, budget, and trade balance. Four economic factors in particular affect business investment:

1. Differences in size and economic growth rate of various nation-states. For example, when McDonald’s decided to engage in international business, the company initially located its restaurants only in countries that already had high growth rates. As more and more developing nations moved toward a market economy, McDonald’s expanded into

Russia

, China, Brazil,

Mexico

, and other countries deemed to have potentially high growth rates.

2. The impact of central planning versus a market economy on the availability of supplies. When McDonald’s went into Russia, it had to build its own food-processing center to be certain it would get the quality of beef it needed. Furthermore, because of distribution problems, it used its own trucks to move supplies.

3. The availability of disposable income. This is a tricky issue. Despite the fact that the price of a Big Mac, french fries, and a soft drink equals the average Russian worker’s pay for four hours of work, McDonald’s is serving thousands of customers a day at its Moscow restaurant.

4. The existence of an appropriate transportation infrastructure. Decent roads, railroads, and ports are needed to bring in supplies and then transport them within the host country. McDonald’s experience in Russia is commonplace. Multinational businesses face transportation problems in many developing countries.

Cultural Dimensions

Culture

 may be defined as learned norms of a society that are based on values, beliefs, and attitudes. For example, if people of the same area speak the same language (e.g., Spanish in most of Latin America, with the exception of Brazil and a few small nations), the area is often said to be culturally homogeneous. Religion is a strong builder of common values. In 1995, the Iranian government outlawed the selling and use of satellite communications in Iran on the grounds that they presented “decadent” Western values that were undermining Muslim religious values. Now, in 2010, it monitors Internet communications, which has led some U.S. congresspersons to seek a ban on all trade with Iran.

culture

Learned norms of society based on values and beliefs.

A failure to understand that some cultures are based on ascribed group membership (gender, family, age, or ethnic affiliation) rather than on acquired group membership (religious, political, professional, or other associations), as in the West, can lead to business mistakes. For example, gender- and family-based affiliations are very important in

Saudi Arabia

, where a strict interpretation of Islam prevents women from playing a major role in business. Most Saudi women who work hold jobs that demand little or no contact with men, such as teaching or acting as doctors only for women.

Another important cultural factor is the attitude toward work. Mediterranean and Latin American cultures base their group affiliation on family, and place more emphasis on leisure than on work. We often say that the Protestant ethic, stressing the virtues of hard work and thrift, is prevalent in Western and other industrialized nations. Yet the Germans work no more than 35 hours a week and take 28 days of paid vacation every year. The average hourly wage is higher in

Germany

than in the

United States

, and German workers’ benefits far outpace those of U.S. workers.

Business managers must carefully consider language, religion, attitudes toward work and leisure, family versus individual reliance, and numerous other cultural values when planning to do business in another nation-state. They also need to find a method of reconciling cultural differences between people and companies from their own nation-state and those from the country in which they intend to do business.

Corruption and

Trade

The nature of trade between nations, between multinationals, and between multinationals and nation-states has led to global competition, and sometimes bribery, and thus corruption (see the “Corruption Perception Index” from Transparency International in the “

Comparative Law Corner

” feature later in this chapter). Attempts to lessen such bribery and corruption through bilateral and multilateral agreements have been led by the United States Foreign Corrupt Practices Act of 1977 (FCPA) and the Convention on Combating Bribery of Foreign Officials in International Business Transactions (CCBFOIBT) drafted by the

Organization for Economic Cooperation and Development (OECD)

and signed by 34 countries. The Convention adopts the standards of the FCPA. 

Chapter 22

 provides additional details governing both acts.

In this text, 

Chapter 23

, you will find a brief discussion of the FCPA provisions that forbid payments to foreign officials when those amounts are more than “grease payments.” “Facilitating payments” made to obtain permits, licenses, or other official documents associated with contract performance, or movement of goods across a country, are considered lawful. The Justice Department, as well as other agencies and individuals, may enforce the FCPA. Activities that constitute a bribe are often the basis for legal action. The case excerpted here deals with this problem.

 Case 8-1 United States v. Kay

359 F.3d 738 (5th Cir. 2004)

David Kay (defendant) was an American citizen and a vice president for marketing of American Rice, Inc. (ARI), who was responsible for supervising sales and marketing in the Republic of

Haiti

. Douglas Murphy (defendant) was an American citizen and president of ARI.

Beginning in 1995 and continuing to about August 1999, Kay, Murphy, and other employees and officers of ARI paid bribes and authorized the payment of bribes to induce customs officials in Haiti to accept bills of lading and other documents that intentionally understated the true amount of rice that ARI shipped to Haiti for import, thus reducing the customs duties owed by ARI and RCH to the Haitian government.

In addition, beginning in 1998 and continuing to about August 1999, Kay and other employees and officers of ARI paid and authorized additional bribes to officials of other Haitian agencies to accept the false import documents and other documents that understated the true amount of rice being imported into and sold in Haiti, thereby reducing the amount of sales taxes paid to the Haitian government.

Kay directed employees of ARI to prepare two sets of shipping documents for each shipment of rice to Haiti, one that was accurate and another that falsely represented the weight and value of the rice being exported to Haiti.

Kay and Murphy agreed to pay and authorized the payment of bribes, calculated as a percentage of the value of the rice not reported on the false documents or in the form of a monthly retainer, to customs and tax officials of the Haitian government to induce these officials to accept the false documentation and to assess significantly lower customs duties and sales taxes than ARI would otherwise have been required to pay.

ARI, using official Haitian customs documents reflecting the amounts reported on the false shipping documents, reported only approximately 66 percent of the rice it sold in Haiti and thereby significantly reduced the amount of sales taxes it was required to pay to the Haitian government.

In 2001, a grand jury charged Kay with violating the FCPA and subsequently returned the indictment, which charged both Kay and Murphy with 12 counts of FCPA violations. Both Kay and Murphy moved to dismiss the indictment for failure to state an offense, arguing that obtaining favorable tax treatment did not fall within the FCPA definition of payments made to government officials in order to obtain business. The district court dismissed the indictment, and the United States of America appealed.

Justice Wiener

The principal dispute in this case is whether, if proved beyond a reasonable doubt, the conduct that the indictment ascribed to defendants in connection with the alleged bribery of Haitian officials to understate customs duties and sales taxes on rice shipped to Haiti to assist American Rice, Inc. in obtaining or retaining business was sufficient to constitute an offense under the FCPA. Underlying this question of sufficiency of the contents of the indictment is the preliminary task of ascertaining the scope of the FCPA, which in turn requires us to construe the statute.

Because an offense under the FCPA requires that the alleged bribery be committed for the purpose of inducing foreign officials to commit unlawful acts, the results of which will assist in obtaining or retaining business in their country, the questions before us in this appeal are (1) whether bribes to obtain illegal but favorable tax and customs treatment can ever come within the scope of the statute, and (2) if so, whether, in combination, there are minimally sufficient facts alleged in the indictment to inform the defendants regarding the nexus between, on the one hand, Haitian taxes avoided through bribery, and, on the other hand, assistance in getting or keeping some business or business opportunity in Haiti.

No one contends that the FCPA criminalizes every payment to a foreign official: It criminalizes only those payments that are intended to (1) influence a foreign official to act or make a decision in his official capacity, or (2) induce such an official to perform or refrain from performing some act in violation of his duty, or (3) secure some wrongful advantage to the payor. And even then, the FCPA criminalizes these kinds of payments only if the result they are intended to produce—their quid pro quo—will assist (or is intended to assist) the payor in efforts to get or keep some business for or with “any person.”

Stated differently, how attenuated can the linkage be between the effects of that which is sought from the foreign official in consideration of a bribe (here, tax minimization) and the briber’s goal of finding assistance or obtaining or retaining foreign business with or for some person, and still satisfy the business nexus element of the FCPA?

Invoking basic economic principles, the SEC reasoned in its amicus brief that securing reduced taxes and duties on imports through bribery enables ARI to reduce its cost of doing business, thereby giving it an “improper advantage” over actual or potential competitors, and enabling it to do more business, or remain in a market it might otherwise leave.

Section 78dd-1(b) excerpts from the statutory scope “any facilitating or expediting payment to a foreign official . . . the purpose of which is to expedite or to service the performance of a routine governmental action by a foreign official. . . .” 15 U.S.C. § 78dd-1(b).

For purposes of deciding the instant appeal, the question nevertheless remains whether the Senate, and concomitantly Congress, intended this broader statutory scope to encompass the administration of tax, customs, and other laws and regulations affecting the revenue of foreign states. To reach this conclusion, we must ask whether Congress’s remaining expressed desire to prohibit bribery aimed at getting assistance in retaining business or maintaining business opportunities was sufficiently broad to include bribes meant to affect the administration of revenue laws. When we do so, we conclude that the legislative intent was so broad.

Obviously, a commercial concern that bribes a foreign government official to award a construction, supply, or services contract violates the statute. Yet, there is little difference between this example and that of a corporation’s lawfully obtaining a contract from an honest official or agency by submitting the lowest bid, and—either before or after doing so—bribing a different government official to reduce taxes and thereby ensure that the under-bid venture is nevertheless profitable. Avoiding or lowering taxes reduces operating costs and thus increases profit margins, thereby freeing up funds that the business is otherwise legally obligated to expend. And this, in turn, enables it to take any number of actions to the disadvantage of competitors. Bribing foreign officials to lower taxes and customs duties certainly can provide an unfair advantage over competitors and thereby be of assistance to the payor in obtaining or retaining business. This demonstrates that the question [of] whether the defendants’ alleged payments constitute a violation of the FCPA truly turns on whether these bribes were intended to lower ARI’s cost of doing business in Haiti enough to have a sufficient nexus to garnering business there or to maintaining or increasing business operations that ARI already had there, so as to come within the scope of the business nexus element as Congress used it in the FCPA. Answering this fact question, then, implicates a matter of proof and thus evidence.

Given the foregoing analysis of the statute’s legislative history, we cannot hold as a matter of law that Congress meant to limit the FCPA’s applicability to cover only bribes that lead directly to the award or renewal of contracts. Instead, 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. The FCPA’s legislative history instructs that 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.

*

* 

United States v. Kay 359 F.3d 738 (5th Cir. 2004).

Reversed and remanded in favor of the United States.

Critical Thinking About The Law

Congressional intent is a guiding principle of judicial interpretation. Here the court is asked to make a judgment about the scope of legislation. It answers that question by examining the purpose of the law and the applicability of that purpose to the facts of this case.

1. What is the difference between bribery and “innocuous grease payments?”

Clue: For a payment to be innocuous, what effects would it have had to avoid?

2. What ethical norm is advanced by enforcing the statute in this case?

Clue: How is fairness affected by permitting a firm to escape some of its tax liability?

Comparative Law Corner

9.4

1.4

9.4

9.3

1.7

9.0

1.8

1.8

8.7

1.9

1.9

8.4

1.9

2.0

2.0

2.0

7.5

2.0

2.0

2.1

2.1

2.1

Least Corrupt	Most Corrupt
Denmark			9.4	Somalia		1.4
	Finland	Myanmar
	New Zealand		Iraq	1.5
	Singapore		9.3	Haiti	1.6
	Sweden	Uzbekistan		1.7
Iceland	9.2	Tonga
Netherlands		9.0	Sudan			1.8
Switzerland	Chad
	Canada		8.7	Afghanistan
Norway	Laos				1.9
	Australia	8.6	Guinea
Luxembourg		8.4	Equatorial Guinea
United Kingdom	Congo, Democratic Republic
Hong Kong	8.3	Venezuela						2.0
Austria	8.1	Turkmenistan
	Germany	7.8	Papua New Guinea
Ireland		7.5	Central African Republic
	Japan	Cambodia
	France	7.3	Bangladesh
	United States	7.2	Zimbabwe				2.1
Belgium	7.1	Tajikistan
Chile	7.0	Sierra Leone
Liberia

Corruption generally discourages foreign investment, according to data published by Transparency International in its annual Corruption Perception Index (CPI). The CPI is determined by an annual survey of businesspeople, academicians, and analysts in each of 91 countries. The CPI, in its latest published data, lists Nigeria, Uganda,

Indonesia

, Bolivia, Kenya, Cameroon, and Russia as countries most prone to corruption. Finland, Denmark, New Zealand, Iceland, Singapore, Sweden, and Canada are perceived as having the least corruption. The United States ranks seventeenth.

a

a
Corruption Perception Index, 2009, 

transparency.org

. © 2009 Transparency International EU.

When doing business with countries where corruption is rampant (e.g., a U.S. company trading oil equipment with Nigeria), it would behoove the business managers to learn what “facilitating payments” are lawful under U.S. law (FCPA), and what payments are legal under host-country laws (e.g., Nigerian statutes), if there exist such statutes. Even in countries that have statutes similar to those of the United States, it is also important to check with legal counsel to determine exceptions to host-countries’ laws (e.g., when a U.S. company is trading oil equipment with Canada). In both cases, one should not presume that either Nigerian or Canadian laws are similar with regard to “facilitating payments” (grease payments) as set out in the FCPA.

Legal Dimensions

When they venture into foreign territory, business managers have to be guided by the national legal system of their own country and that of the host country, and also by international law.

National Legal Systems

 When deciding whether to do business in a certain country, business managers are advised to learn about the legal system of that country and its potential impact in such areas as contracts, investment, and corporate law. The five major families of law are (1) common law, (2) 

Romano-Germanic

civil law, (3)

Islamic law

, (4) socialist law, and (5)

Hindu law

(

Table 8-1

).

The common-law family is most familiar to companies doing business in the United States, England, and 26 former British colonies. The source of law is primarily case law, and decisions rely heavily on case precedents. As statutory law has become more prominent in common-law countries, the courts’ interpretation of laws made by legislative bodies and of regulations set forth by administrative agencies has substantially increased the body of common law.

Countries that follow the Romano-Germanic civil law (e.g., France, Germany, and Sweden) organize their legal systems around legal codes rather than around cases, regulations, and precedents, as do common-law countries. Thus, judges in civil-law countries of Europe, Latin America, and Asia resolve disputes primarily by reference to general provisions of codes and secondarily by reference to statutes passed by legislative bodies. As the body of written opinions in civil-law countries grows, and as they adopt computer-based case and statutory systems such as Westlaw and Lexis, however, the highest courts in these countries are taking greater note of case law in their decisions. Civil-law systems tend to put great emphasis on private law, that is, law that governs relationships between individuals and corporations or between individuals. Examples are the law of obligations, which includes common-law contracts, torts, and creditor–debtor relationships. In contrast to common-law systems, civil-law systems have an inferior public law: This is a law that governs the relationships between individuals and the state. In fact, their jurists are not extensively trained in such areas as criminal, administrative, and labor law.

1

1 

See R. Davids and J. Brierly, Major Legal Systems in the World Today (Free Press, 1988) p. 437, and Schaffer, Richard, Augusti, Filiberio, and Dhooge, Lucien, International Business Law and Its Environment (Cengage Learning, 8th edition, 2015) p. 47.

More than 1.3 billion Muslims in approximately 30 countries that are predominantly Muslim, as well as many more Muslims living in countries where Islam is a minority religion, are governed by Islamic law.

2

 In many countries,

2 

Id. at 437–38; Id. at 49.

Table 8-1 Families of Law

Family	Characteristics
Common law	Primary reliance is on case law and precedent instead of statutory law. Courts can declare statutory law unconstitutional.
Romano-Germanic	Primary reliance is on codes and statutory law rather than case law.
Civil law	In general, the high court cannot declare laws of parliament unconstitutional (an exception is the German Constitutional Court).
Islamic law	Derived from the Shari’a, a code of rules designed to govern the daily lives of all Muslims.
Socialist law	Based on the teachings of Karl Marx. No private property is recognized. Law encourages the collectivization of property and the means of production and seeks to guarantee national security. According to classical Marxist theory, both the law and the state will fade away as people are better educated to socialism and advance toward the ultimate stage of pure communism.
Hindu law	Derived from the Sastras. Hindu law governs the behavior of people in each caste (hereditary categories that restrict members’ occupations and social associations). Primarily concerned with family matters and succession. Has been codified into India’s national legal system.

Islamic law, as encoded in the Shari’a, exists alongside the secular law. In nations that have adopted Islamic law as their dominant legal system (e.g., Saudi Arabia), citizens must obey the Shari’a, and anyone who transgresses its rules is punished by a court. International business transactions are affected in many ways by Islamic law. For example, earning interest on money is forbidden (however, Islamic banks have found a way to work around this stricture: in lieu of paying interest on accounts, they pay each depositor a share of the profits made by the bank).

Socialist law systems are based on the teachings of Karl Marx and Vladimir Lenin (who was, incidentally, a lawyer). Right after the Bolshevik Revolution of 1917 in Russia, the Czarist legal system, which was based on the Romano-Germanic civil law, was replaced by a legal system consisting of People’s Courts staffed by members of the Communist Party and peasant workers. By the early 1930s, this system had been replaced by a formal legal system with civil and criminal codes that has lasted to this day. The major goals of the Soviet legal system were to (1) encourage collectivization of the economy; (2) educate the masses as to the wisdom of socialist law; and (3) maintain national security.

3

 Most property belonged to the state, particularly industrial and agricultural property. Personal (not private) property existed, but it could be used only for the satisfaction and needs of the individual, not for profit—which was referred to as “speculation” and was in violation of socialist law. Personal ownership ended either with the death of the individual or with revocation of the legal use and enjoyment of the property. Socialist law is designed to preserve the authority of the state over agricultural land and all means of production. It is still enforced in

North Korea

,

Cuba

, and to some degree,

Libya

, but the countries that made up the old Soviet Union and the East European bloc have been moving toward Romano-Germanic civil-law systems and private-market economies in the past decade or so.

3 

Id. at 437–38; Id. at 49.

Hindu law, called Dharmasastra, is linked to the revelations of the Vedas, a collection of Indian religious songs and prayers believed to have been written between 100 BC and AD 300 or 400.

4

 It is both personal and religious. Hindus are divided into social categories called castes, and the rules governing their behavior are set out in texts known as Sastras. The primary concerns of Hindu law are family matters and property succession. Four-fifths of all Hindus live in India; most of the remaining Hindus are spread throughout Southeast Asia and Africa, with smaller numbers living in Europe and the Americas. After gaining independence from England in 1950, India codified Hindu law. Today it plays a prominent role in Indian law alongside secular statutory law, which, especially in the areas of business and trade, uses legal terminology and concepts derived from common law. Both the Indian criminal and civil codes strongly reflect the British common-law tradition.

5

 The civil code is particularly important today when issues involving outsourcing to and from India are discussed by the multinationals and governments involved.

4 

Id. at 176–79.

5 

Id. at 468–71.

Selected National Legal Systems

United States

Canada

Japan

New Zealand

Iraq

Singapore

France

Australia

Sweden

Finland

Germany

Common Law	Romano-Germanic Civil Law	Islamic Law	Socialist Law
Italy	Saudi Arabia	Russia
Kuwait	North Korea
Great Britain	Mexico	Abu Dhabi	Cuba
Poland	China
Indonesia
Bahrain
Libya
Algeria
Comment: With the growth of the Internet the classification of each nation’s law has become blurred. Further, former colonies, now independent, inherited legal principles and systems which are mixed with present-day principles, customs, and religious rites in many nations.

International Law

 The law that governs the relationships between nation-states is known as 

public international law.

 

Private international law

 governs the relationships between private parties involved in transactions across national borders. In most cases, the parties negotiate between themselves and set out their agreements in a written document. In some cases, however, nation-states subsidize the private parties or are signatories to the agreements negotiated by those parties. In such instances, the distinction between private and public international law is blurred.

public international law

Law that governs the relationships between nations.

private international law

Law that governs the relationships between private parties involved in transactions across borders.

The sources of international law can be found in (1) customs; (2) treaties between nations, particularly treaties of friendship and commerce; (3) judicial decisions of international courts, such as the International Court of Justice; (4) decisions of national and regional courts, such as the U.S. Supreme Court, the London Commercial Court, and the European Court of Justice; (5) scholarly writings; and (6) international organizations. These sources are discussed throughout this text.

Applying the Law to the Facts . . .

Let’s say that Sandra, a resident of Detroit, Michigan, is selling a car to Brianna, who lives in Detroit but is a citizen of The Bahamas. The two women draft and sign a contract for the sale of the vehicle. However, Brianna later finds out Sandra lied about the car and it was defective. Brianna wants to sue Sandra. What kind of international law would govern the conflict of the individuals from the two countries?

International business law includes laws governing (1) exit visas and work permits; (2) tax and antitrust matters and contracts; (3) patents, trademarks, and copyrights; and (4) bilateral treaties of commerce and friendship between nations and multilateral treaties of commerce such as the

North American Free Trade Agreement

(NAFTA), the

European Union (EU)

, and the

World Trade Organization (WTO)

. All are explored later in this chapter.

The U.S. Constitution grants the U.S. president the power to enter into treaties, with the advice and consent of the U.S. Senate (two-thirds must concur). The Constitution prohibits a state from entering into “any Treaty, Alliance or Confederation.”

6

 The U.S. Supreme Court, however, has allowed the states to enter into treaties that “do not encroach upon or impair the supremacy of the United States.”

7

 The states’ power to enter into treaties is very limited, as indicated by the following case. This issue has gained some significance in today’s world because states of the United States are presently seeking to enter into trade and other agreements with other countries, independent of the federal government.

6 

U.S. CONST. ART 1, § 10.

7 

Virginia v. Tennessee, 148 U.S. 503, 518 (1893).

 Case 8-2 Crosby v. National Foreign Trade Council

Supreme Court of the United States

530 U.S. 363 (2000)

In 1996, the Commonwealth of Massachusetts passed a law barring governmental entities in Massachusetts from buying goods or services from companies doing business with Burma (Myanmar). Subsequently, the U.S. Congress enacted federal legislation imposing mandatory and conditional sanctions on Burma. The Massachusetts law was inconsistent with the new federal legislation. The National Foreign Trade Council sued on behalf of its several members, claiming that the Massachusetts law unconstitutionally infringed on the federal foreign-affairs power, violated the Foreign Commerce Clause of the U.S. Constitution, and was preempted by the subsequent federal legislation. The district and appeals courts ruled in favor of the council, and the Commonwealth appealed.

Justice Souter

The Massachusetts law is preempted, and its application is unconstitutional under the Supremacy Clause of the U.S. Constitution. State law must yield to a congressional act if Congress intends to occupy the field, or to the extent of any conflict with a federal statute. This is the case even where the relevant congressional act lacks an express preemption provision. This Court will find preemption where it is impossible for a private party to comply with both state and federal law and where the state law is an obstacle to the accomplishment and execution of Congress’s full purposes and objectives. In this case, the state act is an obstacle to the federal act’s delegation of discretion to the president of the United States to control economic sanctions against Burma. Within the sphere defined by Congress, the statute has given the President as much discretion to exercise economic leverage against Burma, with an eye toward national security, as law permits. It is implausible to think that Congress would have gone to such lengths to empower the President had it been willing to compromise his effectiveness by allowing state or local ordinances to blunt the consequences of his actions—exactly the effect of the state act.

In addition, the Massachusetts law interferes with Congress’s intention to limit economic pressure against the Burmese Government to a specific range. . . . Finally, the Massachusetts law conflicts with the President’s authority to speak for the United States among the world’s nations to develop a comprehensive, multilateral Burma strategy. In this respect, the state act undermines the President’s capacity for effective diplomacy.
*

* 
Crosby v. National Foreign Trade Council, Supreme Court of the United States 530 U.S. 363 (2000).

The Court affirmed the lower courts in favor of the defendant, National Foreign Trade Council.

Methods of Engaging in International Business

For purposes of this chapter, methods of engaging in international business are classified as (1) trade, (2) international licensing and franchising, and (3) foreign direct investment.

Trade

We define 

international trade

 generally as exporting goods and services from a country and importing the same into a country. There are two traditional theories of trade relationships. The theory of absolute advantage, which is the older theory, states that an individual nation should concentrate on exporting the goods that it can produce most efficiently. For example, Sri Lanka (formerly Ceylon) produces tea more efficiently than most countries can, and thus any surplus in Sri Lanka’s tea production should be exported to countries that produce tea less efficiently. The theory of comparative advantage arose out of the realization that a country did not have to have an absolute advantage in producing a good in order to export it efficiently; rather, it would contribute to global efficiency if it produced specialized products simply more efficiently than others did.

international trade

The export of goods and services from a country, and the import of goods and services into a country.

To illustrate this concept, let’s assume that the best attorney in a small town is also the best legal secretary. Because this person can make more money as an attorney, it would be more efficient for her to devote her energy to working as a lawyer and to hire a legal secretary. Similarly, let’s assume that the United States can produce both wheat and tea more efficiently than Sri Lanka can. Thus, the United States has an absolute advantage in its trade with Sri Lanka. Let us further assume that U.S. wheat production is comparatively greater than U.S. tea production vis-à-vis Sri Lanka. That is, by using the same amount of resources, the United States can produce two-and-a-half times as much wheat but only twice as much tea as Sri Lanka. The United States then has a comparative advantage in wheat over tea.

8

8 

J. Daniels, L. Radebaugh, and D. Sullivan, International Business: Environments and Operations (10th ed.) 148, 149 (Upper Saddle River, NJ: Pearson Prentice Hall, 2004).

In this simplified example, we made several assumptions: that only two countries and two commodities were involved; that transport costs in the two countries were about the same; that efficiency was the sole objective; and that political factors were not significant. In international trade, things are far more complex. Many nations and innumerable products are involved, and political factors are often more potent than economic considerations.

Trade is generally considered to be the least risky means of doing international business, because it demands little involvement with a foreign buyer or seller. For small and middle-sized firms, the first step toward involvement in international business is generally to hire an export management company, which

Linking Law And Business Global Business

Your management class may have discussed the growing trend of globalization. One level of an organization’s involvement in the international arena is the multinational corporation. There are three basic types of employees in multinational corporations: (1) expatriates—employees living and working in a country where they are not citizens; (2) host-country nationals—employees who live and work in a country where the international organization is headquartered; (3) third-country nationals—employees who are expatriates in a country (working in one country and having citizenship in another), while the international organization is located in another country. Typically, organizations with a global focus employ workers from all three categories. The use of host-country nationals, however, is increasing, considering the cost of training and relocating expatriates and third-country nationals. By hiring more host-country nationals, managers may spend less time and money training employees to adapt to new cultures, languages, and laws in foreign countries. In addition, managers may avoid potential problems related to sending employees to work in countries where they do not have citizenship or understand the culture; thus, managers may still obtain organizational objectives through cheaper and respectable means by hiring a greater number of host-country nationals.

Source: S. Certo, Modern Management (Upper Saddle River, NJ: Prentice Hall, 2000), pp. 78, 84–85.

is a company licensed to operate as the representative of many manufacturers with exportable products. These management companies are privately owned by citizens of various nation-states and have long-standing links to importers in many countries. They provide exporting firms with market research, identify potential buyers, and assist the firms in negotiating contracts.

Export trading companies, which are governed by the Export Trading Act in the United States, comprise those manufacturers and banks that either buy the products of a small business and resell them in another country or sell products of several companies on a commission basis. Small- and medium-sized exporting companies may also choose to retain foreign distributors, which purchase imported goods at a discount and resell them in the foreign or host country. Once a company has had some experience selling in other countries, it may decide to retain a foreign sales representative. Sales representatives differ from foreign distributors in that they do not take title to the goods being exported. Rather, they usually maintain a principal–agent relationship with the exporter.

International Licensing and Franchising

International licensing

 is a contractual agreement by which a company (licensor) makes its trade secrets, trademarks, patents, or copyrights (intellectual property) available to a foreign individual or company (licensee) in return either for royalties or for other compensation based on the volume of goods sold or a lump sum. All licensing agreements are subject to restrictions of the host country, which may include demands that its nationals be trained for management positions in the licensee company, that the host government receive a percentage of the gross profits, and that licensor technology be made available to all host-country nationals. Licensing agreements may differ vastly from country to country.

international licensing

Contractual agreements by which a company (licensor) makes its intellectual property available to a foreign individual or company (licensee) for payment.

In the following case, the court was asked to resolve a conflict between two licensees of exclusive distribution rights to Russian films in the United States.

 Case 8-3 Russian Entertainment Wholesale, Inc. v. Close-Up International, Inc.

787 F. Supp. 2d 392 (2011) United States District Court (E.D.N.Y.)

Two Russian film studios (the studios) granted rights to produce and distribute DVD versions of their films to multiple licensees. Each licensee received different limited exclusive rights. Krupny Plan, which could distribute the films only in the original Russian language, sublicensed its rights to the films for home use in the United States and Canada to Close-Up, a New York corporation. Ruscico could distribute multilingual versions of the same films that were dubbed or subtitled and sublicensed its rights to its distributor in the United States, Image. At the time of licensing, none of the parties considered that a viewer of the subtitled films could simply turn off the subtitles and hear the film in any of several languages, including Russian. None of the agreements had a requirement that the films prevent the disabling of subtitles. Close-Up brought this action against Ruscico and Image for damages from copyright infringement, claiming that it is the “exclusive” U.S. licensee of the Russian-language only versions of the films. The federal district court held for the defendants, and Close-Up appealed.

Judge Cogan

The Copyright Act establishes that the “legal or beneficial owner of an exclusive right under a copy-right” may bring suit for infringement under the act [citations omitted]. However, when this provision is invoked by an exclusive licensee, the licensee may seek relief from infringement only for the rights that the licensee has been exclusively licensed by the copyright holder. Plaintiff has shown that . . . it was the legal and beneficial licensee of the narrow right to reproduce and distribute Russian-language-only versions of the subject works. Therefore, even if plaintiff had a valid sublicense, plaintiff would still only have standing to sue for infringement of the narrow right to reproduce and distribute Russian-language-only DVDs. . . .

The evidence presented at trial proves that [the studios] elected to grant a “Russian language only” right to one licensee, and a separate “multilingual” right to another. The rights-holders did not consider sales of the multilingual DVDs manufactured by [the defendants] to violate the “Russian language only” license separately given to Krupny Plan. Instead, they considered the multilingual DVDs to be a distinct line of products, geared towards the separate non-Russian–speaking market.

Plaintiff has failed to put forth any evidence that defendants ever produced or distributed works that infringed plaintiff’s limited rights in Russian-language–only DVDs . . . Instead, the evidence shows that all of the DVDs produced and distributed by defendants were multilingual DVDs, which [the studios] viewed as being distinct from the Russian-language-only DVDs that they had authorized Krupny Plan to reproduce and distribute. Plaintiff thus has failed to make out a claim for copyright infringement against any of the defendants.

Because there is no evidence that defendants reproduced or distributed DVD copies of the [films] that did not contain subtitles or dubbing in foreign languages, defendants’ conduct was entirely within the scope of their rights . . .

Plaintiff next argues that paragraph 1.2.1 [of defendants’ license], which states that “[r]eproduction of the Films in the original language without the accompaniment of the picture by sound and/or subtitles in a foreign language is a violation of the present Agreement,” should be interpreted to mean that production of DVDs that could be watched in Russian without subtitles or dubbing was a violation of the agreement. However, plaintiff reads too much into this provision, which explicitly states that its purpose was to ensure that the DVDs produced by [the defendants] would be “multilingual versions.” In this context, it is clear that paragraph 1.2.1 simply forbade [the defendants] from producing DVD copies . . . that did not include foreign subtitles or dubbing accompanying the films. Because all of the DVDs produced by defendants were multilingual versions that included subtitles in numerous foreign languages, defendants did not violate this provision of the agreement by producing DVDs that did not contain a disabling feature.
*

* 
Russian Entertainment Wholesale, Inc. v. Close-Up International, Inc. 787 F. Supp. 2d 392 (2011) United States District Court (E.D.N.Y.).

The district court’s opinion was affirmed in Russian Entertainment Wholesale, Inc. v. Close-Up International, Inc., 482 Fed. Appx. 602 (2d Cir. 2012).

International franchising permits a licensee of a trademark to market the licensor’s goods or services in a particular nation (e.g., Kentucky Fried Chicken franchises in China). Often companies franchise their trademark to avoid a nation-state’s restrictions on foreign direct investment. Also, political instability is less likely to be a threat to investment when a local franchisee is running the business. Companies considering entering into an international franchise agreement should investigate bilateral treaties of friendship and commerce between the franchisor’s nation and the franchisee’s nation, as well as the business laws of the franchisee country.

international franchising

Contractual agreement whereby a company (licensor) permits another company (licensee) to market its trademarked goods or services in a particular nation.

In some instances, licensing and franchising negotiations are tense and drawn out because businesses in many industrialized nations are intent on protecting their intellectual property against “piracy” or are adamant about getting assurances that franchising agreements will be honored. These are major and legitimate concerns. For example, between 1994 and 1999, the United States threatened to impose sanctions against China because of that nation’s sale of pirated U.S. goods and its failure to comply with international franchising requirements. A series of last-minute agreements encouraged by Chinese and U.S. businesses averted the sanctions, which would have proved expensive for private and public parties in both countries. By the year 2000, Congress and the president of the United States granted normal trade relations with China and left open the opportunity for the latter to join the WTO.

9

 In June 2001, with a China–U.S. agreement on agriculture, a major barrier to entrance was overcome.

9 

See “Backers Hope China Pact Will Promote Reform,” USA Today 10 (Sept. 20, 2000).

In November 2001, China and Taiwan entered the WTO after considerable negotiations between the Western nations over many issues. For example, at China’s insistence, all membership documents refer to China as the People’s Republic of China, whereas Taiwan is referred to as the Separate Customs Territory of Taiwan, Penghu, Kinmen, and Matsu. (The latter three islands are under the control of Taiwan.) Taiwan is not recognized as an independent nation by many, but as a territory belonging to the mainland. (See 

Chapter 25

 for a discussion of franchising.)

Foreign Direct Investment

Direct investment in foreign nations is usually undertaken only by established multinational corporations. Foreign direct investment may take one of two forms: The multinational either creates a wholly or partially owned and controlled 

foreign subsidiary

 in the host country, or enters into a joint venture with an individual, corporation, or government agency of the host country. In both cases, the risk for the investing company is greater than the risk in international trade and international franchising and licensing, because serious amounts of capital are flowing to the host country that are subject to its government’s restrictions and its domestic law.

Large multinationals choose to create foreign subsidiaries for several reasons: (1) to expand their foreign markets; (2) to acquire foreign resources, including raw materials; (3) to improve their production efficiency; (4) to acquire knowledge; and (5) to be closer to their customers and competitors. Rarely do all these reasons pertain in a single instance. For example, U.S. companies have set up foreign subsidiaries in Mexico, Western Europe, Brazil, and India for quite different reasons. Mexico provided cheap labor and a location close to customers and suppliers for U.S. automobile manufacturers. In the case of Western Europe, the impetus was both a threat and an opportunity. The member nations of the EU have been moving to eliminate all trade barriers among themselves, but at the same time imposing stiffer tariffs on goods and services imported from non-EU countries. U.S. companies have been rushing to establish foreign subsidiaries in EU countries, not only to avoid being shut out of this huge and lucrative market, but also to expand sales among the EU’s approximately 380 million people. Brazil is not only the largest potential market in Latin America, but it also offers low labor and transportation costs, making it ideal for U.S. automakers desiring to export to neighboring Latin American countries.

Union Carbide, Inc., a producer of chemicals and plastics, decided to establish a subsidiary in India, where cheap labor (including highly skilled chemists and engineers) and low-cost transportation enabled the parent company to produce various materials cheaply and thus boost its bottom line. The Indian subsidiary turned out to be a very expensive investment for Union Carbide after the Bhopal disaster. The civil suit that resulted illustrates an issue that is often overlooked by managers of multinationals when setting up subsidiaries in foreign nation-states: Should a parent corporation be held liable for the activities of its foreign subsidiary? Although the case presented here is framed in a jurisdictional context (whether a U.S. court or an Indian court should hear the suit), bear in mind the issue of corporate parent liability as you read it.

 Case 8-4 In re Union Carbide Corp. Gas Plant Disaster v. Union Carbide Corp.

United States Court of Appeals 809 F.2d 195 (2d Cir. 1987)

The Government of India (GOI) and several private class action plaintiffs (Indian citizens) sued Union Carbide India Limited (UCIL) and the parent corporation, Union Carbide Corporation (UCC), for more than $1 billion after a disaster at a chemical plant operated by UCIL in 1984. There was a leak of the lethal gas methyl isocyanate from the plant on the night of December 2, 1984. The deadly chemicals were blown by wind over the adjacent city of Bhopal, resulting in the deaths of more than 2,000 persons and the injury of more than another 200,000 persons. UCIL is incorporated under the laws of India; 50.9 percent of the stock is owned by UCC, 22 percent is owned or controlled by the government of India, and the balance is owned by 23,500 Indian citizens. The federal district court (Judge Keenan) granted UCC’s motion to dismiss the plaintiffs’ action on the ground that Indian courts, not U.S. courts, were the appropriate forum for the suit. The plaintiffs appealed this decision.

Judge Mansfield

As the district court found, the record shows that the private interests of the respective parties weigh heavily in favor of dismissal on grounds of forum non conveniens. The many witnesses and sources of proof are almost entirely located in India, where the accident occurred, and could not be compelled to appear for trial in the United States. The Bhopal plant at the time of the accident was operated by some 193 Indian nationals, including the managers of seven operating units employed by the Agricultural Products Division of UCIL, who reported to Indian Works Managers in Bhopal. The plant was maintained by seven functional departments employing over 200 more Indian nationals. UCIL kept daily, weekly, and monthly records of plant operations and records of maintenance, as well as records of the plant’s Quality Control, Purchasing, and Stores branches, all operated by Indian employees. The great majority of documents bearing on the design, safety, start-up, and operation of the plant, as well as the safety training of the plant’s employees, is located in India. Proof to be offered at trial would be derived from interviews of these witnesses in India and study of the records located there to determine whether the accident was caused by negligence on the part of the management or employees in the operation of the plant, by fault in its design, or by sabotage. In short, India has greater ease of access to the proof than does the United States.

The plaintiffs seek to prove that the accident was caused by negligence on the part of UCC in originally contributing to the design of the plant and its provision for storage of excessive amounts of the gas at the plant. As Judge Keenan found, however, UCC’s participation was limited and its involvement in plant operations terminated long before the accident. Under 1973 agreements negotiated at arm’s length with UCIL, UCC did provide a summary “process design package” for construction of the plant and the services of some of its technicians to monitor the progress of UCIL in detailing the design and erecting the plant. However, the UOI controlled the terms of the agreements and precluded UCC from exercising any authority to “detail design, erect and commission the plant,” which was done independently over the period from 1972 to 1980 by UCIL process design engineers who supervised, among many others, some 55 to 60 Indian engineers employed by the Bombay engineering firm of Humphreys and Glasgow. The preliminary process design information furnished by UCC could not have been used to construct the plant. Construction required the detailed process design and engineering data prepared by hundreds of Indian engineers, process designers, and subcontractors. During the ten years spent constructing the plant, the design and configuration underwent many changes.

In short, the plant has been constructed and managed by Indians in India. No Americans were employed at the plant at the time of the accident. In the five years from 1980 to 1984, although more than 1,000 Indians were employed at the plant, only one American was employed there and he left in 1982. No Americans visited the plant for more than one year prior to the accident, and during the five-year period before the accident the communications between the plant and the United States were almost nonexistent.

The vast majority of material witnesses and documentary proof bearing on causation of and liability for the accident is located in India, not the United States, and would be more accessible to an Indian court than to a United States court. The records are almost entirely in Hindi or other Indian languages, understandable to an Indian court without translation. The witnesses for the most part do not speak English but Indian languages understood by an Indian court but not by an American court. These witnesses could be required to appear in an Indian court but not in a court of the United States. India’s interest is increased by the fact that it has for years treated UCIL as an Indian national, subjecting it to intensive regulations and governmental supervision of the construction, development, and operation of the Bhopal plant, its emissions, water and air pollution, and safety precautions. Numerous Indian government officials have regularly conducted on-site inspections of the plant and approved its machinery and equipment, including its facilities for storage of the lethal methyl isocyanate gas that escaped and caused the disaster giving rise to the claims. Thus India has considered the plant to be an Indian one and the disaster to be an Indian problem. It therefore has a deep interest in ensuring compliance with its safety standards.
*

* 
In re Union Carbide Corp. Gas Plant Disaster v. Union Carbide Corp., United States Court of Appeals 809 F.2d 195 (2d Cir. 1987).

Affirmed in favor of Defendant, Union Carbide.

Critical Thinking About The Law

Please refer to 

Case 8-4

 and consider the following questions:

1. Highlight the importance of facts in shaping a judicial opinion by writing an imaginary letter that, had it been introduced as evidence, would have greatly distressed Union Carbide Corporation (UCC).

Clue: Review the first part of the decision, in which Judge Mansfield discussed the extent of UCC’s involvement in the plant where the accident occurred. What facts would counter his statement that the parent company had only “limited” involvement?

2. Suppose a U.S. plant exploded, resulting in extensive deaths in the United States. Further, suppose that all the engineers who built the plant wrote and spoke German only. Could Judge Mansfield’s decision be used as an analogy to seek dismissal of a negligence suit against the owners of the plant?

Clue: Review the discussion of the use of legal analogies in

 Chapter 1

 and apply what you read to this question.

3. What additional information, were it to surface, would strengthen Union Carbide’s request for a dismissal of the case described?

Clue: Notice the wide assortment of facts that Judge Mansfield organized to support his decision.

Comment:

The Bhopal victims filed their claims in U.S. courts against UCC because the parent company had more money than the subsidiary (UCIL). Also, suing the parent company made it more likely that the case would be heard in U.S. courts, which are considered to be far better forums for winning damages in personal injury actions than Indian courts are. After the lawsuits were removed to an Indian court, UCC agreed to pay $470 million to the Bhopal disaster victims. Union Carbide’s stock substantially decreased in value, and UCC was threatened by a takeover (though the attempt was thwarted in 1985). More than half of UCC was subsequently sold or spun off, including the Indian subsidiary (UCIL). In 1989, the Indian Supreme Court ordered UCC to pay $470 million to compensate Bhopal victims; criminal charges against the company and its officials were dropped. About 12,000 people worked for UCC in 1995, in contrast to the 110,000 employed by the company a decade earlier. In 2001, Dow Chemical acquired Union Carbide (see Wall Street Journal, August 12, 2009, p. B-10).

On June 7, 2010, a district court in Bhopal found seven former Union Carbide India, Ltd. officials guilty of “causing death by negligence” for a gas leak at the plant that killed approximately 3,000 people some 25 years before. This was the first criminal conviction. All convicted were Indian citizens. They were sentenced to 2 years in prison and fined 100,000 rupees ($2,130). The former Union Carbide subsidiary was convicted of the same charges and fined 5,000 rupees. All seven defendants were freed on bail. As of June, 2010, no cleanup has taken place in the affected area (see Lydia Polgreen and Hari Kumar, “8 Former Executives Guilty in ‘84 Bhopal Chemical Leak,” New York Times, June 8, 2010, p. A-8; T. Lahiri, “Court Convicts Seven in Bhopal Gas Leak,” Wall Street Journal, June 8, 2010, p. A-11).

Joint ventures

, which involve a relationship between two or more corporations or between a foreign multinational and an agency of a host-country government or a host-country national, are usually set up for a specific undertaking over a limited period of time. Many developing countries (such as China) allow foreign investment only in the form of a joint venture between host-country nationals and the multinationals. Recently, three-way joint ventures have been established among United States–based multinationals (e.g., automobile companies such as Chrysler and General Motors), Japanese multinationals (e.g., Mitsubishi and Honda), and Chinese government agencies and Chinese nationals. Joint ventures are also used in host countries with fewer restrictions on foreign investment, often to spread the risk or to amass required investment sums that are too large for one corporation to raise by itself. Some of these joint ventures are private associations, with no host-government involvement.

foreign subsidiary

A company that is wholly or partially owned and controlled in a company based in another country.

Risks of Engaging in International Business

Unlike doing business in one’s own country, the “rules of the game” are not always clear when engaging in business in a foreign country, particularly in what we have classified as middle- and low-income economies. Here we set out three primary risks that managers engaged in international business may face: (1) expropriation of private property by the host foreign nation, (2) the application of the sovereign immunity doctrine and the act-of-state doctrine to disputes between foreign states and U.S. firms, and (3) export and import controls.

Expropriation of Private Property

Expropriation

—the taking of private property by a host-country government for either political or economic reasons—is one of the greatest risks companies take when they engage in international business. Thus, it is essential for business managers to investigate the recent behavior of host-country government officials, particularly in countries that are moving from a centrally planned economy toward one that is market oriented (e.g., Russia and Eastern European nations).

joint venture

Relationship between two or more persons or corporations or an association between a foreign multinational and an agency of the host-country government or a host-country national set up for a business undertaking for a limited time period.

One method of limiting risk in politically unstable countries is to concentrate on exports and imports (trade) and licensing and franchising. Another method is to take advantage of the low-cost insurance against expropriation offered by the Overseas Private Investment Corporation (OPIC). If a U.S. plant or other project is insured by OPIC and is expropriated, the U.S. firm receives compensation in return for assigning to OPIC the firm’s claim against the host-country government.

Bilateral investment treaties (BITs)

, which are negotiated between two governments, obligate the host government to extend fair and nondiscriminatory treatment to investors from the other country. A BIT normally also includes a promise of prompt, adequate, and effective compensation in the event of expropriation or nationalization.

expropriation

The taking of private property by a host-country government for political or economic reasons.

bilateral investment treaty (BIT)

Treaty between two parties to outline conditions for investment in either country.

Sovereign Immunity Doctrine

Another risk for companies engaged in international business is the 

sovereign immunity doctrine

, which allows a government expropriating foreign-owned private property to claim that it is immune from the jurisdiction of courts in the owner’s country because it is a government rather than a private-sector entity. In these cases, the company whose property was expropriated often receives nothing because it cannot press its claims in its own country’s courts, and courts in the host country are seldom amenable to such claims.

sovereign immunity doctrine

States that a foreign-owned private property that has been expropriated is immune from the jurisdiction of courts in the owner’s country.

The sovereign immunity doctrine has been a highly controversial issue between the United States and certain foreign governments of developing nations. To give some protection to foreign businesses without impinging on the legitimate rights of other governments, the U.S. Congress in 1976 enacted the Foreign Sovereign Immunities Act (FSIA), which shields foreign governments from U.S. judicial review of their public, but not their private, acts. The FSIA grants foreign nations immunity from judicial review by U.S. courts unless they meet one of the FSIA’s private exceptions. One such exception is the foreign government’s involvement in “commercial activity.” 

Case 8-5

 clarifies the U.S. Supreme Court’s definition of “commercial activity” under the FSIA. Note how the Court emphasizes the nature of the Nigerian government’s action by asking whether it is the type of action a private party would engage in.

 Case 8-5 Keller v. Central Bank of Nigeria

United States Court of Appeals 277 F.3d 811 (6th Cir. 2002)

Prince Arthur Ossai, a government official in Nigeria, entered into a contract with Henry Keller (plaintiff), a sales representative for H.K. Enterprises, Inc., a Michigan-based manufacturer of medical equipment. They agreed that, among other things, Ossai would have an exclusive distribution right to sell H.K. products in Nigeria, which would buy $4.1 million of H.K. equipment for $6.63 million, plus a $7.65 million “licensing fee.” Before the deal closed, though, Ossai demanded that $25.5 million on deposit in the Central Bank of Nigeria (CBN) be transferred into an account set up by Keller. CBN employees charged Keller $28,950 in fees for the transaction, but the funds were never transferred. Keller and H.K. filed a suit in a federal district court against the CBN and others, asserting in part a claim under the Racketeer Influenced and Corrupt Organizations Act (RICO). The defendants filed a motion to dismiss under the Foreign Sovereign Immunities Act. The court denied the motion, concluding that the claim fell within the FSIA’s “commercial activity” exception. The defendants appealed to the U.S. Court of Appeals for the Sixth Circuit.

Justice Norris

[The defendants] claim that the illegality of the deal alleged precludes a finding that it is a commercial activity. The FSIA defines “commercial activity” as “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. [W]hen a foreign government acts, not as regulator of a market, but in the manner of a private player within it, the foreign sovereign’s actions are commercial within the meaning of the FSIA.

In the instant case, the conduct was a deal to license and sell medical equipment, a type of activity done by private parties and not a “market regulator” function. The district court correctly concluded that this was a commercial activity, and that any fraud and bribery involved did not render the plan non-commercial.

Defendants claim that plaintiffs cannot establish another element of the commercial activity exception, namely, that there was a direct effect in the United States. [A]n effect is “direct” if it follows as an immediate consequence of the defendant’s activity.

In this case, defendants agreed to pay but failed to transmit the promised funds to an account in a Cleveland bank. Other courts have found a direct effect when a defendant agrees to pay funds to an account in the United States and then fails to do so. The district court in the instant case correctly concluded, in accord with the other [courts], that defendant’s failure to pay promised funds to a Cleveland account constituted a direct effect in the United States.
*

* 
Keller v. Central Bank of Nigeria., United States Court of Appeals 277 F.3d 811 (6th Cir. 2002).

Affirmed for the Plaintiff.

Critical Thinking About The Law

Context plays a vital role in any legal decision. The existence or nonexistence of certain events directly affects the court’s verdict. In 
Case 8-5
, the court applies the strictures of the FSIA to the specific facts of the case. If certain facts exist, the federal statute protects the plaintiff, and the court should appropriately reject the defendant’s motion to dismiss. Otherwise, the CBN is immune, and the statute does not protect the plaintiff.

Understanding the facts is the starting point for legal analysis. The following questions encourage you to consider the significance of the facts in 
Case 8-5
.

1. What facts are critical in the court’s ruling in favor of the plaintiff?

Clue: Reread the introductory paragraph.

2. Look at the facts you found. To illustrate the importance of context, which fact, if it had not been included in the case, might have resulted in the court’s granting the defendant’s motion to dismiss?

Clue: Find the elements of the federal statute that the judge discusses and use these elements as a guide to highlight the most significant facts.

Act-of-State Doctrine

The 

act-of-state doctrine

 holds that each sovereign nation is bound to respect the independence of every other sovereign state and that the courts of one nation will not sit in judgment on the acts of the courts of another nation done within that nation’s own sovereign territory. This doctrine, together with the sovereign immunity doctrine, substantially increases the risk of doing business in a foreign country. Like the sovereign immunity doctrine, the act-of-state doctrine includes some court-ordered exceptions, such as when the foreign government is acting in a commercial capacity or when it seeks to repudiate a commercial obligation.

act-of-state doctrine

A state that each nation is bound to respect the independence of another and the courts of one nation will not sit in judgment on the acts of the courts of another nation.

Congress made it clear in 1964 that the act-of-state doctrine shall not be applied in cases in which property is confiscated in violation of international law, unless the president of the United States decides that the federal courts should apply it. As 

Case 8-6

 demonstrates, the plaintiff has the burden of proving that the doctrine should not apply—that is, the courts should sit in judgment of public acts of a foreign government, in this case, a former government.

 Case 8-6 Linde v. Arab Bank, PLC

United States Court of Appeals Second Circuit 706 F.3d 92 (2013)

Founded in 1930, Arab Bank is one of the largest financial institutions in the Middle East. Headquartered in Jordan, it serves clients in more than 500 branches in 30 countries, including branches in Australia, New York, and Switzerland. The bank is a major economic engine in Jordan and throughout the Middle East/Northern Africa, providing modern banking services and capital, and facilitating development and trade throughout the region. Victims of terrorist attacks that were committed in Israel between 1995 and 2004—during a period commonly referred to as the Second Intifada—filed a suit in a federal district court against Arab Bank, PLC, seeking damages under the Anti-Terrorism Act (ATA) and the Alien Tort Claims Act. According to plaintiffs, Arab Bank provided financial services and support to the terrorists. Over several years and despite multiple discovery orders, the bank failed to produce certain documents relevant to the case. As a result, the court issued an order imposing sanctions. Arab Bank appealed to the U.S. Court of Appeals for the Second Circuit, arguing that the order was an abuse of discretion.

Justice Carney

The Bank argues that the documents are covered by foreign bank secrecy laws such that their disclosure would subject the Bank to criminal prosecution and other penalties in several foreign jurisdictions. The sanctions order takes the form of a jury instruction that would permit—but not require—the jury to infer from the Bank’s failure to produce these documents that the Bank provided financial services to designated foreign terrorist organizations, and did so knowingly.

The District Court carefully explained its decision to impose this sanction. It noted that many of the documents that plaintiffs had already obtained tended to support the inference that Arab Bank knew that its services benefitted terrorists. According to the District Court, these documents included documents from Arab Bank’s Lebanon branch that suggested Arab Bank officials approved the transfer of funds into an account at that branch despite the fact that the transfers listed known terrorists as beneficiaries. As a consequence of Arab Bank’s nondisclosure, the court reasoned, plaintiffs would be “hard-pressed to show that these transfers were not approved by mistake, but instead are representative of numerous other transfers to terrorists.” The permissive inference instruction will, according to the District Court, “help to rectify this evidentiary imbalance.”

Arab Bank argues that the District Court’s decisions ordering production and imposing sanctions should be vacated because they offend international comity. This argument derives from the notion that the sanctions force foreign authorities either to waive enforcement of their bank secrecy laws or to enforce those laws, and in so doing create an allegedly devastating financial liabilities for the leading financial institution in their region. The Bank asserts, further, that international comity principles merit special weight here because the District Court’s decisions affect the United States’ interests in combating terrorism and pertain to a region of the world pivotal to United States foreign policy.

The [District] Court expressly noted that it had “considered the interests of the United States and the foreign jurisdictions whose foreign bank secrecy laws are at issue.”

Additionally, international comity calls for more than an examination of only some of the interests of some foreign states. Rather, the concept of international comity requires a particularized analysis of the respective interests of the foreign nation and the requesting nation. In other words, the analysis invites a weighing of all of the relevant interests of all of the nations affected by the court’s decision. The District Court recognized the legal conflict faced by Arab Bank and the comity interests implicated by the bank secrecy laws. But [the Court] also observed—and properly so—that Jordan and Lebanon have expressed a strong interest in deterring the financial support of terrorism, and that these interests have often outweighed the enforcement of bank secrecy laws, even in the view of the foreign states. Moreover, the District Court took into account the United States’ interests in the effective prosecution of civil claims under that ATA [Anti-Terrorism Act]. This type of holistic, multi-factored analysis does not so obviously offend international comity.
*

* 
Linde v. Arab Bank, PLC, United States Court of Appeals, Second Circuit, 706 F.3d 92 (2013).

The U.S. Court of Appeals for the Second Circuit affirmed the lower court’s decision and order.

Export and Import Controls

Export Controls

Export controls are usually applied by governments to militarily sensitive goods (e.g., computer hardware and software) to prevent unfriendly nations from obtaining these goods. In the United States, the Department of State, the Department of Commerce, and the

Defense

Department bear responsibility, under the Export Administration Act and the Arms Export Control Act, for authorizing the export of sensitive technology. Both criminal and administrative sanctions may be imposed on corporations and individuals who violate these laws.

Export controls often prevent U.S. companies from living up to negotiated contracts. Thus, they can damage the ability of U.S. firms to do business abroad.

Import Controls

Nations often set up import barriers to prevent foreign companies from destroying home industries. Two such controls are tariffs and quotas. For example, the United States has sought historically to protect its domestic automobile and textile industries, agriculture, and intellectual property (copyrights, patents, trademarks, and trade secrets). Intellectual property has become an extremely important U.S. export in recent years, and Washington has grown more determined than ever to prevent its being pirated. After several years of frustrating negotiations with the People’s Republic of China, the U.S. government decided to threaten imposition of 100 percent tariffs on approximately $1 billion of Chinese imports in 1995, and again in 1996 and 1997. In retaliation, the Chinese government has threatened several times to impose import controls on many U.S. goods. Washington took action only after documenting that hundreds of millions of dollars’ worth of “pirated” computer software and products (including videodiscs, law books, and movies) was being produced for sale within China and for export to Southeast Asian nations in violation of the intellectual property laws of both China and the United States, as well as international law. The documentation showed that 29 factories owned by the state of Communist Party officials were producing pirated goods. A last-minute settlement in which the Chinese government pledged to honor intellectual property rights prevented a trade war that would have had negative implications for workers in import–export industries in both countries. American consumers would also have suffered because Chinese imports would have become twice as expensive had the 100 percent tariff taken effect—though the effect on consumers would have been offset by an increase in imports of the affected goods from other foreign countries (e.g., English and Japanese bikes would have replaced Chinese bikes in demand).

Another form of import control is the imposition of antidumping duties by two U.S. agencies, the International

Trade Commission

(ITC) and the International Trade Administration (ITA). The duties are levied against foreign entities that sell the same goods at lower prices in U.S. markets than in their own in order to obtain a larger share of the U.S. market (i.e., entities that practice “dumping”).

Legal and

Economic Integration

as a Means of Encouraging International Business Activity

Table 8-2

 summarizes a number of groups that have been formed to assist businesspeople in carrying out international transactions. These groups range from the WTO (formerly the General Agreement on Tariffs and Trade), which is attempting to reduce tariff barriers worldwide, to the proposed

South American Common Market

, which would form a duty-free zone for all the nations of South America. The most ambitious organization is the EU, which is in the process of forming a Western European political and economic community with a single currency and a common external tariff barrier toward nonmembers.

Multinational corporations are learning that doing international business is much easier when they are aware of the worldwide and regional groups listed in 
Table 8-2
. We will describe three of these groups: the WTO, the EU, and NAFTA. We chose to examine these three because they represent three different philosophies and structures of legal and economic integration, not because we do not appreciate the major effects of other integrative groups outlined in the table.

The World Trade Organization

Purpose and Terms

 On January 1, 1995, the 47-year-old General Agreement on Tariffs and Trade (GATT) organization was replaced by a new umbrella group, the World Trade Organization. The WTO has the power to enforce the new trade accord that evolved out of seven rounds of GATT negotiations, with more than 140 nations participating. All 144 signatories to this accord agreed to reduce their tariffs and subsidies by an average of one-third on most goods over the next decade, agricultural tariffs and subsidies included. Economists estimated that this trade pact would result in tariff reductions totaling $744 billion over the next 10 years.

Moreover, the accord, which the WTO will supervise, prohibits member countries from placing limits on the quantity of imports (quotas). For example, Japan had to end its ban on rice imports, and the United States had to end its import quotas on peanuts, dairy products, and textiles. Furthermore, the agreement

Table 8-2 Legally and Economically Integrated Institutions

Name	Members and Purpose
World Trade Organization (WTO)	Replaced General Agreement on Tariffs and Trade (GATT) in 1995 and the most-favored- nation clause with the normal trade relations principle. Composed of 144 member nations. Goal is to get the nations of the world to commit to the trade principles of nondiscrimination and reciprocity so that, when a trade treaty is negotiated between two members, the provisions of that bilateral treaty will be extended to all WTO members. All members are obligated to harmonize their trade laws or face sanctions. The WTO, through its arbitration tribunals, is to mediate disputes and recommend sanctions.
European Union (EU)	Composed of 28 European member states. Established as the European Economic Community (later called the European Community) by the Treaty of Rome in 1957. Goal is to establish an economic “common market” by eliminating customs duties and other quantitative restrictions on the import and export of goods and services among member states. In 1986, the treaty was amended by the SEA, providing for the abolition of all customs and technical barriers between nations by December 31, 1992. In 1991, the Maastricht Summit Treaty proposed monetary union, political union, and a “social dimension” (harmonizing labor and social security regulations) among EU members, although not all aspects were approved by all members. The treaty was subsequently amended by the treaties of Amstermdam (1997), Nice (2001), and Lisbon (2007). The Treaty of Lisbon entered into force in December of 2009 and is still effective today.
North American Free Trade Agreement (NAFTA)	The United States, Canada, and Mexico are members at present; Chile has been invited to join. NAFTA seeks to eliminate barriers to the flow of goods, services, and investments among member nations over a 15-year period, starting in 1994, the year of its ratification. Unlike the EU, NAFTA is not intended to create a common market. Whereas EU states have a common tariff barrier against non-EU states, members of NAFTA maintain their own individual tariff rates for goods and services coming from non-NAFTA countries.
Organization for Economic Cooperation and Development (OECD)	This organization was established in 1951 with Western European nations including Australia, New Zealand, United States, Canada, Japan, Russia, and some Eastern European nations as associate members. The OECD’s original purpose was to promote economic growth after World War II. Today it recommends and evaluates options on environmental issues for its members and establishes guidelines for multinational corporations when operating in developed and developing countries.
European Free Trade Association (EFTA)	Founded in 1960 and originally composed of Finland, Sweden, Norway, Iceland, Liechtenstein, Switzerland, and Austria. EFTA has an intergovernmental council that negotiates treaties with the EU. Finland, Sweden, and Austria left the EFTA in 1995 and joined the EU. In the future, EFTA will have only minor significance.
Andean Common Market (ANCOM)	Composed of Bolivia, Venezuela, Colombia, Ecuador, and Peru. ANCOM seeks to integrate these nations politically and economically through a commission, the Juanta Andean Development Bank, and a Reserve Fund and a Court of Justice. Founded in 1969, achievement of its goals has been hampered by national interests.
Mercado Commun del Ser Mercosul (Mercosul)	Composed of Argentina, Brazil, Paraguay, and Uruguay. Mercosul’s purposes are to reduce tariffs, eliminate nontariff barriers among members, and establish a common external tariff. The organization was founded in 1991, and these goals were to be met by December 31, 1994. For political reasons, they have not yet been fully met.
South American Common Market	A duty-free common market made up of countries in the ANCOM and Mercosul groups, created on January 1, 1995. On that date, tariffs were ended on 95 percent of goods traded among Brazil, Argentina, Paraguay, and Uruguay. All three nations adopted common external tariffs.
Asia-Pacific Economic Corporations (APEC)	Formed in 1989. A loosely organized group of 11 developed and developing Pacific Group nations, including Japan, China, United States, Canada, and New Zealand. APEC is not a trading bloc and has no structure except for a secretariat. An underlying Trans-Pacific Partnership (TPP) represents a proposed trade deal between the United States and 11 Asian-Pacific nations. If enacted, this TPP trade deal would affect nearly 1 billion people and 65% of global trade worldwide. It is opposed by trade unions, environmentalists, and political figures in all parties.
Association of Southeast Asian Nations (ASEAN)	Formed in 1967. Composed of Indonesia, Malaysia, Vietnam, Philippines, Singapore, Thailand, and Brunei. ASEAN’s purpose is to encourage economic growth of member nations by promoting trade and industry. There have been tariff reductions among members, and ASEAN’s secretariat has represented nations vis-à-vis other regional groups such as the EU.
Gulf Cooperation Council (GCC)	Founded in 1982. Composed of Saudi Arabia, Kuwait, Bahrain, Qatar, United Arab Emirates, and Oman. The GCC’s purposes are to standardize industrial subsidies, eliminate trade barriers among members, and negotiate with other regional groups to obtain favorable treatment for GCC goods, services, and investments.

bans the practice of requiring high local content of materials for manufactured products such as cars. It also requires all signatory countries to protect patents, trademarks, copyrights, and trade secrets. (See 

Chapter 16

 for a discussion of these topics, which fall under the umbrella of intellectual property.)

General Impact

 The accord created the WTO, which consists of all nations whose governments approved and met the GATT—Uruguay Round Accord.

10

 Each member state has one vote in the Ministerial Conference, with no single nation having a veto. The conference meets at least biannually, and a general council meets as needed. The conference may amend the charter created by the pact—in some cases, by a two-thirds vote; in others, by a three-fourths vote. Changes apply to all members, even those that voted no.

10 

Uruguay Round Amendments Act, Pub. L. No. 103–465, was approved by Congress on December 8, 1994. One hundred eight states signed the final act embodying the results of the Uruguay Round of multilateral trade negotiations. Bureau of National Affairs, International Reporter 11 (Apr. 20, 1994). Sixteen more states have joined since 1994.

The WTO has been given the power to set up a powerful dispute-resolution system with three-person arbitration panels that follow a strict schedule for dispute-resolution decisions. WTO members may veto the findings of an arbitration panel. This is a matter of great concern to the United States, and it figured prominently in the House and Senate debates preceding approval of the WTO. U.S. farmers (and other groups), who had previously won decisions before GATT panels, saw these decisions vetoed by the EU countries that subsidize the production of soybeans and other agricultural products; they enthusiastically supported the new WTO process. Environmentalists and consumer groups, in contrast, feared that the WTO would overrule U.S. environmental laws and in other ways infringe on the sovereignty of the nation. To assuage these fears, the framers of the accord added a provision that allows any nation to withdraw upon six months’ notice. Congress also attached a condition to its approval that calls for the establishment of a panel of U.S. federal judges to review the WTO panels’ decisions.

Impact on Corporate Investment Decision Making

 The WTO pact makes it less risky for multinationals to source parts—that is, to have them built in cheap-labor countries and then brought back to the multinational’s home country for use in making a product (e.g., brakes for automobiles). Industries that were expected to shift quickly to buying parts from all over the world for their products include computers, telecommunications, and other high-tech manufacturing. It is anticipated that with a freer flow of goods across borders, businesses will gain increased economies of scale by building parts-manufacturing plants at a location that serves a wide market area.

Because the tariff cuts were to be introduced gradually over a six-year period and were to be finalized only after 10 years, the impact on trade was not immediate. Once the major nations ratified the WTO pact, however, companies began to make investment and employment decisions predicated on dramatic reductions in tariffs, subsidies, and other government-established deterrents to free trade.

The European Union

Purpose

 The 28-member EU grew out of the European Economic Community (later called the European Community), established by six Western European nations through the Rome Treaty of 1957. Its goals were to create a “customs union” that would do away with internal tariffs among the member states and to create a uniform external tariff to be applied to all nonmembers. The EU is thoroughly committed to achieving the free movement of goods, services, capital, and people across borders (

Exhibit 8-1

).

The EU’s ambitious plan to create an immense “common market” of 400 million people and $4 trillion worth of goods was greatly strengthened by the 1986 signing of the Single European Act (SEA), which set a deadline for economic integration of December 31, 1992, and instituted new voting requirements to make passage of EU legislation easier. A treaty that was proposed at the Maastricht Summit in 1991 was ratified in 1993. It provided for (1) monetary union through the creation of a single currency for the entire EU, (2) political union, and (3) a “social dimension” through the establishment of uniform labor and Social Security regulations. The leaders of the 12 nations that were members at the time agreed to the creation of a European Monetary Institute by 1994, a European Central Bank by 1998, and a uniform European currency unit (ECU) by 1999.

Three new members (Finland, Austria, and Sweden) joined the EU in 1994, bringing the total to 15 nations. In May 2004, 10 more nations joined the EU: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia (see 

Exhibit 8-2

). Bulgaria, Croatia, and Romania were accepted into the EU in 2007.

Structure

 The EU consists of (1) a Council of Ministers, (2) a Commission, (3) a Parliament (Assembly), (4) the European Court of Justice (with the addition of the Court of First Instance), and (5) the European Central Bank (ECB) and the European

Monetary Union

(EMU).

Exhibit 8-1 European Union and an attempt to Centralize Power

Exhibit 8-2 From 15 to 28: The EU Spreads to the East

Source: The Legal Environment of Business and On Line Commerce (5th ed.), by Henry Cheeseman (© 2007) p. 77, Ex. 5-2. Reproduced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey

1. Council of Ministers. The Council of Ministers is composed of one representative from each of the member nations. Its purposes are to coordinate the economic policies of member states and, more recently, to negotiate with nonmember states. In the past, the council generally rubber-stamped legislation proposed by the Commission, but this docility is less assured as the council begins to flex some of the authority granted it by the SEA and the Maastricht Treaty.

2. Commission. The Commission consists of 20 members who represent the EU, not national concerns. It is responsible for the EU’s relations with international organizations such as the United Nations and the WTO. Member states are apportioned voting power in the Commission on the basis of their population and economic power. The Commission elects a president from among its members. Each Commission member supervises a functional area (e.g., agriculture or competition) that may be affected by several directorates. There are 22 directorates that are run by “supranational” civil servants called director generals. In theory, the directorates serve the Commission, but in fact the director generals often heavily influence legislation as it moves through the Commission.

Key Elements of the Treaty of Maastricht

Agreement

Goals and Stumbling Blocks

Monetary Union

The European Monetary Institute was created on January 1, 1994, and started operating on January 1, 1999.

A single currency issued any day after January 1, 1999, is the goal of 25 nations that meet three standards: (1) Annual budget deficit cannot exceed the ceiling of 3 percent of gross domestic product; (2) the public debt limit for each country must not exceed 60 percent of gross domestic product; and (3) a country’s inflation rate must be lower than 2.9 percent, based on a complex formula set out in 1997.

Great Britain was allowed to opt out of the EC currency union until an unspecified date. It opposes monetary union for ideological reasons.

Denmark was also allowed to opt out pending a referendum on the issue, a constitutional requirement. The Danish government backs monetary union.

Political Union

EC jurisdiction in areas including industrial affairs, health, education, trade, environment, energy, culture, tourism, and consumer and civil protection. Member states vote to implement decisions.

Increased political cooperation under a new name—European Union. Permanent diplomatic network of senior political officials created in the EC capitals.

Great Britain rejected EC-imposed labor legislation, forcing the removal of the so-called social chapter from the treaty. It will be implemented separately by the other 14 members, officials said.

Federalism

EC leaders dropped reference to an EC “with a federal goal.” Instead, the political Union accord describes the community as “an ever-closer union in which political decisions have to be taken as near to the people as possible.”

Great Britain rejected the “federalism” concept as the embodiment of what it feels would be an encroaching EC superstate.

Foreign Affairs

EC states move toward a joint foreign policy, with most decisions requiring unanimity. Great Britain wanted the ability to opt out of any joint decision. How this provision will be interpreted by the various sides is yet to be determined.

Defense

The Western EU, a long-dormant group of nine EC states, will be revived to act as the EC’s defense body but linked to the NATO alliance. Although France and Germany supported a greater military role for the Union, Great Britain, Italy, and others did not want to see NATO’s influence diluted.

European Parliament

The 754 member EC assembly gets a modest say in shaping some EC legislation. Its new powers fall short of what the assembly had sought (i.e., an equitable sharing of the right to make EC laws with the EC governments).

Great Britain and Denmark refused to grant the assembly broader powers.

3. Parliament. The Parliament (Assembly) is made up of representatives elected from each nation-state for a term set by the nation-state. The representatives come from most of the major European political factions (Socialists, Christian Democrats, Communists, Liberals, etc.), and each of the parties in the Parliament also exists in the member states. The Parliament elects a president to preside over its deliberations. The Parliament’s general powers are to (1) serve as a consultative body to the Council, (2) refer matters affecting EU interests to the Commission or Council, (3) censure the Commission when necessary, (4) assent to trade agreements with countries outside the EU, (5) amend the EU budget, and (6) participate with the Commission in the legislative procedure.

4. European Court of Justice. The European Court of Justice performs the functions of arbiter and final decision maker in conflicts between EU law and individual member states. The national courts of member states are obligated to follow EU law and Court of Justice decisions. The Court of First Instance was established in 1989 to reduce the workload of the Court of Justice. It has jurisdiction over appeals of the Commission’s decisions on mergers and acquisitions. It also sets the penalties for price-fixing when non-EU companies are involved.

5. The European Central Bank and the European Monetary Union. The Maastricht Treaty required all member states of the EU to converge their economic and monetary policies with the goal of creating a single currency, the euro. The criteria set forth required the harmonization of budget deficits, inflation levels, and long-term interest rates, and specific levels of currency inflations to achieve exchange-rate stability. The European Monetary Union was created in January 1999. By giving up their national currencies, members of the EMU have relinquished control of their exchange rates and monetary policy to an independent European Central Bank based in Frankfurt. The primary duty of the ECB is to maintain price stability, by lowering or raising interest rates. With the exception of Denmark and Great Britain, most members of the EMU have adopted the euro.

Impact

Unity of Law

 Agricultural, environmental, and labor legislation is being made uniform throughout the member nations, with allowances and subsidies for the poorer members. The national courts of member states are now following decisions of the European Court of Justice.

Economic Integration

 The SEA and Maastricht Treaty have pushed the EU members to eliminate tariff and nontariff barriers among themselves. British and French differences over the creation of a single currency have forced the suspension of this goal.

Political Union

 The political union envisioned by the Maastricht Treaty has been an elusive goal for the EU, because member states (and their citizens) have proved more reluctant to make the necessary compromises on national sovereignty than the treaty’s architects anticipated. Nonetheless, the EU is the only regional organization that has in place the sophisticated structure required to make political union a realistic possibility.

The “Big Fat Greek” Bailout

On May 10, 2010, Euro-zone lenders (17 nations belonging to the European Union), the International Monetary Fund (IMF), and the European Central Bank decided to “bail out” the nearly bankrupt nation of Greece. They agreed to a nearly $1 trillion package of loans, guarantees, swaps, and bond purchases for use by Greece and other EU nations. The IMF contributed $318 billion. (It should be noted that the United States [taxpayer] had a role in this bailout because of its contributions to the IMF and its voting strength in that body. President Obama encouraged European leaders to act quickly. The Federal Reserve also provided credits for European banks that were lenders to Greece.) Given the existing precedents, the degree of international cooperation was surprising. As of May 2010, it seemed doubtful that the full $1 trillion would be needed, but the markets of Portugal, Spain, and Ireland, in the eyes of some, were similar to the situation in Greece.

Markets worldwide fell sharply following the bailout on May 9, 2010. Investors showed a lack of confidence in European markets and the euro. Similar to the U.S. bailout of banks and some other large business entities (insurance and automobile companies) in 2009, the EU sought to pledge support for debt markets in the Euro-zone combined with attempts to correct fiscal problems in certain countries. It may be easier to help individual banks and corporations in the United States than to bail out a sovereign country (or group of countries), having a single currency.

Why does a small country like Greece deserve a bailout, and why should it be able to shake the global financial system? Some thoughts follow:

· The problem may be larger than Greece. Many European nations, like Greece, have poor tax collection systems, and thus have problems servicing their sovereign debt. Spain, Portugal, Ireland, and Italy have similar problems. Spain may be too big to be bailed out.

· Prior to the establishment of the EU, problems with the countries of Europe would not have been as visible. If Greece had had its own currency (drachmas), it would have gone bankrupt, boosting both its exports and the cost of borrowing money, leaving it with less debt and perhaps more revenues and tax revenue to service the debt. Within the EU structure (with fixed exchange- rate systems like the euro), free-market signals are masked. Interest rates are held artificially low for reckless borrowers such as Greece, whose debt was largely held by private and state banks of Germany, France, and Spain. These nations played a role in bailing out Greece in 2010.

· The global economy may suffer deflationary effects. If enforceable austerity measures take place in countries that receive bailout money, millions of people (like residents in Greece) will end up living on less, resulting in less demand for worldwide natural resources, consumer goods, and housing components. The price of gold may initially jump as Europeans seek to protect a weakening euro.

· U.S. investors may be concerned about reduced earnings of multinationals that do business in EU countries. However, U.S. banks could gain from money that flees Europe, and U.S. consumer spending could benefit from weaker commodity prices.

Update: As of July, 2013, Greece has been on an austerity program and received bailout money from the IMF, the ECB, Germany, and indirectly from the United States. With the election of a new government in 2015, a new liberal policy seeks to bring Greece away from an austerity program. What will result in Greece and the EU is unclear.

See Kopin Tan, “Bet on the Greenback to Beat the Euro,” Barron’s, May 17, 2010, F-19.

North American Free Trade Agreement
Purpose

 The NAFTA, ratified in 1994, sought to eliminate barriers to the flow of goods, services, and investments among Canada, the United States, and Mexico over a 15-year period. NAFTA envisioned a gradual phasing-out of these barriers, with the length of the phaseout varying from industry to industry. The ultimate goal was a totally free trade zone among the three member states, with eventual inclusion of other Central and Latin American countries. So far, the only country invited to join the founding members is Chile.

Structure

 NAFTA is administered by a three-member Trade Commission, which oversees a

Secretariat

and arbitral panels.

Trade Commission

 Staffed by trade ministers from each of the three nations, the Trade Commission meets once a year and makes its decisions by consensus. It supervises the implementation of the treaty and resolves disputes over interpretation. The daily operations of NAFTA are conducted by ad hoc working groups appointed by the three governments.

Secretariat

 The permanent Secretariat is composed of national sections (departments) representing each member country. Its purposes are to provide technical support for the Trade Commission and to put together arbitral panels to resolve disputes between members.

Arbitral Panels

 The treaty has detailed arbitration provisions for settling disputes, particularly those involving dumping of goods (selling a good in a member country at a lower price than at home) and interpretations of the treaty. Although the arbitration proceedings are designed especially to resolve disputes between member nations, the treaty encourages private parties to use them as well. If they do, they must agree to abide by the arbitral panel’s decision.

Each arbitral panel has five members, chosen from a roster of 30 legal experts from NAFTA and non-NAFTA countries. Within 90 days, the panel will give the disputant countries a confidential report. Over the next 14 days, the disputants may present their comments on the report to the panel. Within 30 days of the issuance of the initial report, the arbitral panel must present its final report to the parties and to the Trade Commission, which publishes the report. The countries then have 30 days to resolve their dispute, or, if the panel has found one party wrong, the other may legally retaliate.

Impact

 NAFTA has not only brought together three North American neighbors of different historical and cultural background, but it has also provided a model of economic integration for other countries in Central and Latin America.

The Asian Infrastructure Investment Bank and Development Bank

In April of 2015, China announced the formation of two new banks, attracting 46 countries, including Great Britain, Germany, Australia, and South Korea. The United States declined membership. The bank is to begin operation by the end of 2015. The Obama administration advised the allies not to join, fearing the undermining of the World Bank led by the United States and the Asian Development Bank led by Japan. Some nations feared that China’s large state-owned enterprises will dominate and push for large infrastructure projects to the exclusion of competitors. The Chinese sought to allay such concerns, despite the fact that they will be the biggest shareholder. This is similar to the United States’ interest in the World Bank.

The interim leader of the new Asian Investment Bank indicated that it will be “lean, clean, and green.” It will seek to be corruption free. This will apparently seek to be in contrast to the World and Asian banks which many nations have criticized for their bureaucratic infrastructure. Both originated following World War II.

Technology And The Legal Environment WTO Says U.S. Ban on Online Gambling Violates International Law

The island nation of Antigua and Barbuda (plaintiff) brought a case against the United States to a WTO panel. The nation licenses 19 companies that offer sports betting and casino games (e.g., blackjack) over the Internet. It argued that the United States is in violation of international law by prohibiting cross-border gambling operations via the Internet. The plaintiff argues that the U.S. trade policy does not prohibit cross-border gambling operations.

The WTO panel ruled in favor of Antigua and Barbuda. In its decision in 2004, the panel stated that U.S. policy prohibiting online gambling operations emanating from the plaintiff nation violates international law. WTO panels do not have to give reasons for their decisions.

Some important legal, political, and cultural considerations:

1. WTO panel decisions apply only to the set of facts and case before the panel. Internet gambling using credit cards takes place in the Caribbean, Costa Rica, Great Britain, and Canada. Although this case is not a precedent, the United States should expect more legal action, as several million customers are at stake, and revenues from offshore players are important to nation-states that operate Internet casinos.

2. Present federal law in the United States makes it illegal to bet over the Internet if not allowed by individual states. Although untested as legal theory, the Justice Department is seeking to crack down on broadcasters and print media that accept advertising from offshore Internet casinos, on the ground that they are aiding and abetting an illegal enterprise. The airwaves are controlled by the Federal Communications Commission. Some questions are being raised:

a. Is the lobbying of American gambling companies against Internet betting (emanating from abroad) the real reason for the U.S. government’s stand? American companies have a lock on U.S. gambling and do not want to lose it to worldwide Internet casino interests.

b. On the basis of international trade law, countries allowing online casino gambling may seek to raise tariffs on services or goods of U.S. companies doing business within their jurisdiction (e.g., AT&T) as a way of retaliating against U.S. policy. Will this prompt U.S. companies to express their concerns to members of Congress? Does AT&T contribute to the reelection of members of Congress? Do gambling interests provide funds for reelection bids? Will there be a clash of interests?

Update: In June of 2013, the Justice Department indicated that individual states may sponsor games such as online poker with certain conditions attached.

It has had a significant impact on each country’s exports and imports. It has served as an institution for arbitration of disputes. For example, one of the first arbitral panels was set up when the U.S. government filed a complaint on behalf of United Parcel Service (UPS) and UPS believed that it was being hampered by NAFTA government regulations in Mexico, which limit the size of delivery trucks to be used in delivering packages. The arbitral panel ruled in favor of UPS.

Global Dispute Resolution

Many times, when private or public parties enter into an international business agreement, they incorporate means for resolving future disputes (e.g., arbitration clauses) into the agreement. Another form of protection for firms doing business internationally is the insurance some nation-states offer domestic companies to encourage them to export (e.g., United States Overseas Private Investment Corporation). Still, the two methods used most frequently to resolve irreconcilable differences between parties involved in international transactions are arbitration and litigation.

Arbitration

Arbitration is a dispute resolution process whereby parties submit their disagreements to a private individual decision maker they have agreed on or to a panel of decision makers whose selection has been provided for in the contract the parties signed. Arbitration clauses in contracts involving international business transactions should meticulously stipulate what law will govern the arbitration, where and when the arbitration will take place, what language will be used, and how the expenses of arbitration will be shared. They should also stipulate a waiver of judicial (court) review by both parties to the dispute. All these matters should be carefully negotiated when the contract is being drafted.

Arbitration of disputes may also come about through treaties. For instance, the United Nations Convention on the Recognition of Foreign Arbitral Awards encourages the use of arbitration agreements and awards. The World Bank’s International Center for the Settlement of Investment Disputes (ICSID), created in 1965 by treaty (the Washington Convention), provides arbitration rules as well as experienced arbitrators to disputants, and the International Chamber of Commerce offers a permanent arbitration tribunal. Finally, individual countries have arbitration associations that can provide experienced arbitrators to parties desiring assistance in settling their disputes.

Litigation

When contracts do not contain arbitration clauses and no other alternative (such as mediation or conciliation) is available, 

litigation

 may be the only way to resolve a dispute between parties. Some private international business contracts include a choice-of-forum clause so that the parties know which family of law is to be applied in case of a dispute and what nation’s courts will be used. When negotiating contracts in the international arena, managers should make sure that choice-of-forum clauses are specific as to these questions. Either or both can make a major difference to the outcome. Because there is no single international court or legal system capable of resolving all commercial disputes between private parties, a choice-of-forum clause should be negotiated in all agreements involving major transactions. London’s Commercial Court, established in 1895, is the most popular neutral forum for resolving commercial litigation, owing to its more than 100 years of experience.

litigation

A dispute resolution process going through the judicial system; a lawsuit.

Most of the international and regional organizations discussed in this chapter emphatically encourage the arbitration of private contractual disputes, because the arbitration process is a quicker and less public means of resolving disputes than litigation. In certain areas of the world (particularly the Far East), companies and governments strenuously seek to avoid litigation.

Applying the Law to the Facts . . .

Let’s say that Jamal from Saudi Arabia and Annette from the United States have a contract stipulating that Jamal agrees to send Annette 15 pounds of Turkish coffee each week for six months. Jamal breaches the contract and Annette decides that she needs to take legal action. She is not sure what forum to use, but wants to choose the quickest option. What type of dispute resolution does she most likely attempt to pursue?

Globalization: Hurts or Helps

In most of the chapters in this text, we have examined the globalization aspect of several areas of business ethics and law. We have attempted to present some factual bases for these discussions. In the following table, you will find a debate that is taking place all over the world. We invite you to participate in this sometimes vigorous discussion of whether globalization of business helps or hurts societies all over the world. It is skillfully summarized by Professor Murray Wiedenbaum in his text Business and Government in the Global Marketplace.

Pros	Cons
“Accelerates economic growth, increasing living standards”	“Generates widespread poverty in the pursuance of corporate greed”
“Offers consumers greater variety of products and at lower prices”	“Results in greater income inequality”
“Increases jobs and wages and improves working conditions”	“Moves jobs to low-wage factories that abuse workers’ rights”
“Encourages a greater exchange of information and use of technology”	“Provides opportunity for criminal and terrorist groups to operate on a global scale”
“Provides wealth for environmental cleanup”	“Pollutes local environments that lack ecological standards”
“Helps developing nations and lifts millions out of poverty”	“Traps developing countries in high-debt loans”
“Extends economic and political freedoms”	“Threatens national sovereignty”
“Raises life expectancy, health standards, and literacy rates”	“Worsens public health and harms social fabrics of agricultural-based societies”

Source: M. Wiedenbaum, Business and Government in the Global Marketplace, 7th ed. (Upper Saddle River, NJ: Prentice Hall, 2004), p. 190.

Summary

Although the emphasis in this book is on legal and ethical issues, managers whose companies are undertaking international business ventures need to consider the political, economic, cultural, and legal dimensions of the international environment of business. The major families of law are common law, which relies primarily on case law and precedent; civil law, which relies primarily on codes and statutory law; Islamic law, which relies on the Shari’a, a religious code of rules; socialist law, which is based on Marxism–Leninism and does not recognize private property; and Hindu law, which relies primarily on the Sastras, a religious code.

International law is divided into public international law, governing the relationships between nation-states, and private international law, governing the relationships between private parties involved in international transactions.

The major methods of engaging in international business are trade, international licensing and franchising, and foreign direct investment. The principal risk of engaging in international business are expropriation, the sovereign immunity doctrine and the act-of-state doctrine, export and import controls, and currency controls and fluctuations (particularly in developing nations).

World and regional integrative organizations, especially the WTO, the EU, and NAFTA, are making a strong impact on international business. Arbitration and litigation are the major methods of international dispute resolution.

Assignment On The Internet

As this chapter demonstrates, there are many important issues to consider before engaging in international business. Go to www.lib.uchicago.edu and search for “Lyonette Louis-Jacques international law” (Louis-Jacques is a librarian and lecturer of law at the University of Chicago, and the author of the link you will be taken to). Under “catalog results,” click on the first link. Click on “details” and copy and paste the URL given. Once here, pick a country you are not familiar with and research the issues you think most important to consider before doing business in that country. What are its cultural, economic, political, and legal dimensions? What are its trade laws? Does it belong to any international treaties or organizations?

If you cannot find all the information you need, make a list of detailed questions you would want answered. Finally, for each of the questions you researched, explain why that question was significant in your thinking.

Chapter Eighteen The Law of

Administrative Agencies

Introduction to

Administrative Law

and Administrative Agencies

Administrative Law

For the purposes of this text, 

administrative law

 is defined broadly as any rule (statute or regulation) that affects, directly or indirectly, an administrative agency. These rules may be procedural or substantive, and they may come from the legislative, executive, or judicial branch of government or from the agencies themselves. Such rules may be promulgated at the federal, state, or local levels. A 

procedural rule

 generally has an impact on the internal processes by which the agencies function or prescribes methods of enforcing rights. For example, under the

Administrative Procedure Act (APA)

, a federal administrative agency must give adequate notice to all parties involved in an agency hearing. A 

substantive rule

 defines the rights of parties. An example is an act of Congress that forbids the FTC from applying the antitrust laws to all the Coca-Cola bottlers in the United States. In this instance, the rights and regulations of both the FTC and the Coca-Cola bottlers were defined by Congress.

administrative law

Any rule (statute or regulation) that directly or indirectly affects an administrative agency.

procedural rule

A rule that governs the internal processes of an administrative agency.

substantive rule

A rule that creates, defines, or regulates the legal rights of administrative agencies and the parties they regulate.

Critical Thinking About The Law

As a future business leader, you will certainly encounter many governmental regulations. Congress created administrative agencies, in part, because it could not hope to address the enormous variety and number of concerns that are now covered by administrative agencies. Although you will not learn about every administrative agency in this chapter, you can jump-start your thinking about administrative agencies by answering these critical thinking questions.

1. Your roommate states that people do not have to follow the regulations passed by administrative agencies because these regulations are not laws. She argues that only Congress can make laws. Which critical thinking question could be applied to settle this disagreement?

Clue: 

 

Do you and your roommate agree on the meaning of the words she is using?

2. Some individuals may argue that the creation of regulations by administrative agencies promotes unfair restrictions on business. What ethical norm seems to be behind this thought?

Clue:  If you want fewer restrictions from the government, what ethical norm is influencing your thought? What ethical norm seems to conflict with the wish for fewer governmental regulations?

3. Congress assumes that the administrative agencies will address problems effectively in their respective areas. For example, the EPA ensures compliance with environmental laws. If Matt makes the assumption that environmental problems are so complex and widespread that the EPA could not hope to make a difference, what conclusion do you think Matt would draw regarding administrative agencies?

Clue:  Think about a contrary assumption. If Matt assumed that the administrative agencies were effective, would he be more likely to support the regulations passed by the various agencies?

Administrative Agencies

An 

administrative agency

 is any body that is created by the legislative branch (e.g., Congress, a state legislature, or a city council) to carry out specific duties. Some agencies are not situated wholly in the legislative, executive, or judicial branch of government. Instead, they may have legislative power to make rules for an entire industry, judicial power to adjudicate (decide) individual cases, and executive power to investigate corporate misconduct. Examples of such independent federal administrative agencies are the EPA, the FCC, and the FTC; at the state level, examples are public utilities commissions and building authorities; at the city level, examples are city planning commissions and tax appeals boards.

administrative agency

Any body that is created by the legislative branch to carry out specific duties.

Types

Administrative agencies are generally classified as independent or executive (see 

Table 18-1

). 

Independent administrative agencies

, such as the FTC and the SEC, are usually headed by a board of commissioners, who are appointed for a specific term of years by the president with the advice and consent of the Senate. A commissioner can be removed before serving out a full term only for causes defined by Congress, not at the whim of the president—which is why these agencies are called independent. Generally, the majority of a board must be of the sitting president’s party. This is dictated by the Administrative Procedure Act of 1946.

independent administrative agency

An agency whose appointed heads and members serve for fixed terms and cannot be removed by the president except for reasons defined by Congress.

Executive administrative agencies

 are generally located within departments of the executive branch of government. For example, the

Occupational Safety and Health Administration (OSHA)

is located in the Department of Labor, and the

National Transportation Safety Board (NTSB)

is in the Department of Transportation. Heads and members of these boards have no fixed term of office. They serve at the pleasure of the president, meaning that they can be removed from their positions by the chief executive at any time.

executive administrative agency

An agency located within a department of the executive branch of government; heads and appointed members serve at the pleasure of the president.

Table 18-1 Selected Federal Administrative Agencies

Independent Agencies	Executive Agencies
Commodity Futures Trading Commission (CFTC)	Federal Deposit Insurance Corporation (FDIC)
Consumer Product Safety Commission (CPSC)	General Services Administration (GSA)
Equal Employment Opportunity Commission (EEOC)	International Development Corporation Agency (IDCA)
Federal Communications Commission (FCC)	National Aeronautics and Space Administration (NASA)
Federal Trade Commission (FTC)	National Science Foundation (NSF)
National Labor Relations Board (NLRB)	Occupational Safety and Health Administration (OSHA)
National Transportation Safety Board (NTSB)	Office of Personnel Management (OPM)
Nuclear Regulatory Commission (NRC)	Small Business Administration (SBA)
Securities and Exchange Commission (SEC)	Veterans Administration (VA)
Department of Homeland Security (DHS)

Reasons for Growth

Administrative agencies have proliferated rapidly since the late 1890s for the following reasons:

1. Flexibility. Unlike the court proceedings presented in 

Chapter 3

, administrative agency hearings are not governed by strict rules of evidence. For example, hearsay rules are waived in most cases.

2. Need for expertise. The staff of each of the agencies has technical expertise in a relatively narrow area, gained from concentrating on that area over the years. It would be impossible, for example, for 435 members of the House of Representatives and 100 senators to regulate the television, radio, and satellite communications systems of the United States on a daily basis. Only the FCC staff has that expertise.

3. Prevention of overcrowding in courts. If administrative agencies did not exist, our highly complex, often litigious society would have to seek redress of grievances through the federal and state court systems. As explained in 

Chapter 4

, both corporations and individuals are already seeking alternatives to the overburdened court system.

4. Expeditious solutions to national problems. After the 1929 stock market crash and the ensuing Depression, Congress sought to give investors confidence in the securities markets by creating the SEC in 1934. The SEC was intended to be a “watchdog” agency that would ensure full disclosure of material information to the investing public and prevent a repeat of the fraudulent practices that marked the freewheeling 1920s. When the public became concerned about the deterioration of the nation’s water, land, and air, Congress created the EPA to implement air, water, and waste regulations.

All these reasons and more are why administrative agencies exist. These reasons, however, are frequently challenged by proponents of deregulation—or no regulation—of industry.

The debate between advocates of returning to a period in our history when market forces were the sole regulators of business conduct and champions of administrative agency regulation is highlighted throughout Part III of this text. We also now have advocates of reregulation in areas such as the power sector. With rising prices for electricity, for both homes and businesses, calls for reregulation are often heard. Administrative agencies are becoming more important again. This is especially true today, because the current administration’s philosophy includes a belief that federal regulation is necessary to solve national problems.

Creation of Administrative Agencies

Congress creates federal administrative agencies through statutes called 

enabling legislation

. In general, an enabling statute delegates to the agency congressional 

legislative power

 for the purpose of serving the “public interest, convenience, and necessity.” Armed with this mandate, the administrative agency can issue rules that control individual and business behavior. In many instances, such rules carry criminal as well as civil penalties. In 

Chapter 23

, you will see how the SEC, using its mandate under the 1933 and 1934 Securities Acts, can both fine and criminally prosecute individuals involved in insider trading. The enabling statute also delegates 

executive power

 to the agency to investigate potential violations of rules or statutes. 
Chapter 23
 sets out the wide-ranging investigative powers of the SEC staff. Finally, the enabling statutes delegate 

judicial power

 to the agency to settle or adjudicate any disputes it may have with businesses or individuals. For example, the SEC, using its congressional mandate under the 1933 and 1934 Securities Acts, has prescribed rules governing the issuance of, and trading in, securities by businesses as well as by brokers and underwriters. Administrative law judges are assigned to the SEC adjudicate cases in which individuals or corporations may have violated the rules.

enabling legislation

Legislation that grants lawful power to an administrative agency to issue rules, investigate potential violations of rules or statutes, and adjudicate disputes.

legislative power

The power delegated by Congress to an administrative agency to make rules that must be adhered to by individuals and businesses regulated by the agency; these rules have the force of law.

executive power

The power delegated by Congress to an administrative agency to investigate whether the rules enacted by the agency have been properly followed by businesses and individuals.

judicial power

The power delegated by Congress to an administrative agency to adjudicate cases through an administrative proceeding; includes the power to issue a complaint, have a hearing held by an administrative law judge, and issue either an initial decision or a recommended decision to the head(s) of an agency.

Because the framers of the U.S. Constitution carefully separated the legislative (Article I), executive (Article II), and judicial powers of government into three distinct branches, some people complain that allowing administrative agencies (Article III) to exercise all three powers violates the spirit of the Constitution. Critics go so far as to state that these agencies constitute a “fourth branch of government.” In 1995, the House of Representatives and the Senate overwhelmingly passed a bill that required all administrative agencies (both executive and independent) to do a cost-benefit analysis of any proposed regulation that would cost the economy more than $25 million. All agencies also have to identify possible alternatives to the proposed regulation that would require no government action, as well as varying actions customized for different regions of the country, and “the use of market-based mechanisms.” The Office of Management and Budget (OMB) reviews all proposed rules judged to be “major.” Because the OMB (located in the executive branch) recommends annual budgets to Congress for each administrative agency, it has influence over all rulemaking.

Functions of Administrative Agencies

Administrative agencies perform the following functions: (1) rulemaking; (2) adjudication of individual cases brought before administrative law judges by agency staff; and (3) administrative activities, which include (a) informal advising of individual businesses and consumers, (b) preparation of reports and performance of studies of industries and consumer activities, and (c) issuance of guidelines for the business community and others as to what activities are legal in the eyes of agency staff.

Rulemaking

We said that administrative agencies are authorized to perform the legislative function of making rules or regulations by virtue of their enabling statutes. For example, the enabling statute of the OSHA gave the secretary of labor authority to set “mandatory safety and health standards applicable to businesses affecting interstate commerce.” The secretary was also given the power to “prescribe such rules and regulations that he may deem necessary to carry out the responsibilities under this act.” In some cases, the procedures for implementing the rulemaking function are spelled out in the enabling act. If they are not, agencies follow the three major rulemaking models—formal, informal, and hybrid—outlined in the 

Administrative Procedure Act (APA)

 of 1946.

Administrative Procedure Act (APA)

Law that establishes the standards and procedures that federal administrative agencies must follow in their rulemaking and adjudicative functions.

Formal Rulemaking

Section 553(c) of the APA requires formal rulemaking when an enabling statute or other legislation states that all regulations or rules must be enacted by an agency as part of a formal hearing process that includes a complete transcript. This procedure provides for (1) an agency notice of proposed rulemaking to the public in the Federal Register; (2) a public hearing at which witnesses give testimony on the pros and cons of the proposed rule, each witness is cross-examined, and the rules of evidence are applied; and (3) the making and publication of formal findings by the agency. On the basis of these findings, an agency may or may not promulgate a regulation. Because of the expense and time involved in creating a formal transcript and record, most enabling statutes do not require agencies to go through a formal rulemaking procedure when promulgating regulations.

Informal Rulemaking

As provided by Section 553 of the APA, informal rulemaking applies in all situations in which the agency’s enabling legislation

Exhibit 18-1 Steps in the Informal Rulemaking Process

or other congressional directives do not require another form. The APA requires that the agency (1) give prior notice of the proposed rule by publishing it in the Federal Register; (2) provide an opportunity for all interested parties to submit written comments; and (3) publish the final rule, with a statement of its basis and purpose, in the Federal Register. 

Exhibit 18-1

 lays out the five-step process for promulgating a rule according to the informal rulemaking model. Executive and independent agencies are required to set out a cost-benefit analysis in Step 1 of the process.

Informal rulemaking is the model most often used by administrative agencies because it is efficient in terms of time and cost. No formal public hearing is required, and no formal record needs to be established, as in formal rulemaking. Parties opposed to a particular rule arrived at through informal rulemaking, however, often seek to persuade the appellate courts that the agency in question did not take important factors into account when the rule was being made.

Hybrid Rulemaking

 

Interested parties often complained that informal rulemaking gave them little opportunity to be heard other than in writing. Both Congress and the executive branch wanted administrative agencies to do a cost-benefit analysis of proposed regulations. Out of this input, from the public and two branches of government, came hybrid rulemaking, which combines some of the aspects of formal and informal rulemaking. This model requires the agency to give notice of a proposed regulation, set a period for public comments, hold a public hearing, and have a cost-benefit analysis done by an independent executive agency.

Exempted Rulemaking

 

Section 553 of the APA allows the agencies to decide whether there will be public participation in rulemaking proceedings relating to the “military or foreign affairs” and “agency management or personnel,” as well as in proceedings relating to “public property, loans, grants, benefits, or contracts” of an agency. Public notice and comment are also not required when the agency is making interpretive rules or general statements of policy.

It is generally conceded that proceedings dealing with military and foreign affairs often require speed and secrecy, both of which are incompatible with public notice and hearings.

Judicial Review of Rulemaking

 After a regulation is promulgated by an administrative agency and is published in the Federal Register, it generally becomes law. Appellate courts have accepted agency-promulgated regulations as law unless a business or other affected groups or individuals can show that:

1. the congressional delegation of legislative authority in the enabling act was unconstitutional because it was too vague and not limited;

2. an agency action violated a constitutional standard, such as the right to be free from unreasonable searches and seizures under the Fourth Amendment (e.g., if an agency such as OSHA promulgated a rule that allowed its inspectors to search a business property at any time without its owner’s permission and without an administrative search warrant, that rule would be in violation of the Fourth Amendment); and

3. the act of an agency was beyond the scope of power granted to it by Congress in its enabling legislation.

Judicial review of administrative agency action provides a check against agency excesses that can prove very costly to the business community. The landmark case below illustrates this power of judicial review of administrative agencies.

 Case 18-1 City of Arlington v. Federal Communications Commission

United States Supreme Court 133 S. Ct. 1863 (2013)

State and local zoning authorities must approve applications by wireless telecommunications network companies to build new towers, as well as approve applications to place new antennas on existing towers. The Telecommunications Act of 1996 “imposed specific limitations on the traditional authority of state and local governments to regulate the location, construction, and modification” of wireless telecommunications networks. These limitations are incorporated into the Communications Act of 1934, which “empowers the Federal Communications Commission [FCC] to ‘prescribe such rules and regulations as may be necessary in the public interest to carry out its provisions.’” One such provision requires state and local governments to act “within a reasonable period of time” after an application for a wireless tower or antenna site is filed.

An organization representing various wireless service providers petitioned the FCC to clarify the meaning of “reasonable period of time.” In late 2009, the FCC, “relying on its broad statutory authority,” issued a declaratory ruling determining that “a reasonable period of time” is presumptively (but rebuttably) 90 days when the application requests permission to place a new antenna on an existing tower and 150 days for all other applications. Certain state and local governments argue that the FCC did not have authority to issue such a declaratory ruling because the FCC did not have authority to “interpret ambiguous provisions” of the act and because two of the act’s clauses (a saving clause and a judicial review provision) “together display[ed] a congressional intent to withhold from the [FCC] authority to interpret” the phrase “reasonable period of time.” The cities of Arlington and San Antonio, Texas, then petitioned for review of the declaratory order in the U.S. Court of Appeals for the Fifth Circuit.

The Fifth Circuit held that the framework articulated in Chevron U.S.A. Inc. v. National Resources Defense Council, Inc., governed the threshold question of whether the FCC had the statutory authority to adopt the 90- and 150-day time frames. In Chevron, the U.S. Supreme Court held that ambiguities in statutes should be resolved “within the bounds of reasonable interpretation, not by the courts but by the [applicable] administering agency.” After concluding that certain language in the act was “ambiguous,” the court held that the FCC had permissibly construed the statute to determine its statutory authority. The Plaintiff cities appealed.

Justice Scalia

Chevron is rooted in a background presumption of congressional intent: namely, “that Congress, when it left ambiguity in a statute” administered by an agency, “understood that the ambiguity would be resolved, first and foremost, by the agency, and desired the agency (rather than the courts) to possess whatever degree of discretion the ambiguity allows.” Chevron thus provides a stable background rule against which Congress can legislate: Statutory ambiguities will be resolved, within the bounds of reasonable interpretation, not by the courts but by the administering agency. Congress knows to speak in plain terms when it wishes to circumscribe, and in capacious terms when it wishes to enlarge, agency discretion.

The question here is whether a court must defer under Chevron to an agency’s interpretation of a statutory ambiguity that concerns the scope of the agency’s statutory authority (i.e., its jurisdiction). The argument against deference rests on the premise that there exist two distinct classes of agency interpretations: Some interpretations—the big, important ones, presumably— define the agency’s “jurisdiction.” Others—humdrum, run-of-the-mill stuff—are simply applications of jurisdiction the agency plainly has. That premise is false, because the distinction between “jurisdictional” and “nonjurisdictional” interpretations is a mirage. No matter how it is framed, the question a court faces when confronted with an agency’s interpretation of a statute it administers is always, simply, whether the agency has stayed within the bounds of its statutory authority.

In sum, judges should not waste their time in the mental acrobatics needed to decide whether an agency’s interpretation of a statutory provision is “jurisdictional” or “nonjurisdictional.” Once those labels are sheared away, it becomes clear that the question in every case is, simply, whether the statutory text foreclosed the agency’s assertion of authority, or not . . . The federal judge as haruspex, sifting the entrails of vast statutory schemes to divine whether a particular agency interpretation qualifies as “jurisdictional,” is not engaged in reasoned decision-making.

. . . If “the agency’s answer is based on a permissible construction of the statute,” that is the end of the matter.*

The judgment of the Court of Appeals was affirmed.

Adjudication

In carrying out its adjudicative function in individual cases, as opposed to rulemaking for whole industries, an administrative agency usually pursues a four-step process. After receiving a complaint alleging violation of an administrative law, the agency notifies the party against whom the complaint is made and conducts an investigation into the merits of the complaint. If the agency staff finds that the complaint has merit, the agency next negotiates with the party to see if it can get the party to stop the violation voluntarily. If negotiation is unsuccessful, the third step is to file a complaint with an administrative law judge (ALJ). Step 4 consists of a hearing and decision by the ALJ. The party may appeal the ALJ’s decision to the full commission or agency head and ultimately to a federal court of appeals and the U.S. Supreme Court.

All these steps are guided by the APA, which sets out minimum procedural standards for administrative agency adjudication. Enabling statutes that create agencies often add other procedural requirements. Finally, case law arising out of appeals of agency decisions to the U.S. circuit courts of appeal and the U.S. Supreme Court provides further guidelines for agencies in carrying out their adjudicative function. In the following detailed description of the four-step adjudicative process for federal administrative agencies, we use the FTC as a representative agency. You will find it easier to follow our discussion if you look first at the organizational outline of the FTC provided in 

Exhibit 18-2

 and the summary of adjudication and judicial review of agency decision making given in 

Exhibit 18-3

.

Exhibit 18-2 Federal Trade Commission

Source: U.S. Government Manual 2002–2003. Washington, DC: Office of the Federal Register, 2003, 722.

Applying the law to the facts . . .

The EPA is informed of a company dumping waste into Lake Erie, so it contacts the company and attempts to get the company to stop dumping waste into the lake. The company ignores all messages from the EPA. Finally, the EPA files a complaint with an administrative law judge (ALJ). A hearing almost immediately follows. What step did the EPA mistakenly leave out in this scenario?

Investigation and Complaint

The FTC, which includes the Bureau of Competition and the Bureau of Consumer Protection, is obliged to conduct an investigation whenever it receives a complaint from other government agencies, competitors, or consumers. For example, upon receiving a complaint about a mouthwash product that is advertised as killing germs and protecting people from sore throats, the commission examines the product to see if the statement has any scientific validity. Should the commission’s staff find that the advertising is “deceptive” or “unfair” within the meaning of Section 5 of the Federal Trade Commission Act, it will seek to stop the advertising campaign in one of two ways:

1. Voluntary compliance. The staff will ask the corporation to stop the advertising campaign voluntarily. Usually, no penalty is assessed if the company agrees to do this.

1. Exhibit 18-3 Adjudication and Judicial Review of Agency Decision Making

2. Consent order. If voluntary compliance is not obtained, the staff notifies the mouthwash company that it has 10 days to enter into a consent order; otherwise, the staff will issue a formal complaint.

Most cases are closed at this stage because, under a 

consent order

, the company does not have to admit that it was deceptive or unfair in its advertising; it only has to promise that it will not do such unlawful advertising again and agree to the remedy the commission imposes. The latter may be some form of corrective advertising that tells the public that the mouthwash does not kill germs. A consent order helps the commission staff to obtain a binding cease-and-desist order with limited effort and time. It also benefits the company, because by agreeing to a consent order, the company avoids both an admission of guilt and the cost of litigation and shareholder and consumer lawsuits that might ensue if the next steps in the adjudication process—a formal complaint and a hearing by an ALJ—resulted in an adverse decision for the company.

consent order

An agreement by a business to stop an activity that an administrative agency alleges to be unlawful and to accept the remedy the agency imposes; no admission of guilt is necessary.

Formal Complaint and Hearing

If the case is not settled by voluntary compliance or a consent order, the commission’s staff, usually through the FTC’s Office of the General Counsel (see 
Exhibit 18-2
), will issue a formal complaint listing the charges against the mouthwash company and will request that certain penalties be assessed by the ALJ. 

Administrative law judges (ALJs)

, who number approximately 1,150, are selected on the basis of a merit examination and are assigned to specific administrative agencies. They usually come from within the federal administrative bureaucracy and are given life tenure. Administrative law judges are noted for their independence, even though they may be assigned to a particular independent or executive agency for a number of years.

3

3 

See “Administrative Law Judges Are Washington’s Potent Hybrids,” New York Times, Dec. 3, 1980 and “Symposium: Administrative Law Judges,” Western New England Law Review 6: 1 (1984).

administrative law judge (ALJ)

A judge, selected on the basis of a merit exam, who is assigned to a specific administrative agency.

A hearing before an ALJ may take several months or years. It resembles a judicial proceeding in that it includes notice to the parties, discovery, the presentation of evidence by both the staff of the commission and the accused party (the respondent), direct examination and cross-examination of the witnesses, and presentation of motions and arguments to the ALJ. There is, however, no jury at these hearings, and they are more informal than court proceedings. For instance, an ALJ will often intervene to ask questions and to take note of evidence that neither of the parties has introduced. At times in fact, the ALJ becomes a severe questioner of both parties, especially in hearings involving disability and welfare claims. Thus, adjudicative proceedings are less adversarial and more investigative, or inquisitorial, than court proceedings.

Initial or Recommended Decision

After the hearing is completed, both the commission staff and the respondent submit proposed findings of facts and conclusions of law. Under the APA, the ALJ must then prepare an initial or recommended decision. An initial decision becomes the final agency action unless an appeal is taken to the full commission by either the staff or the respondent. In contrast, a recommended decision is not final; it has to be acted on by the full commission or by the head of the agency. Agency heads and commissions are not required to defer to the ALJ’s factual findings. It is important to remember that commissioners and agency heads are political appointees of the president and may have political or policy reasons for overruling an ALJ’s decision. Should either the staff or the respondent appeal a full commission’s decision to a federal circuit court of appeals, the court is likely to give deference to the ALJ’s factual findings, because the ALJ is the person who actually heard the witnesses testify and read the submitted exhibits.

Appeal to the Full Commission

If the losing party (the agency staff or the respondent) does not agree with the ALJ’s decision, it may appeal to the full commission in the case of the FTC or to the head of an executive department (or agency) in the case of an executive agency. In the mouthwash case used as an example, a majority of the commission members must rule in favor of one of the parties on the basis of a 

preponderance of the evidence

 standard (51 percent or more). The APA requires that the commission state factual, legal, and policy bases for its decision. This requirement makes the agency responsible for its decision both to the public and to the courts that may later review it.

preponderance of the evidence

A legal standard whereby a bare majority (51 percent) of the evidence is sufficient to justify a ruling.

Judicial Review of Adjudicative Proceedings

If the party that loses at the full-commission or agency-head level in an adjudicative proceeding wishes to appeal, it must file a motion for appeal with the federal circuit court of appeals that has jurisdiction in the case. Briefs are filed by both parties, and the court hears oral argument. The court also reviews the whole record, including the ALJ’s findings, in the case. It does not review the commission’s factual findings as long as they are supported by substantial evidence in the record. (The substantial evidence rule requires that the court find that a reasonable person, after reviewing the record, would make the same findings the agency did.) Rather, it reviews the commission’s legal findings to ensure that (1) it acted in a constitutionally approved way, (2) it acted within the scope of its jurisdiction as outlined by the enabling statute, and (3) it followed proper statutory procedures and did not act in an arbitrary or capricious manner.

4

 The following case considers the application of the arbitrary and capricious standard.

4 

Administrative Procedure Act of 1946 (APA), 5 U.S.C. §§ 551–706; 5 U.S.C. § 706(2)(A).

 Case 18-2 Fox Television Stations, Inc. v. Federal Communications Commission

United States Court of Appeals 489 F.3d 444 (2d Cir. 2007)

The Federal Communications Commission’s (FCC’s) policing of “indecent” speech stems from 18 U.S.C. Section 1464, which provides that “[w]hoever utters any obscene, indecent, or profane language by means of radio communication shall be fined or imprisoned not more than two years, or both.” The FCC first exercised its statutory authority to sanction indecent (but nonobscene) speech in 1975, when it found Pacifica Foundation’s radio broadcast of comedian George Carlin’s “Filthy Words” monologue indecent.

Under the FCC’s definition, indecent speech is language that describes, in terms patently offensive as measured by contemporary community standards for the broadcast medium, sexual or excretory activities and organs.

During [a] January 19, 2003, live broadcast of the Golden Globe Awards, musician Bono stated in his acceptance speech: “[T]his is really, really, brilliant. Really, really, great ****” (expletive included in the original broadcast).

On a complaint about the broadcast by individuals associated with the Parents Television Council, the FCC held that any use of any variant of “the F-Word” inherently has sexual connotation and therefore falls within the scope of the indecency definition. The Commission found that use of the word was fleeting and isolated irrelevant, and it overruled all prior decisions in which fleeting use of an expletive was held not indecent.

On February 21, 2006, the Commission found Fox Television Stations, Inc.’s broadcast of the 2002 Billboard Music Awards and Fox’s broadcast of the 2003 Billboard Music Awards indecent and profane. During the 2002 broadcast, Cher stated: “People have been telling me I’m on the way out every year, right? So f*** ‘em.”

Fox filed a petition for review of the FCC’s order in the U.S. Court of Appeals for the Second Circuit.

Justice Pooler

Agencies are of course free to revise their rules and policies. Such a change, however, must provide a reasoned analysis for departing from prior precedent. When an agency reverses its course, a court must satisfy itself that the agency knows it is changing course, has given sound reasons for the change, and has shown that the rule is consistent with the law that gives the agency its authority to act. In addition, the agency must consider reasonably obvious alternatives and, if it rejects those alternatives, it must give reasons for the rejection. The agency must explain why the original reasons for adopting the rule or policy are no longer dispositive [a deciding factor].

The primary reason for the crackdown on fleeting expletives advanced by the FCC is the so-called “first blow” theory. Indecent material on the airwaves enters into the privacy of the home uninvited and without warning. To say that one may avoid further offense by turning off the [television or] radio when he hears indecent language is like saying that the remedy for an assault is to run away after the first blow.

We cannot accept this argument as a reasoned basis justifying the Commission’s new rule. First, the Commission provides no reasonable explanation for why it has changed its perception that a fleeting expletive was not a harmful “first blow” for the nearly thirty years between [the decisions in Pacifica’s case] and Golden Globes. More problematic, however, is that the “first blow” theory bears no rational connection to the Commission’s actual policy regarding fleeting expletives.

A re-broadcast of precisely the same offending clips from the two Billboard Music Award programs for the purpose of providing background information on this case would not result in any action by the FCC.

The Order makes passing reference to other reasons that purportedly support its change in policy, none of which we find sufficient. For instance, the Commission states that even non-literal uses of expletives fall within its indecency definition because it is “difficult (if not impossible) to distinguish whether a word is being used as an expletive or as a literal description of sexual or excretory functions.” This defies any commonsense understanding of these words, which, as the general public well knows are often used in everyday conversation without any “sexual or excretory” meaning. Even the top leaders of our government have used variants of these expletives in a manner that no reasonable person would believe referenced “sexual or excretory organs or activities.” [The court proceeded to recount examples of when President Bush and Vice President Cheney used the questionable words in public.]

Accordingly, we find that the FCC’s new policy regarding “fleeting expletives” fails to provide a reasoned analysis justifying its departure from the agency’s established practice. For this reason, Fox’s petition for review is granted.*

Affirmed for Fox Television.

Administrative Activities

In addition to rulemaking and adjudication, executive and independent agencies perform a variety of tasks that are less well known but equally important to the average individual or business. The most significant of these are the following:

1. Advising businesses and individuals concerning what an agency considers legal and not legal. The antitrust merger guidelines we discuss in 

Chapter 24

 are an example of an attempt by the Justice Department and the FTC to advise all interested parties about what conduct will be considered violations of Section 7 of the Clayton Act. More generally, lawyers representing interested parties meet daily with agency officials to receive informal comments or advice.

2. Conducting studies of industry and markets. Agencies such as the FTC, OSHA, and the FDA carry out studies to determine the level of economic concentration in an industry, dangerous products in the workplace, and the harmful effects of legal drugs.

3. Providing information to the general public on myriad matters by answering telephone calls, distributing pamphlets, and holding seminars.

4. Licensing of businesses in certain areas, such as radio and television stations (FCC).

5. Managing property. The General Services Administration (GSA) is the largest landlord in the country. It buys, sells, and leases all property used by the U.S. government.

6. Limitations on Administrative Agencies’ Powers

7. Statutory Limitations

8. Certain federal statutes, summarized in 

Table 18-2

, limit the power of administrative agencies and their officials. We have already discussed the APA. You should carefully review the brief descriptions of the other statutes listed in the table. It is important that you know, both as a future business manager and as an individual citizen, their major provisions. For instance, under the Federal Register Act of 1933, the Federal Privacy Act of 1974, and the Freedom of Information Act of 1966 as amended in 1974 and 1976, the decision-making processes of administrative agencies are open to the public. This legislation prevents secret, arbitrary, or capricious activity by the “fourth branch of government.” Also, as you have seen, judicial review of administrative agencies’ rulemaking and adjudication functions serves a similar purpose. Note also that private citizens have a means of relief against improper acts by employees of federal administrative agencies through the Federal Tort Claims Act of 1946, which forces agencies to waive sovereign immunity for their tortious actions and those of their employees. Tortious actions under this act include assault, battery, abuse of prosecution, false arrest, and trespass. For example, if an inspector from the EPA illegally enters a business property after being told to leave, the inspector, as well as the agency, may be held liable.

9. We said earlier that agencies were exempted from holding open hearings in certain circumstances, chiefly when proceedings concern military matters or foreign affairs. Some agencies have tried to stretch the exemption to cover proceedings in other “sensitive” matters.

10. Institutional Limitations

11. Executive Branch

12.  

13. The power of administrative agencies is limited by the executive branch through (1) the power of the president to appoint the heads

14. Table 18-2 Federal Statutes Limiting Administrative Agencies’ Authority

Statute

Summary

of Provisions

Federal Register of Act of 1993

Created the Federal Register system, which mandates the publication of all notices of federal agency meetings, proposed regulations, and final regulations in the Federal Register. The Federal Register system includes the Government Manual, which lists information, updated yearly, about each administrative agency, and the Code of Federal Regulations (CFR), which codifies regulations promulgated by agencies of the federal government.

Freedom of Information Act of 1966 (FOIA)

Requires each agency to publish in the Federal Register places where the public can get information from the agency, procedural and substantive rules and regulations, and policy statements. Also, the FOIA requires each agency to make available for copying on request such items as staff manuals, staff instruction orders, and adjudicated opinions, as well as interpretations of policy statements. Nine exceptions enable an agency to deny an FOIA request by the public, a business, or other groups.

Government in Sunshine Act of 1976 (Sunshine Act)

Requires each agency headed by a collegiate body to hold every portion of a business meeting open to public attendance. A collegiate body exists if the agency is headed by two or more individuals, the majority of whom are appointed by the president and confirmed by the Senate.

Federal Privacy Act of 1974 (FPA)

Prevents an agency from disclosing any record in a system of records, by any means of communication, to any person or agency without the written authority of the individual. Eleven exceptions to the statute allow information to be released by the agency without the consent of individuals. Some exceptions are (1) to meet an FOIA request, (2) for use by the Selective Service System, (3) for use by another federal agency in civil or criminal law enforcement, (4) for use by a committee of the Congress, or (5) to meet a court order. Also, under the FPA, an individual may obtain information and correct errors in his or her record.

Administrative Procedure Act (APA)

The APA requires that all federal administrative agencies follow certain uniform procedures when performing their rulemaking and adjudicative functions.

Federal Tort Claims Act of 1946 (FTCA)

Requires the federal government to waive sovereign immunity and to assume liability for the tortious acts of its employees if nondiscretionary functions are being carried out by the employee.

Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA)

Requires analysis that measures the cost that a proposed rule would impose on a business (particularly a small business). Congress may review a proposed regulation for 60 days. The SBREFA helps enforce the Regulatory Flexibility Act to make sure federal agencies seek to reduce the impact of new regulations on small businesses.

Congressional Review Act of 1996

This law, in effect, gives Congress a “veto power” over every single regulation that agencies pass. Under this statute, a regulation cannot take effect until at least 60 working days have passed since the regulation was promulgated. If, during the 60-day period, a majority of the members of Congress pass a resolution of disapproval of the rule and either the president signs it or Congress overrules his veto of it, the regulation is nullified.

15. of the agencies, (2) the power of the OMB to recommend a fiscal-year budget for each agency, and (3) presidential executive orders.

16. The president not only appoints the head of each administrative agency but also designates some lower-level heads of departments and divisions that do not come under the federal civil service system. Naturally, presidential appointees tend to have the same philosophical bent as the chief executive and are often of the same party. In this way, the president gains some influence over both independent and executive agencies.

17. Presidents exercise even greater influence over executive agencies through the budget process and executive orders. In 1981, for instance, President Reagan signed Executive Order 12291, which requires executive agencies to perform a cost-benefit analysis before promulgating a major federal regulation. A major federal regulation is a regulation that will cost businesses $100 million or more to comply with. Another example, this one concerning the budget process, Executive Order 12498, signed in 1985 (also by President Reagan), extended the OMB’s powers so that it now has authority over “pre-rulemaking action” by executive agencies. This executive order requires civilian government agencies to submit a Draft Regulatory Program listing all pre-rulemaking and other significant actions they intend to take in a fiscal year. These Draft Regulatory Programs become part of the administration’s Regulatory Program. Once that program is published by the OMB, no agency may deviate from the plan without approval from the OMB unless forced to do so by the courts.

18. Note that these executive orders affect executive administrative agencies. However, independent administrative agencies have been requested to comply voluntarily with these orders, and some have done so. A bill passed by the House of Representatives and the Senate in 1995, and discussed in this chapter under “Creation of Administrative Agencies,” applies to both executive and independent administrative agencies.

19. Legislative Branch

20. Congress limits the authority of administrative agencies through its (1) oversight power, (2) investigative power, (3) power to terminate an agency, and (4) power to advise on and consent to presidential nominations for heads of administrative agencies.

21. When Congress creates an agency, it delegates to that agency its own legislative power over a narrow area of commerce (e.g., human rights). Each year, through one of its oversight committees, it determines whether the agency has been carrying out its mandated function. Suppose, for example, that the House Energy and Commerce Committee’s Subcommittee on Consumer Finance and Telecommunications finds that the SEC is not enforcing laws against insider trading and fraud. The full committee will investigate and, if it finds dereliction, will order the SEC to enforce the laws as it is charged to do.

22. The greatest legislative limitation on agency power, however, lies in Congress’s right to approve or disapprove an agency budget submitted by the executive branch (the OMB). If Congress disagrees with the agency’s actions, it can slash the budget or refuse to budget the agency at all. The latter action, of course, will shut down the agency. In contrast, if Congress believes that the executive branch is shortchanging an agency for some reason, it can raise that agency’s budget above the amount proposed by the OMB.

23. Judicial Branch

24. The courts can curb administrative agencies’ rulemaking and adjudicative excesses by reversing or modifying such actions, as explained earlier in this chapter. You might want to go back to that portion of the chapter at this point and reread the standards used by the courts in reviewing these agency functions.

State and Local Administrative Agencies

Each of the 50 states, the District of Columbia, and territories such as Puerto Rico and Guam have created state and local administrative agencies to carry out tasks assigned to them by their legislative bodies. Most have utilities commissions (or the equivalent) that regulate local and in-state telephone rates and are similar to the Federal Communications Commission, which regulates telephone rates for calls between states (interstate calls). Agencies that regulate state-chartered banks, workers’ compensation, state universities, and state taxes are common at the state level and are assigned duties by the state legislature. At the city and county level, real estate planning boards, zoning commissions, and supervisory boards are just a few of the administrative agencies that have a profound effect on the life of all citizens; future business leaders should not overlook these when determining where their companies will be located.

When federal and state agency laws conflict, the Supremacy Clause of Article VI of the U.S. Constitution plays a significant role, as shown in the following case.

 Case 18-3 Vonage Holdings Corp. v. Minnesota Public Utilities Commission

U.S. District Court of Minnesota 290 F. Supp. 2d 993 (2003); aff’d 394 F.3d 568 (2004)

Vonage Holdings Corporation markets and sells Vonage DigitalVoice, a service that permits voice communication via a high-speed (broadband) Internet connection. Vonage’s service uses a technology called Voice over Internet Protocol (VoIP), which allows customers to place and receive voice transmissions routed over the Internet.

Traditional telephone companies use circuit-switched technology. Voice communication using the Internet has been called Internet protocol (IP) telephony, and rather than using circuit switching, it utilizes “packet switching,” a process of breaking down data into packets of digital bits and transmitting them over the Internet.

Vonage has approximately 500 customers with billing addresses in Minnesota. The Minnesota Department of Commerce (MDOC) investigated Vonage’s services and on July 15, 2003, filed a complaint with the Minnesota Public Utilities Commission (MPUC). The complaint alleged that Vonage failed to obtain a proper certificate of authority required to provide telephone service in Minnesota.

Vonage then moved to dismiss the MDOC complaint. The MPUC concluded that Vonage was required to comply with Minnesota statutes and rules regarding the offering of telephone service. Vonage then filed a complaint seeking an injunction.

Justice Davis

The issue before the Court is whether Vonage may be regulated under [a] Minnesota law that requires telephone companies to obtain certification authorizing them to provide telephone service. Vonage asserts that the Communications Act of 1934, as amended by the Communications Act of 1996, preempts the state authority upon which the MPUC’s order relies. Vonage asserts that its services are “information services,” which are not subject to regulation, rather than “telecommunications services,” which may be regulated.

The Supremacy Clause of Article VI of the Constitution empowers Congress to preempt state law. Preemption occurs when (1) Congress enacts a federal statute that expresses its clear intent to preempt state law; (2) there is a conflict between federal and state law; (3) compliance with both federal and state law is in effect physically impossible; (4) federal law contains an implicit barrier to state regulation; (5) comprehensive congressional legislation occupies the entire field of regulation; or (6) state law is an obstacle to the accomplishment and execution of the full objectives of Congress. Moreover, a federal agency acting within the scope of its congressionally delegated authority may preempt state regulation.

Examining the statutory language of the Communications Act, the Court concludes that the VoIP service provided by Vonage constitutes an information service because it offers the “capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information via telecommunications.” Vonage’s services are closely tied to the provision of telecommunications services as defined by Congress, the courts, and the [Federal Communications Commission (FCC)], but this Court finds that Vonage uses telecommunications services, rather than provides them.

The Court acknowledges the attractiveness of the MPUC’s simplistic “quacks like a duck” argument, essentially holding that because Vonage’s customers make phone calls, Vonage’s services must be telecommunications services. However, this simplifies the issue to the detriment of an accurate understanding of this complex question. The Court must follow the statutory intent expressed by Congress, and interpreted by the FCC. Short of explicit statutory language, the Court can find no stronger guidance for determining that Vonage’s service is an information service.

Where federal policy is to encourage certain conduct, state law discouraging that conduct must be preempted.*

For the Plaintiff, injunction granted.

Global Dimensions of Administrative Agencies

In the United Kingdom, the Financial Services Authority (FSA) regulates the banking, securities, commodities futures, and insurance industries. The FSA is an independent, nongovernmental body whose board of directors is nominally appointed by the Crown. In contrast, in the United States, banks are regulated by the Federal Reserve Board, the Comptroller of the Currency, and state bank regulators; securities firms are regulated by the SEC, state securities commissions, and the National Association of Securities Dealers; commodities futures are regulated by the Commodities Futures Trading Commission; and insurance is regulated by state insurance commissions.

The FSA’s self-avowed goals are to (1) maintain confidence in the British financial system, (2) promote public understanding of that system, (3) secure the right degree of protection for customers, and (4) help reduce financial crime. Like its American counterparts, the FSA oversees transactions, demands ethical and legal conduct from firms, and sets standards. Unlike the American system, which utilizes government funding, the FSA charges all firms it regulates annual licensing fees and thus is privately funded. This idea is to allow the FSA to act independently by removing all subjectivity, such as governmental wishes. The concentration of power in the FSA theoretically allows it to better regulate the country’s banking and trading exchanges because it does not have to coordinate with other bodies that may have diverging goals and interests.

Summary

Administrative law is defined broadly as any rule (statute or regulation) that directly or indirectly affects an administrative agency. The APA provides procedural guidelines for federal agencies; these guidelines are often copied, in whole or in part, by state and local administrative agencies.

The major functions of administrative agencies are rulemaking, adjudication, and the carrying out of numerous administrative activities. The executive, judicial, and legislative branches of government limit the power of federal agencies in numerous ways. In addition, several federal statutes limit the authority of administrative agencies.

Federal administrative agencies meet with their counterparts in other nations and enter into international agreements that aid the enforcement powers of U.S. agencies.

Assignment On The Internet

This chapter introduced administrative law and several administrative agencies. There are, however, many agencies not discussed that play a significant role in creating regulations. Use the Internet to discover three federal administrative agencies not discussed in this chapter. Explain the purpose of each agency and state at least two recent rules or regulations it has issued. The websites listed in the following section may be of use in locating the many federal administrative agencies.