978-0078023163 Chapter A Part 5

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Bonus Chapter A – Working within the Legal Environment

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PPT A-36

Chapter 7 Bankruptcy

CHAPTER 7 BANKRUPTCY

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LO A-8

• Creditors with secured claims receive their

collateral or repossess the asset.

• Unsecured claims are paid in this order:

1) Costs of the bankruptcy case

2) Any business costs after ﬁling

3) Wages, salaries, commissions

4) Contributions to employee beneﬁts

5) Refunds to consumers for products not delivered

6) Federal and state taxes

PPT A-37

How Assets Are Divided in Bankruptcy

How ASSETS are DIVIDED in

BANKRUPTCY



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LO A-8

PPT A-38

Going, Going, Gone

GOING, GOING, GONE

Big Bankruptcies of 2008-2014

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LO A-8

• Circuit City

• KB Toys

• Linens N Things

• Borders

• City of Detroit

1. This slide profiles the bankruptcies of 2008-2014.

2. Have students research the companies listed in the

slide. Why did these businesses go bankrupt instead of

their competitors?

3. Ask students: Is there a pattern of why businesses sur-

vive or go bankrupt? What mistakes do failed busi-

nesses make that others do not? What are the effects

on the consumer when businesses fail? What are the

effects on the economy as a whole?

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PPT A-39

Deregulating Commerce

• Deregulation — The government withdraws certain

laws and regulations that seem to hinder competition.

DEREGULATING COMMERCE

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LO A-9

• Deregulation efforts

were active in:

– The airline industry

– Telecommunication

– Some public utilities

Today some believe the airline industry could use more

government regulation since passenger services have de-

creased, delays and flight cancellations have increased, and

charges such as bag fees have become common.

PPT A-40

Hamburger Regulations

HAMBURGER REGULATIONS

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LO A-9

PPT A-41

Test Prep

TEST PREP

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• What is the primary purpose of antitrust law?

• Describe the different bankruptcy provisions

under Chapters 7, 11, and 13.

• What is deregulation? Give examples of

successful and unsuccessful deregulation.

1. The purpose of antitrust law is to foster competition in

the free market.

2. Describe bankruptcy provisions under Chapters 7, 11,

and 13.

• Chapter 7— liquidation of nonexempt assets

used by business and individuals.

• Chapter 11—reorganizations of firms assets

used by businesses

• Chapter 13—allows small businesses and indi-

viduals to pay back creditors over a three- to

five-year time period

3. Deregulation occurs when the government withdraws

certain laws and regulations that seem to hinder com-

petition. Examples of deregulation include telecom-

munications and the airline industry. Deregulation of

the banking and investment industries has not been

successful.

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lecture

enhancers

“Take calculated risks. That is quite different from being rash.”

George S. Patton

“The minute you read something that you can’t understand, you can almost be

sure it was drawn up by a lawyer.”

Will Rogers

“To win without risk is to triumph without glory.”

Pierre Corneille

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DOING BUSINESS WITH A PROACTIVE LEGAL STRATEGY

The sheer size of today’s corporations virtually ensures that companies will have to wrangle with

lots of legal red tape. Most top executives spend as little time as possible dealing with law, choosing ei-

ther to avoid it or grudgingly comply with the restrictions they face. In the former case, a company may

try to move some operations into another country to dodge certain taxes, while in the latter executives

simply do the bare minimum necessary to make it through the legal grind. While those that try to avoid

the law can face potentially dire consequences, companies who take the compliance route at least cover

all their bases.

According to a team of MIT researchers, however, corporations can gain some big advantages

over their competition with a proactive, engaged legal strategy. For instance, years ago many of the Walt

Disney Company’s character trademarks were set to expire. Rather than lose some of the most lucrative

properties in entertainment to the public domain, Disney devised a legal strategy that ensured its trade-

marks would remain in place indefinitely. Besides protecting its existing cast of characters, the plan also

gave Disney the ability to expand their licensing and merchandising efforts. As a result, the house that

Mickey built became even sturdier.

Taking advantage of the legal environment is easier for companies who have lawyers in leader-

ship positions. One study found that corporations with an attorney on their board of directors saw greater

returns and higher stock market valuations than those without one. In fact, 43 percent of U.S. companies

had a lawyer-director in 2009, up from 24 percent in 2000. Nevertheless, many executives continue to

view the law as a nuisance that hinders business rather than helps it. Oftentimes, though, corporations

face difficulties because their lawyers are ordered to react to legal issues, not pursue them. With a more

proactive strategy in place, there’s a good chance these companies could face their legal troubles head on

before they morph into much bigger problems.i

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lecture enhancer A-2

THE DIFFERENCES BETWEEN PATENTS, COPYRIGHTS,

AND TRADEMARKS

Patent is the abbreviated term for letters patent. The Constitution gives Congress the power to

enact laws relative to patents in Article I, section 8. The first Patent Law was enacted in 1790. The most

recent revision was the American Inventors Protection Act of 1999. Patents are issued by the United

States Patent and Trademark Office (USPTO) of the U.S. Department of Commerce. Generally, the term

of a patent is 20 years from the date on which the patent was filed.

A patent is a grant of a property right to the inventor of a device, process, or composition of mat-

ter. Specifically, the right conferred by a patent grant is “the right to exclude others from making, using,

offering for sale, or selling” the invention in the United States. Once a patent is issued, the patentee is re-

sponsible for enforcing the patent, without the aid of the USPTO. The terms patent pending and patent

applied for are used to inform the public that an application for a patent is on file with the USPTO.

In the words of the statute, any person who “invents or discovers any new and useful process,

machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain

a patent.” Utility patents are granted for new processes, machines, or articles of manufacture. Design pa-

tents are granted for new, original, and ornamental designs for an article of manufacture; a new design for

a telephone might be an example. Plant patents are granted for new and distinct, asexually reproduced

plants; examples would include corn hybrids.

A trademark is a word, name, symbol, or device that is used in trade with goods to identify the

source of the goods and to distinguish them from others. A service mark is the same as a trademark but it

identifies the source of a service rather than a product. A real estate agency or a financial consultant might

use a service mark.

Trademarks may be used to prevent others from using a confusingly similar mark but not to pre-

vent others from manufacturing the same product or providing similar services. Names of types of prod-

ucts or devices, such as television or radio, cannot be trademarks; but some product names, intended by

their manufacturers to be trademarks, have lost their legal status as trademarks by virtue of their use by

customers to identify products rather than a specific brand. Some examples are the terms aspirin, cello-

phane, and escalator. While many people still accept Pepsi or RC, when they say “I’d like a coke”

“Coke” is still a registered trademark.

While registering a trademark with the USPTO gives the holder some advantages, registration is

not necessary to establish legal rights. In fact, the symbols TM or SM may be used with a person’s mark

to inform the public of his or her claims. However, the “R in a circle” mark can be used only after the

USPTO actually registers it. Also, a mark cannot be registered unless it had been used “in commerce” or

unless the applicant files an “intent to use” application.

“original works of authorship,” including literary, dramatic, musical, artistic, and certain other intellectual

works. Copyright gives the owner exclusive rights to do and to authorize others to do the following:

Reproduce the work or phonorecord

Prepare derivative works

Distribute copies by sale or rent

Perform the work publicly or, in the case of records, to play the work publicly

Display the work

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tated (as in music or choreography), or saved to a computer disk. Works created after 1978 are protected

by copyright during the author’s lifetime plus 70 years. For works whose rights are owned by a corpora-

tion, the duration of copyright is 95 years from publication or 120 years from creation, whichever is

shorter.

copy or phonorecord for the first time. If a work is prepared over a period of time, the portion that is fixed

on a particular date is protected from that date. Under the 1976 Copyright Act, publication is no longer

the key to obtaining copyright protection.

For works created after March 1, 1989, notice of copyright is not required, but it is beneficial.

Notice of copyright is made by using the word copyright, the abbreviation copyr, or the symbol of a “c in

a circle” (a “p in a circle” for recordings) with the year of publication and the name of the owner of the

Copyrights are registered by the Copyright Office of the Library of Congress.

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NORTEL’S PATENT AUCTION

In early 2009, the telecommunications company Nortel Networks filed for Chapter 11 bankruptcy

in Delaware, Canada, and Europe. In order to cover some of the costs of its financial downfall, the com-

pany hired a small law firm specializing in intellectual property to help sell its cache of patents. While a

patent auction may not carry the same glitz as priceless paintings or jewelry on the block, their value far

exceeds that of any standard trinket sell-off. Analysts estimate the patent portfolio will sell for no less

than several billion dollars.

Whoever ends up in possession of the patents will hold a powerful position in the wireless world.

First of all, the patents could provide integral assistance for some companies wanting to expand their tele-

communications presence. More than that, though, the patents could prove to be a fierce legal weapon in

the highly litigious wireless industry. This point has regulators at the U.S. Justice Department worried

that tech giants like Apple or Google could use the patents to stifle competition by extracting huge licens-

ing fees from rivals.

In the R&D–obsessed world of tech, patents have become something of a prized possession. En-

tire companies exist these days solely to purchase patents. Meanwhile, a whole industry of brokers, law-

yers, and engineers has developed just to figure out exactly how much these things are worth. After all, a

patent is little more than “an exclusive right to develop an invention for a certain period of time.” The

U.S. Patent Office doesn’t attach a price tag to it following approval. In the case of the Nortel cache,

Google’s opening offer of $900 million will provide the starting point for bidding. Originally scheduled

for June 20, 2011, a “significant level of interest” in the auction necessitated a one-week delay. The bid-

ding commenced behind the closed doors of an unnamed New York law firm on June 27, 2011, although

the matter is expected to continue for some time after that.ii

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LED ZEPPELIN’S STAIRWAY TO CONTROVERSY

Led Zeppelin’s 1971 epic “Stairway to Heaven” is widely regarded by music critics as one of the

greatest rock songs of all time. It’s also been one of the most profitable. Clocking in at nearly eight

minutes long, the band refused to release the song as a single, which forced fans to shell out more cash to

buy the album it appeared on. When coupled with the song’s substantial royalties from radio play, “Stair-

way to Heaven” has earned at least $562 million over the years. Much of that fortune has been paid to the

song’s credited composers, Led Zeppelin guitarist Jimmy Page and lead singer Robert Plant.

But a new lawsuit filed 43 years after the song’s release could see a third name tacked onto its

songwriter list. In 1968 the psychedelic rock band Spirit released an album that contained a brief instru-

mental track entitled “Taurus.” The song is a dreamy collection of several different melodies, including a

short acoustic guitar riff that sounds an awful lot like the iconic opening notes to “Stairway to Heaven.”

The composer of “Taurus,” Spirit guitarist Randy California, never approached Led Zeppelin about the

two songs’ similarities. However, plenty of other artists have taken legal action against the band for the

appropriation or outright theft of their music. Led Zeppelin classics like “Dazed and Confused” and

“Whole Lotta Love” have been subject to lawsuits, and in both cases the band had to give royalty rights

and songwriting credits to the plaintiffs.

Now “Stairway to Heaven” will get its day in court as well. Although Randy California died in

1997, a trust formed on his behalf by Spirit bassist Mark Andes sued Led Zeppelin in May 2014 for rights

and royalties to the classic song. Andes points to an early tour his band took with Led Zeppelin as evi-

dence that they were aware of “Taurus.” Led Zeppelin’s history of stealing other artists’ compositions

doesn’t do their defense any favors, either. If the lawsuit is successful, Andes’ trust stands to make a

windfall settlement. Led Zeppelin recently re-released their entire catalogue, potentially adding millions

of dollars to the band’s already enormous fortune.iii

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PIRACY MAY KO UFC

For years, sports leagues have been free of the piracy that has plagued music and movies. Fans

typically like to watch games as they happen, making piracy of a baseball game less appealing to down-

loaders than a film or a song. But as online streaming technology advanced, so too have the pirates’ ef-

forts to get entertainment for free. Thousands of game feeds from the NFL to the UFC now leak onto the

Internet every day. Although company watchdogs constantly scour the Web looking for infringers, the

sheer number of sites involved makes it almost impossible to shut them all down.

Mainstream professional sports leagues earn billions of dollars from exclusive broadcast contracts

with networks and pricey stadium seats. When those games are pirated, though, their brands are under-

mined. The situation is even worse for up-and-coming organizations like the mixed martial arts league

UFC. Given the company’s reliance on $45-a-pop pay-per-view sales, illegal online streams don’t just

damage their brand, they take money directly out of the company’s pockets.

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To combat infringement, UFC, as well as the federal government, is taking streaming sites to

court. In January 2011 UFC’s parent company Zuffa sued Justin.tv, a live video streaming service. That

same month, federal investigators seized 10 domain names that broadcast pirated game feeds. Neverthe-

less, even direct litigation might not be enough to stop infringers. Zuffa’s suit against Justin.tv is much

like Viacom’s unsuccessful lawsuit against YouTube. Justin.tv’s assertion that it removed infringing vid-

eos when prompted by copyright owners is almost identical to YouTube’s winning defense. Also, despite

the government’s wide reach, the servers of many illegal streaming sites are located in other countries

with lax copyright laws and a disinclination to cooperate with American authorities.iv

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NEGOTIABLE INSTRUMENT FORGERY AND

THE UNIFORM COMMERCIAL CODE

Frank W. Abagnale was the main speaker at a seminar on document fraud. He is an unlikely ex-

pert, having spent time in French, Swedish, and U.S. prisons 30 years ago for creating and passing mil-

lions of dollars of bad checks. Interpol, Abagnale said, dubbed him a “master forger,” a badge of honor of

sorts, as Abagnale began his career when he was 16 years old and concluded it at age 21 with a stint in a

French lockup. After serving his time there, he was extradited to Sweden and finally to the United States,

doing 12 years. He was released early on the condition that he assist the U.S. government in its battle

against forgers. (The film Catch Me If You Can is based on Abagnale’s career as a forger.)

Now he’s a “senior advisor” to the FBI’s Financial Crimes Unit. In that role, he assisted in de-

signing the new $100 bill. He also provides consulting services to financial institutions and companies

worldwide.

Abagnale cited a BusinessWeek study, which concluded that $12.6 billion is lost annually to

check forgery. Bank robbers may grab the headlines, but they net only about $68 million yearly, he said.

That’s $50 for every man, woman, and child nationwide lost to check fraud compared to 27 cents per

American taken at gunpoint. Embarrassed companies do not report many frauds, so the $12.6 billion fig-

ure is conservative, Abagnale said.

Lack of publicity about the problem has helped put the document fraud industry where it is today,

Abagnale said. Politicians, prosecutors, and judges don’t concentrate on stopping fraud. Consequently,

punishments are lower for forgery, assuming someone is arrested, which is rare. “Nobody ever ran for

office promising ‘I’ll clear the streets of check writers if you elect me,’” he said.

Advances in modern technology also have made the forger’s job easier. When Abagnale was

practicing his former trade, a four-color printer was the size of a large room and cost $250,000. Now, he

said, $5,000 worth of computer equipment provides a superior and portable alternative.

Disputes over who is liable for bad checks often end up in court. These matters are governed by

the Uniform Commercial Code, or UCC, a set of model statutes designed by legal experts to be used by

all states in order to provide a level playing field for commerce. It is not an all-encompassing federal law,

but rather a guideline for laws to be adopted by the states individually.

States can adopt a provision of the UCC or not. For example, the portion of the UCC concerning

liability in document frauds was amended in 1990. Connecticut adopted the amendment in 1991, but New

York State has not yet done so.

What can a company do to make itself less vulnerable? One powerful weapon is known as “posi-

tive pay.” A customer keeps an electronic list of all checks written and downloads it into the bank’s com-

puter at the end of the day. If a check shows up that is not on the list, it is flagged as a forgery, and the

bank doesn’t honor it. Most banks have positive pay programs, said Abagnale.

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An alternative for smaller businesses that may lack the sophisticated computer software necessary

to create a daily list is “reverse positive pay.” In this case, a bank sends a list to the business owner of

checks drawn upon the company’s account each day. The owner then compares his or her records with the

bank’s list and notifies the bank if there are any discrepancies.

Companies should stay up to date in reconciling bank statements since the UCC allows only 30

days to report a fraudulent instrument.

Banking procedures are not the only defense. Corporate officers who proudly affix their John

Hancocks to annual reports or Security and Exchange Commission filings are a forger’s delight. For a

signature that will pass muster, the forger can just scan it off the report. Abagnale recommends that the

lawyers who draft these reports sign them as opposed to officers whose signatures may appear on checks.

Checks turned out by high-speed laser printers allow forgers to lift the toner off the check with

tools as sophisticated as scotch tape and substitute dollar numbers—usually with several extra zeros.

Abagnale said that “toner anchorage,” a chemical injected into the paper, causes the toner and the paper to

fuse, preventing the writing from being lifted and changed. Also, chemicals can be added to checks so

they change color upon being exposed to materials, such as bleach, which are used to erase the original

writing.

The dollar amounts printed on checks should be in a unique font, or type style. Additionally, the

numbers themselves should have writing incorporated into them. This prevents adding, say, three zeroes

to a $20 check and turning it into $20,000.

Because blank check paper is readily available through mail-order vendors, prudent companies

should arrange with their printer for a unique type of paper with security features built in. One such fea-

ture involves microprinting, used in the new $100 bill. Those lines along Ben Franklin’s collar actually

say something when held under a magnifying glass. Scanners and copiers are not sufficiently sensitive, so

they can’t reproduce the microprinting. The signature line of the check is a good place to use microprint-

ing.

What scanners and copiers will catch is a “void pantograph.” Scanners reproduce patterns of large

dots before they reproduce patterns of small ones. A series of large dots spelling out the word “void”

should be hidden in a secure check. This pattern may not be visible to the naked eye, but should the doc-

ument be scanned or copied, up pops “void,” thereby ruining the forger’s work.

Warning labels should indicate other security features, such as watermarks, and state clearly that

if the check does not have a watermark, “do not cash,” Abagnale said.

Generally, the more difficult a company makes forgery, the less likely it is to be a victim. Forg-

ers, Abagnale said, look for easy targets, of which there are too many. “We make it so easy for people to

steal from us, that people do. People steal from us because we let them,” Abagnale said.

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TAX DODGING CORPORATIONS COST THE US BILLIONS

For decades big companies have done their best to avoid hefty corporate tax rates levied by Uncle

Sam. The U.S. government collects 35 percent of a domestically based corporation’s income, a figure

based on the entirety of the company’s worldwide revenue. This mighty bite from the bottom line leads

many firms to reincorporate their companies in places like the Cayman Islands or Ireland, where the cor-

porate tax rate is just 12.5 percent. While this process of “inversion” is entirely legal, so many companies

are doing it these days that the U.S. could face a major income shortage in coming years.

In fact, some businesses are now forgoing incorporation in America altogether. For instance, the

tech firm Seagate went private in a 2000 buyout and then moved to the Cayman Islands. From there it

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incorporated in Dublin ten years later, even though its headquarters and principal offices are all in Cali-

fornia. Companies like these can dodge American taxes without fear of reprisal because they were never

technically based here in the first place. So far 60 U.S. companies have either inverted or chosen this

“never–here” course of action, and experts predict that more will follow their lead.

This creates an environment where businesses can benefit from public services that they don’t

pay for. Carnival Cruise Lines, for example, is headquartered in Miami but incorporated in tax friendly

Panama. As a result, Carnival doesn’t pay its fair share to the U.S. Coast Guard, an organization that

helped rescue the company’s burning vessel Triumph last year. Although the cruise line eventually reim-

bursed the Coast Guard for its assistance, the government could never hope to recoup the billions it loses

each year due to similar loopholes. As it stands now, legislators have two clear options for stemming this

tax exodus: draft a law making inversion more difficult or reform the tax code altogether. Many business

leaders argue that U.S. tax laws are uncompetitive, while opponents feel that corporations should simply

be restricted to paying their fair share.v

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GOOGLE’S TAX TACTICS

Tax havens have long been used by multinationals to skirt the stringent corporate tax laws of their

home countries. But for many in and outside the business world, the abundance of tax havens by no

means justifies the revenue they deprive deserving states. Unfortunately, not only is tax sheltering com-

mon, in most cases it is legal. Google, for instance, earned $12.5 billion overseas since 2007, only 2.4%

of which was taxed. Google’s clever, entirely legal money funneling saved the company $3.1 billion and

boosted 2009’s earnings by 26%.

The system starts in Dublin at Google’s international headquarters. All the money from ad sales

outside the United States finds its way to Google Ireland, where corporate profits are taxed at 12.5%. The

company’s ultimate goal is to send its earnings to Bermuda, where there’s no corporate income tax at all.

But sending the money directly to the Caribbean would incur a large fee according to Irish law. To cir-

cumvent this, the money is sent to Google Netherlands Holdings, a shell company with no employees.

Ireland doesn’t tax payments to companies in other European Union states, ensuring that Google’s money

can take advantage of the Netherlands’ lax tax laws. From there, 99.8% of the money that hits Holland’s

shores goes off to Bermuda.

Google also eliminates a portion of its domestic taxes by licensing its search and advertising

technology through Google Ireland, even though most of the development is performed in the United

States. In total, tax avoidance from corporations costs the U.S. government as much as $60 billion annual-

ly. And though Google is certainly not alone in its tax control techniques, no other tech company has

managed to manipulate its overseas tax rate quite as low as the search giant. From a legal standpoint, the

company has done no wrong, but some believe Google has violated its famous “Don’t be evil” motto.

However, such a statement ignores the popular belief that businesses have an obligation to its sharehold-

ers to minimize its taxes and other costs legally. Whether ethically or unethically, Google has certainly

accomplished that task.vi

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BAD TIMING FOR BANKRUPTCY LAW CHANGES

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In October 2005, the U.S. Bankruptcy Code was changed to make it harder for individuals to file

for bankruptcy. The code sets new limits on personal bankruptcy filing and requires people to get profes-

sional credit counseling before they file petitions. It prohibits most middle-income filers from filing

Chapter 7 petitions, which would allow debts to be erased. Instead, if people judged to have at least $100

a month left over after paying certain debts, they must submit a five-year repayment plan under the more

restrictive rules. During the months leading up to the October transition, bankruptcy petitions hit a record

high.

For residents of the south-central Gulf Coast, the timing could not have been any worse. Hurri-

cane Katrina had swept through the area just five weeks before, causing over $80 billion in destruction.

These figures represent lives changed forever. Not only were homes destroyed, but also jobs, re-

lationships, religious communities, and dreams. For many the cost impact was doubled—when a home

was lost to wind damage, insurers were required to pay the amount of the homeowner’s policy. However,

when any part of the damage was due to water, insurers generally refused to cover most loses. After the

storm, homeowners found that although their homes and businesses were damaged beyond repair with no

insurance reimbursement, mortgage holders still expected to be paid. For many families and small busi-

nesses, the storm’s devastation was not to be fully felt for weeks or months—until they faced the crip-

pling financial consequences of lost property, lost wages, and lost jobs. They may have lost the house and

the car, but the obligation to pay for them didn’t expire.

Most people who file for bankruptcy do so only when a major life disruption occurs. Almost 80%

of bankruptcy filings occur due to death of a spouse, huge medical expenses, breakup of a family, job

loss, or natural disaster.

A study of bankruptcy filing shows that following the biggest hurricanes of the past 30 years

bankruptcy filings were about 50% higher in states that suffered a direct hit. When storms hit areas with

less expensive buildings (rather than expensive beachfront condos), the increase in bankruptcy rates goes

even higher. The highest increase in bankruptcy filings occurred when Hurricane Elena hit Mississippi in

1985.

Once the new bankruptcy bill went into effect, everyone—regardless of income and regardless of

the reason for filling—was required to file extensive new paperwork and meet the new procedural re-

quirements. The new rules demand more payments for car lenders and credit card issuers. Many workers

discovered that the bankruptcy court may believe they have phantom income for repayment—money

from jobs they held before the storm. The court may presume they still have income even when those jobs

are gone.

What happens to small businesses is even worse. They new Chapter 11 provisions target smaller

businesses for special treatment. Unlike major corporations, small businesses face a shutdown if they

cannot confirm a plan of reorganization within 300 days. Under the new law, small businesses—and only

small businesses—will be required to submit a stack of new forms for more extensive examination by

bankruptcy judges. Just when the Gulf Coast region needs its entrepreneurs most, fewer of them will get

the chance to recover from the devastation and start their businesses again.

The Justice Department has acknowledged the problems but has not changed the rules or guaran-

teed expedited treatment. When the stunned and exhausted victims of Hurricane Katrina finally arrive in

bankruptcy courts, they will find that the bankruptcy laws now offer less relief than before the storms

struck.vii

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endnotes